State entity annual spending plans, or budgets, begin with agencies, departments, boards and commissions submitting Supplementary Schedule of Appropriations (Schedule 10) and Supplementary Schedule of Revenues and Transfers (Schedule 10R) to the Department of Finance (DOF). These schedules include actual revenues and expenditures for the most recent completed fiscal year (past year), revenues and expenditures estimates for the current year (current year) and proposed revenues and expenditures for the upcoming budget year (budget year).

DOF budget analysts review the data and compile the information into the past, current and budget year format as presented in the annual Governor’s Budget. As the budget data are compiled and reviewed, the Governor, through DOF, modifies the budget to reflect his policy emphasis.

Budget year proposed amounts are based on the current year’s budget, with changes to the base budget made through Budget Change Proposals (BCP). BCPs are developed by department staff and are submitted to the department directors for approval. Directors may approve, deny, or modify BCPs before forwarding them to the agency secretary, if applicable, for approval. BCPs are further reviewed by the agency secretary who may modify, approve, or deny them. BCPs approved by the director and agency secretary are submitted to DOF for review.

After receiving and reviewing BCPs, DOF may question the department about its budget changes, their effects on programs and their fiscal impacts. Approved BCPs are incorporated into the Governor’s Budget as modifications to the department’s budget. The Governor’s Budget proposal is submitted to the Legislature by January 10th each year.

In addition to BCPs, DOF, acting as the Governor’s chief fiscal advisor, analyzes all legislation and any other proposals that may affect the state’s fiscal condition and policies.

The Legislative Analyst Office (LAO) reviews the Governor’s Budget proposal and submits its analysis to the Legislature. LAO’s analysis provides further scrutiny and commentary on the Governor’s spending plan and assumptions.

From January through May, DOF continues its analysis and refines the budget by collecting updated information and honing projected revenues and expenditures. Each year, by May 14, Revision. The May Revision includes updated General Fund revenue estimates, changes in Proposition 98 (school) funding, and caseload, enrollment and population adjustments.

Each House of the Legislature scrutinizes and deliberates the spending plan in budget subcommittees. The Legislature holds budget hearings, and questions department and DOF representatives about the proposed budgets. LAO representatives also provide input and commentary during these hearings. Program stakeholders may also participate in the hearings and voice their views on various state policies and programs.

Each House of the Legislature modifies the Budget to reflect their program and policy emphasis. Each House then approves its version of the Budget, and the two versions are moved to a Conference Committee to resolve the discrepancies. After both Houses approve the Budget with a two-thirds vote, the Budget Bill is moved to the Governor for signature. Prior to signing the bill, the Governor can veto items he does not want included in the final spending plan.

Once the Governor signs the Budget Act, the State Controller’s Office (SCO) and each department inputs the authorized spending plan into their accounting systems and begins posting expenditures in accordance with the Budget Act.

The budgetary deliberative process provides significant opportunities for discussion of program effectiveness and necessity.

Note that throughout our analysis, percentages reported are based on the actual amounts from identified source material.

State fiscal activity is accounted for in sets of separate self-balancing accounts called funds. The General Fund is principal among them, and is significant because it accounts for the traditional state revenue sources, e.g., personal income tax, and is the primary funding source for most state expenditures. Approximately three-fourths of the state’s operating expenditures are funded by the General Fund; therefore, the state’s fiscal condition and ability to provide services relies heavily on the condition of the General Fund.

The state also maintains non-governmental cost funds, which include bond funds, trust and federal funds, public service enterprise funds, working capital and revolving funds, and retirement funds. These funds derive their revenue from sources other than general and special taxes, licenses, fees and other state revenues.

The SCO, Fiscal Year (FY) 2002–2003 Budgetary/Legal Basis Annual Report discloses the General Fund ended the year with a fund balance of (negative) –$7.5 billion; however, all the other Governmental Cost Funds maintained a positive ending balance. Given the General Fund’s condition and its affect on the state’s fiscal condition, we focused our analysis on the General Fund.

The General Fund ending fund balance decreased a total of $11.4 billion from $3.9 billion at June 30, 1999 to (negative) –$7.5 billion at June 30, 2003 as a result of operating deficits in FYs 2000–2001 through 2002–2003. Exhibit 1 summarizes General Fund activity and condition for the past five fiscal years.

As illustrated, revenues exceeded expenditures in FYs 1998–1999 and 1999–2000, resulting in the ending fund balance increasing to $9.6 billion. Revenue and expenditures were relatively equal in FY 2000–2001; expenditures exceeded revenues by $517.5 million. The $517.5 million operating deficit was funded with prior year fund balance.

After positive aggregate operations in FYs 1998–1999, 1999–2000 and 2000–2001, the state incurred an operating deficit of $12.5 billion in FY 2001–2002. The deficit was primarily funded by the $9 billion beginning fund balance and $2.1 billion in transfers from other funds; however, these sources were insufficient to overcome the operating deficit. As a result, the General Fund ending balance at June 30, 2002, was (negative) –$2.1 billion. After exhausting internal borrowing resources, SCO issued $5.7 billion in Revenue Anticipation Notes (RAN) maturing in June 2002, in order to meet the state’s cash needs. In June 2002, SCO issued $7.5 billion in Revenue Anticipation Warrants (RAW) in order to meet the state’s cash needs in early FY 2002–2003. Although the state was able to meet expenses with short-term borrowing, the $2.1 billion funding deficit remained and was carried forward into FY 2002–2003.

Revenues increased from $64.1 billion to $66.1 billion from FYs 2001–2002 to 2002–2003, but were not sufficient to fund expenditures, which increased from $76.6 billion to $77.6 billion in the same period. As a result, the state incurred another operating deficit totaling $11.5 billion. This deficit would have been approximately $2 billion greater if not for the deferral of Education funding into FY 2003–2004.

As a result of FY 2001–2002 deficit carry forward and the FY 2002–2003 operating deficit, the General Fund closed the year with a fund balance of (negative) –$7.5 billion. Similar to FY 2001–2002, SCO issued $12.5 billion in RAN maturing in June 2003 and issued $11 billion in RAW in order to retire the $12.5 billion in RAN and to meet fiscal obligations in early FY 2003–2004.

While the state was able to meet its immediate cash needs using RAN and RAW, the state planned on issuing long-term bonds in order to fund the operating deficit. Specifically, the state proposed issuing $9.2 billion in Fiscal Recovery Bonds in FY 2002–2003. However, legal challenges stopped the bond issuances on the basis they violated the State Constitution, which limits the state from incurring debt beyond $300,000 without voter approval. As a result, the state’s cumulative operating deficit of $7.5 billion was carried forward to FY 2003–2004.

Although the state did not realize revenue from the proposed bonds in FY 2002–2003, it did realize $2.5 billion from Tobacco Settlement Revenue Bonds. In 1998, California and other states signed a Master Settlement Agreement with the four major tobacco companies. The agreement required the tobacco companies to make annual payments (tobacco assets) to the state in perpetuity. Chapter 414, Statutes of 2002, authorized the state to sell the tobacco assets in an amount necessary to provide the state up to $4.5 billion. In January 2003, the state deposited $2.5 billion in tobacco bond proceeds into the General Fund; moreover, Chapter 225, Statutes of 2003, increased the authorized bond issuance from $4.5 billion to $5 billion allowing the state to receive another $2.3 billion in tobacco bond proceeds in September 2003.

In March 2004, California voters approved the California Economic Recovery Bond Act (Proposition 57), which authorized the state to issue up to $15 billion in Economic Recovery Bonds (ERB). The state issued $12.2 billion in ERB in FY 2003–2004 to fund the cumulative operating debt, as well as other obligations; moreover, the state may issue the remaining $2.8 billion in future years as needed. The ERBs will be repaid by shifting 0.25 percent of the base sales tax designated for local government general purpose use to the state’s Fiscal Recovery Fund and ultimately fund ERB debt service.

The large transfers in FY 2000–2001 primarily represent a $6.2 billion transfer from the General Fund to the Department of Water Resources Electric Power Fund as a result of the 2000 through 2001 energy crisis. Specifically, Chapter 4, Statutes of 2001, authorized the Department of Water Resources (DWR) to enter into contracts and purchase electric power. Furthermore, Chapter 9, Statutes of 2001, authorized DWR to issue bonds up to $13.4 billion in fulfilling its charge and to repay the General Fund loan. Although SCO accrued the loan repayment in 2000–2001, DWR issued bonds totaling $11.7 billion in October 2002, at which time the General Fund was repaid with interest. Although the delay in repaying the General Fund affected the state’s cash management, the loan did not cause the state’s FYs 2001–2002 and 2002–2003 operating deficits and resulting cumulative debt.

General Fund revenues are composed of two broad categories: major and minor revenue. Major revenue primarily consists of personal income tax, sales tax and corporation tax. Minor revenue consists of other lesser taxes, fees, licenses and other revenue sources. These revenues comprise the state’s primary source to fund state expenditures.

As illustrated in Exhibit 2, revenue spiked in FYs 1999–2000 and 2000–2001; however, revenues returned to a more sustainable level in FY 2001–2002.

  

Although all revenue components increased, the most significant growth occurred in personal income tax revenue. The revenue growth is primarily due to increased tax revenues from stock market driven sources such as capital gains, stock options and dividends. However, once the market driven revenue sources diminished, personal income tax revenue returned to more typical levels. Although personal income tax fluctuated significantly, the other revenue components reflect less dramatic variation and affect on the overall revenue windfall in FYs 1999–2000 and 2000–2001.

As illustrated in Exhibit 3, total operating revenue grew $7.1 billion (12.1 percent), for the five-year period from FY 1998–1999 through FY 2002–2003. Personal income tax revenue grew 5.9 percent; however, retail sales and use tax reflects the largest sustained dollar growth, $3.5 billion.

Although most revenue components increased, estate tax revenue decreased resulting in a decrease in Other Major Revenue. The decrease occurred because the state estate tax is linked to the federal estate tax. In 2002, the federal Economic Growth and Tax Reconciliation Act of 2001 (Act) began phasing out the federal estate tax. As a result, state estate tax revenue has begun to decline and will be eliminated in 2005. However, when the Act expires in 2010, the federal and state estate tax could be reinstated.

Overall, minor revenue grew by $445.6 million (60.5 percent). While various components of minor revenue fluctuated, the increase was largely driven by tobacco settlement proceeds. Specifically, the state deposited $515 million, $380 million and $76 million into the General Fund in FYs 1999–2000, 2000–2001 and 2001–2002, respectively. As previously discussed, the state sold its rights to the settlement payments and received $4.5 billion in bond proceeds.

Beginning in FY 2000–2001, the state received approximately $300 million annually in association with child support collections. To receive public assistance in the CalWorks, Foster Care or Medi-Cal programs, custodial parties must trade their right to collect child support payments in exchange for services provided. Child support monies collected from the noncustodial parent(s) are collected by the counties and remitted to the state’s General Fund.

Each year, the Governor’s Budget includes General Fund revenue estimates based on economic forecast data developed in late November of the prior year. Then, the following May, these revenue estimates are updated and included in the May Revision. The May revenue estimates include updated economic forecast information, including personal income tax revenues collected and estimated first payments due as of April 15th, and form the basis for the General Fund spending plan.

As illustrated in Exhibit 4, the difference between estimated and actual General Fund revenues fluctuated between an $8.8 billion underestimate in 1999–2000 to a $10 billion overestimate in FY 2001–2002. Moreover, the $10 billion overestimate in FY 2001–2002 was followed by an additional $6 billion overestimate in FY 2002–2003, resulting in a $16 billion overestimate for the two-year period. The wide estimate swings point to the difficulties posed by single-year budgets.

The difference between estimated and actual General Fund revenue is primarily due to the difficulty in estimating personal income tax (PIT) revenues, which account for almost half of all General Fund revenues. The extreme rise and fall of stock market driven revenue sources in the late 1990s and early 2000s made estimating PIT revenues extremely difficult. As illustrated in Exhibit 5, PIT revenues were underestimated by $6.7 billion in FY 1999–2000, and overestimated by $9.1 billion and $4.9 billion in FYs 2001–2002 and 2002–2003, respectively.

Further compounding the overstated revenue estimates in FYs 2001–2002 and 2002–2003, is the state’s pattern of enacting spending plans that exceed the revenue estimates. As illustrated in Exhibit 6, estimated budget expenditures exceeded estimated revenues every year for the period FYs 1998–1999 through 2002–2003, resulting in a total estimated deficit of $15.4 billion.

Most of the anticipated funding gaps for FYs 1998–1999 through 2001–2002 were to be funded by accumulated savings, or fund balance. The only budget that did not rely on using fund balance was in FY 2002–2003, which identified one-time revenue of $4.5 billion from the Tobacco Settlement Revenue Bonds. However, as noted, only $2.5 billion was realized in FY 2002–2003.

When estimated revenues fell $16 billion short of actual revenues in FYs 2001–2002 and 2002–2003, the state enacted mid-year spending reductions. Exhibit 7 illustrates various mid-year solutions enacted, resulting in $3.2 billion and $3.3 billion savings in FYs 2001–2002 and 2002–2003, respectively. We combined source information from DOF in the exhibit. Approximately half of the $3.2 billion in FY 2001–2002 mid-year savings resulted from loans, fund shifts, federal funding increases, accelerations/transfers, fund sweeps and other actions. For FY 2002–2003, the Administration requested mid-year savings of $5.6 billion, but achieved $3.3 billion, including reversions, cuts and funding redirections, and relying heavily on savings generated in education funding. Education solutions in FY 2002–2003 included $1.3 billion in deferrals, $0.7 billion in fund shifts and reversions, $0.4 billion in K–12 reductions and $0.2 billion in community college reductions.

Although the mid-year reductions were made, they failed to match the revenue declines. As a result, the state incurred operating deficits of $12.5 billion and $11.5 billion in FYs 2001–2002 and 2002–2003, respectively, as discussed in the General Fund Fiscal Activity Summary above.

For the five-year period FYs 1993–1994 through 1997–1998, General Fund expenditures grew from $38.9 billion to $53.1 billion (36.6 percent). Similarly, for the period FYs 1998–1999 through 2002–2003, General Fund expenditures increased from $57.3 billion to $77.6 billion (35.4 percent). For a detailed listing of department expenditure changes, see Appendix II. However, unlike the balanced expenditure and revenue growth from FYs 1993–1994 to 1997–1998, revenue growth did not match expenditure growth in FYs 1998–1999 through 2002–2003, which resulted in the operating deficits in FYs 2001–2002 and 2002–2003.

As Exhibit 8 illustrates, State Operations expenditures increased $3.5 billion, while Local Assistance grew $16.9 billion from $42.3 billion to $59.2 billion. State Operations are expenditures that support State government activities, excluding capital outlay projects. Local Assistance generally supports local government activities; however, it may also encompass support for local non-profit activities, such as the regional centers that fund and coordinate services for the developmentally disabled.

Although expenditures increased by a net $20.3 billion, 98 departments and activities reported expenditure increases totaling $21.8 billion, and 53 departments and activities reported expenditure decreases totaling $1.5 billion. Significant reductions occurred in the Trade and Commerce Agency, Office of Emergency Services and the California Arts Council. Other departments’ lower reported General Fund expenditures often resulted from shifts to other funding sources. Therefore, while their General Fund expenditures decreased, their total expenditures may have remained the same or even increased.

Given that the greatest expenditure growth occurred in Local Assistance, not surprisingly, the greatest departmental expenditure growth occurred in departments that provide significant funding to local governments, local not-for-profits, etc. Specifically, we observed that $15.2 billion of the total $20.3 billion General Fund growth occurred in six budget areas, five of which provide significant Local Assistance. Exhibit 9, based on SCO Budgetary/Legal Basis Annual Report, shows these entities. Note that this SCO report summarizes expenditures by department, not by program.

In order to get programmatic expenditure detail and “drill down” into these growth areas, we first reviewed the Governor’s Budget department detail. We noticed that department expenditures reported in the Governor’s Budget (past year actual) did not agree with department expenditures as reported by SCO. Exhibit 10 illustrates the top six growth areas according to the Governor’s Budget.

Expenditures reported in the Governor’s Budget Summary are based on Schedule 10s submitted by the departments (discussed in the Budget Process Overview above). Expenditures reported by SCO are based on department expenditures processed by SCO and accrual information from the Departments’ financial statements. Although the top six growth areas remain the same (except the rank order of the Departments of Corrections and Developmental Services), the total difference between the two sources for the “top six” is $193.4 million as illustrated in Exhibit 11.

The variances are generally timing differences in reporting and differences in how expenditures are treated between a budget perspective and an accounting perspective. DOF annually reconciles the differences between the Governor’s Budget and SCO; both sides make corrections and adjustments. Any differences that remain are reflected in the Governor’s Budget Summary, Schedule 7, which annually reconciles the Governor’s Budget to SCO versions of the General Fund. Therefore, differences between the two presentations are annually analyzed and disclosed. The annual cumulative differences between the Governor’s Budget and SCO for the period FYs 1998–1999 through 2002–2003 are immaterial (less than 1 percent) in relation to total expenditures as illustrated in Exhibit 12.

The following is our analysis of the top six areas of General Fund growth. Since it focuses on specific program growth, we based our analysis on Governor’s Budget data. As discussed above, although there are differences between the expenditures reported by SCO and the Governor’s Budget, the top six areas remain the same regardless of source material.

The Department of Education incurred the largest General Fund expenditure growth increasing $4.5 billion from $22.3 billion in FY 1998–1999 to $26.8 billion in FY 2002–2003. The Proposition 98 guarantee funding largely controls Education’s funding and is the primary reason for the increase. Specifically, Proposition 98 Local Assistance funding increased $3.8 billion from $22 billion in FY 1998–1999 to $25.8 billion in FY 2002–2003. In addition, non-Proposition 98 Local Assistance funding increased by $648 million, from $246 million in FY 1998–1999 to $894 million in FY 2002–2003.

Tax Relief/Local Government Assistance is the second largest General Fund growth area, contributing $3.5 billion to the total $19.7 billion expenditure growth (Governor’s Budget). The tax relief funding supplements several programs ranging from senior citizen renters’ tax assistance to open space subventions. However, the Vehicle License Fee (VLF) Offset program is the largest portion of the increase representing $3.3 billion of the $3.5 billion growth. Furthermore, all Tax Relief/Local Government Assistance expenditures represent funding provided to local governments.

The Department of Health Services (DHS) represents the third highest General Fund expenditure growth area, contributing $3.2 billion to the total $19.7 billion growth (Governor’s Budget). Notably, nearly all of the increase is attributable to increased Local Assistance funding as illustrated by Exhibit 13.

The predominant growth in Local Assistance is attributable to the California Medical Assistance Program (Medi-Cal), which provides health care services to welfare recipients and other qualified low-income persons (primarily families with children and the aged, blind or disabled). Specifically, Medi-Cal represents $3.1 billion of the $3.2 billion growth in DHS.

Approximately 94 percent of local assistance Medi-Cal funding goes directly to pay for benefits; the remaining 6 percent is for administration. Expenditures for Medi-Cal benefits are shared nearly equally by the General Fund and federal funds. In addition, the state offers 34 optional services, such as outpatient drugs and adult dental care, for which the federal government also provides matching funds.

DHS administers a broad range of public health programs and Medi-Cal services through two primary programs: Public and Environmental Health; and Health Care Services. As illustrated in Exhibit 14, nearly all of DHS’ expenditure increase occurred in the Health Care Services Program. Over 97 percent of the Health Care Services Program’s expenditures are for Medi-Cal services.

Most of the increases in Medi-Cal funding can be attributed to caseload increases resulting from Medi-Cal eligibility expansion for the aged, disabled, working parents and children. Average monthly Medi-Cal eligible caseload estimates indicate that caseload grew by 1.4 million, increasing from 5 million a month in FY 1998–1999 to over 6.4 million a month in FY 2002–2003. In addition, budgeted General Fund Medi-Cal pharmacy expenditures nearly doubled in growth, increasing from slightly under $0.8 billion to slightly over $1.4 billion for this same time period.

The Department of Social Services (DSS) is the fourth highest General Fund expenditure growth area, contributing $1.8 billion to the total $19.7 billion growth (Governor’s Budget). Moreover, the increase is entirely attributable to increased Local Assistance funding as illustrated by Exhibit 15.

DSS administers three primary programs: Welfare, Social Services and Licensing and the Disability Evaluations and Other Services Program. Exhibit 16 illustrates these programs’ expenditure growth.

The Welfare Program provides temporary financial assistance to eligible California residents. The Social Services and Licensing Program monitors and oversees the development of policy, regulations and procedures for the delivery of services to clients, and the monitoring and evaluation of services delivered. As illustrated in Exhibit 17, the most significant growth occurred in five program elements in the Welfare and the Social Services and Licensing Programs, accounting for 95.8 percent of DSS’ General Fund expenditure growth.

Supplemental Security Income/State Supplementary Payment, a cash assistance program for low-income aged, blind and disabled persons, increased $762.4 million (34 percent) from FYs 1998–1999 to 2002–2003. The increase is due primarily to the provision of statutory cost-of-living adjustments (COLA). Caseload grew by only 11 percent during the same time period.

The Foster Care Program provides cash payments for out-of-home care for children who have been removed from their own families due to abuse or neglect. Foster Care General Fund expenditures increased $134.3 million (34.9 percent) from FYs 1998–1999 to 2002–2003, despite a 9 percent decline in program caseload. The growth was attributable to COLAs, rate increases for group homes and increased placements in higher-cost foster family agency and group homes.

The Adoption Assistance Program provides ongoing subsidies to encourage and promote the placement of children into adoptive homes. Program expenditures increased $120.3 million (157.8 percent) from FYs 1998–1999 to 2002–2003. The increase is largely attributable to caseload increases averaging 16.3 percent annually, and coincided with the recently concluded Adoptions Initiative, which provided additional funding for adoption workers and resulted in increased finalized adoptions.

In-Home Supportive Services (IHSS) enables individuals to remain safely in their homes as an alternative to out-of-home care under the Personal Care Services Program and the Residual Program. IHSS’ General Fund expenditures increased $561 million (105.8 percent) from FYs 1998–1999 to 2002–2003. According to DSS staff, program growth was due primarily to caseload growth, increases in authorized service hours and increases in the county wages and benefits.

Children’s Services administers the Child Welfare System. Children’s Services’ General Fund expenditures increased $160.9 million (32.4 percent) from FYs 1998–1999 to 2002–2003. DSS claims that program growth was due to caseload increases, particularly in the area of emergency response assessment, which experienced a 45 percent increase for the above-mentioned time period.

The California Department of Corrections (CDC) is the fifth highest General Fund expenditure growth area, contributing $1.2 billion to the total $19.7 billion growth (Governor’s Budget).

As illustrated in Exhibit 18, the entire $1.2 billion increase in general fund expenditures occurred for State Operations.

CDC is organized into three main programs: Institutions, Health Care Services and Community Correctional Programs. As illustrated in Exhibit 19, the Institutions ($879.8 million) and Health Care Programs ($365.9 million) account for the entire $1.2 billion increase from FYs 1998–1999 to 2002–2003.

The Institutions Program has the ultimate responsibility of safely housing inmates committed to state prison as prescribed by law. The department oversees 32 institutions, divided into 3 regions, with an inmate population of approximately 160,000. The Health Care Services Program is responsible for managing and delivering health care statewide consistent with adopted standards for quality and scope of services within a custodial environment. The Community Services Program is responsible for protecting the public and assisting approximately 115,000 parolees in their reintegration to society.

As illustrated in Exhibit 20, CDC shows increased expenditures in the following five areas comprising 85.9 percent of the growth from FYs 1998–1999 to 2002–2003.

See Appendix III, A Departmental Case Study: California Department of Corrections Increase in General Fund Expenditures from FYs 1998–1999 to 2002-2003, for a detailed analysis and discussion of the expenditure growth in these five areas.

The Department of Developmental Services (DDS) is the sixth highest growth area of General Fund expenditures, contributing $1.2 billion to the total $19.7 billion growth (Governor’s Budget).

Exhibit 21 illustrates the increases in State Operations and Local Assistance expenditures for the period from FYs 1998–1999 through 2002–2003. As illustrated, the more significant dollar growth occurred in Local Assistance (the Regional Centers). Note that much of the growth in State Operations reflects a change in funding mechanism for the Developmental Centers and is not actual expenditure growth.

DDS is responsible for ensuring that persons with developmental disabilities receive the services and support necessary to lead more independent, productive and normal lives and to make choices and decisions about their own lives. These services are provided primarily through the Community Services and the Developmental Centers Programs.

Exhibit 22 illustrates that the largest expenditure growth occurred in the Community Services Program where expenditures grew $861.9 million (130.6 percent). The remaining expenditure growth, $306.3 million, occurred in the Developmental Centers Program. However, $214 million of this amount was not an actual increase in expenditures, but rather the result of a mechanical accounting change in the Developmental Centers Program funding. Prior to FY 2001–02, the Developmental Centers Program used General Funds only for services for non-Medi-Cal eligible residents. The remainder was funded by DHS General Fund budget and transferred to DDS through an interagency agreement and reported as a reimbursement. Beginning in FY 2001–02, the funding for Medi-Cal eligible residents was directly funded through DDS and was reported as an expenditure, which resulted in the large increase.

The Community Services Program provides community-based services to clients through 21 not-for-profit corporations known as Regional Centers. The Regional Centers’ budget includes two major expenditure categories: purchase of services (POS) and operations. POS includes transportation, day programs and residential care. Regional Center operations include eligibility determinations and client assessments, development of individual program plans for clients and service coordination (case management), as well as administrative and personnel costs.

The Developmental Centers program operates five developmental centers and two smaller facilities. The developmental centers are licensed and certified state facilities. More than 7,800 employees staff the developmental centers and provide 24-hour, direct care to approximately 3,500 center clients with developmental disabilities.

DDS’ largest expenditure growth was in the Community Services Program, reflecting increased caseloads and POS costs at the Regional Centers. Between FYs 1998–99 and 2002–03, the Regional Center caseloads grew by an average of 5 percent per year, a total increase of more than 40,000 clients. POS provided to these individuals increased more dramatically during this time period, increasing on average by 72 percent.

According to LAO, increases in caseload growth can be attributed to improved medical care and technologies (resulting in increased life expectancies for the developmentally disabled) and increased cases of autism. Between FYs 1998–99 and 2002–03, caseloads of individuals professionally diagnosed with full syndrome autism increased by 97 percent. Factors related to increased POS include more intensive and costly services associated with an aging client population, and the comparatively higher costs associated with treating autism. In addition, federal requirements for quality of care and staffing resulted in some increased spending at community care facilities.

After adjusting for the Medi-Cal funding change, the remaining Developmental Center Program expenditure growth, $106 million, is related to increases in staffing and a new treatment facility. During the four year period, 1,600 positions were added system-wide to the Developmental Centers in order to regain federal certification and federal funding. Funding increases resulted from the establishment of a Secure Treatment Facility (STF) at the Porterville Developmental Center and increased costs in serving non-Medi-Cal eligible residents residing in the STF.

The state’s fiscal control system does not allow departments to exceed their spending authority. With few exceptions (such as payroll), SCO will not process an expenditure claim unless specific spending authority and funding exist to pay the claim. Therefore, when departments anticipate current year expenditures will exceed their current year spending authority, they must request deficiency appropriations.

Departments first perform an internal review and identify measures to cut spending and postpone expenditures in order to minimize the potential deficiency. Once all internal measures are exhausted, departments submit deficiency request to DOF for the desired supplemental funding.

DOF reviews the requests and seeks additional savings, reductions and other options in order to minimize the deficiency and may approve, deny or modify the request. Once all requests have been considered, DOF proposes an annual Omnibus Bill that generally consolidates all deficiency requests. Apart from the Omnibus Bill, DOF as well as individual departments may introduce separate deficiency legislation. Deficiency bills are further reviewed, scrutinized and modified by the Legislature before supplemental funding is approved.

Exhibit 23 illustrates identified General Fund deficiency funding as a percentage of total General Fund expenditures. Although deficiencies significantly increased in FY 2002–03 as a result of Medi-Cal caseload adjustments, deficiencies have not increased significantly in relation to total expenditures. As illustrated, deficiencies are not a significant percentage of total expenditures and generally fluctuate between 0.5 and 1.7 percent of expenditures. Moreover, these percentages are consistent with those from FYs 1980–81 to 1997–98, which ranged from a low of 0.34 percent in FY 1997–1998 to a high of 1.75 percent in FY 1986–87.

Although the doubling of deficiencies from FY 2001–2002 to 2002–2003 contributed to the state’s operating deficits, deficiencies did not cause them. Moreover, deficiency funding for FYs 1998–1999 through 2002–2003 is not inconsistent with past deficiency funding percentages.

While overall percentages have remained relatively stable, four departments have had reoccurring deficiencies in recent years and account for the bulk of the deficiencies reported. As Exhibit 24 illustrates, DHS, CDC, DDS and the Department of Forestry and Fire Protection have consistently received deficiency funding.

DHS deficiency funding between FYs 1998–1999 and 2002–2003 ranged from a low of $10.5 million in FY 2000–2001 to a high of $727.2 million in FY 2002–2003. Exhibit 25 illustrates DHS’s General Fund deficiency funding as a percentage of its total General Fund expenditures. For the five-year period, 4.1 percent of DHS’s General Fund expenditures were augmented through a deficiency funding.

Medi-Cal funding represents $1.94 billion of the total $1.96 billion in deficiency funding between FYs 1998–1999 and 2002–2003. As illustrated in Exhibit 26, nearly half of the Medi-Cal program deficiencies were due to unanticipated increases in either rates or the number of eligible Medi-Cal beneficiaries. An additional $607.8 million is the result of unrealized Legislative or Administrative assumptions, and $141.9 million resulted from delayed savings. Finally, the remaining $255.8 million is due to other reasons, including lawsuits.

CDC deficiency funding between FYs 1998–1999 and 2002–2003 ranged from a low of $20.7 million in FY 1999–2000 to a high of $265.3 million in FY 2002–2003. Exhibit 27 illustrates CDC’s General Fund deficiency funding as a percentage of its total General Fund expenditures. For the five-year period, CDC’s General Fund expenditures were augmented by 3.9 percent through deficiency funding.

Exhibit 28 provides detail for the CDC deficiencies. As illustrated, structural deficits, increased population, medical costs and workers’ compensation costs represent the most significant areas.

By definition, a structural budgetary shortfall occurs when total expected expenditures exceed total appropriated resources. In other words, the department is unable to live within its budgeted appropriation. Section 27 of the annual Budget Act allows adjustments when program costs exceed budget estimates, such as an increase in the program’s caseload. Section 27 is intended to allow adjustments to spending amounts, consistent with the Legislature’s policy objectives as reflected in the annual budget. Each year, the Legislature has approved CDC’s Section 27 request to address its “structural budgetary shortfall.”

CDC receives funding based on inmate population projections. Underestimating CDC’s inmate population has contributed to budget deficits in FYs 2000–2001, 2001–2002 and 2002–2003. According to CDC, the Administration and Legislature know that reductions in inmate population are not going to materialize; yet departmental funding continues to be based on estimates of reduced inmate populations.

According to DOF, the simplistic explanation that the Administration and Legislature have not accurately budgeted population increases is not accurate. While CDC has incurred costs in excess of its budget authority, the deficiencies are related to other structural issues, such as backfilling posted positions with overtime when correctional officers are on leave, or to CDC policy changes, such as running a higher level of Administrative Segregation than was budgeted. CDC’s situation is discussed further in Appendix III.

DDS’s deficiency funding between FYs 1998–1999 and 2002–2003 ranged from a low of $16.4 million in FY 2001–2002 to a high of $88.8 million in FY 2002–2003. Exhibit 29 illustrates DDS’s General Fund deficiency augmentations as a percentage of its total General Fund expenditures. For the five-year period, 4.2 percent of DDS’s General Fund expenditures were augmented through a deficiency funding.

Most of DDS’s deficiency funding derived from the loss of federal funds. Specifically, at the Regional Centers, the loss resulted from decreases in federal reimbursements for the Home and Community Based Services Waiver and Temporary Assistance for Needy Families. At the Developmental Centers, the loss of federal funds resulted from the decertification or failure to meet recertification status at five facilities. While DDS received $88.8 million in deficiency funding in 2002–2003, of which $46.8 million was for increased POS and administration costs at the Regional Centers, DDS incurred a $52 million unallocated budget reduction at budget enactment. DDS officials stated that since the Regional Centers are required by the Lanterman Act to provide consumer services and support, the unallocated budget reduction could not be fulfilled, which contributed to DDS’s deficiency. Exhibit 30 provides a summary of DDS’s deficiencies.

CDF deficiency funding between FYs 1998–1999 and 2002–2003 ranged from a high of $95 million in FY 2001–2002 to a low of $8.4 million in FY 2002–2003. Exhibit 31 illustrates CDF’s General Fund deficiency augmentations as a percentage of its total General Fund expenditures. For the five-year period, 11.2 percent of CDF’s General Fund expenditures were augmented through deficiency funding.

Exhibit 32 provides a summary description of CDF’s deficiencies as described in the Governor’s Budget, Section 9840, Augmentation for Contingencies or Emergencies. As illustrated, the majority of CDF’s deficiencies relate to emergency fire activities.

Although state expenditures increased from FYs 1998–1999 through 2002–2003, the growth is consistent with increased appropriations, or spending authority. As previously noted, the state’s fiscal control system does not allow departments to exceed their spending authority. Exhibit 33 illustrates that total General Fund expenditures have remained within the spending authority granted by the Legislature and the Administration.

Even if we were to reduce expenditure authority by the amount of the deficiency augmentations, total expenditures would still be within budgeted amounts in three of the five years reviewed, as illustrated in Exhibit 34. FYs 1998–1999 and 1999–2000 (before the revenue collapse) are the only ones in which expenditures would have exceeded spending authority net of deficiency funding. Although we cannot assume that state spending would have remained the same without the deficiency funding augmentations, this comparison does provide a general illustration that deficiencies and deficiency funding did not significantly affect the state’s fiscal condition in FYs 2001–2002 and 2002–2003.

The table shows that the problem is more likely one of spending authority exceeding revenue (without any reserves for flexibility) rather than spending in excess of appropriations. Since departments do not control their own revenue streams, state spending must be controlled limiting spending authority and authorizing spending at appropriate levels. Note that annual expenditures in this exhibit are as reported by SCO. The same analysis using the annual expenditures reported in the Governor’s Budget Summary, Schedule 9 would similar results.

As Exhibit 35 illustrates, encumbrances are not a significant portion of state expenditures; however, they did increase by $1.1 billion from FY 1999–2000 to 2000–2001. This growth is not surprising given the overall increase in state appropriations and expenditures in FY 2000–2001. Although encumbrances more than doubled in FY 2000–2001, the state’s encumbrance balance is slowly returning to a more traditional level which hovers around 1 percent of annual expenditures.

In order to identify the departments with the most significant encumbrance growth in FY 2000–2001, we obtained reports from SCO that listed encumbrances by fiscal year and department. After identifying the departments with the greatest growth, we surveyed them in order to determine what caused the large increases. As illustrated in Appendix IV, the large increase is a result of the increased appropriations, particularly in Local Assistance and Capital Outlay projects. Capital Outlay projects frequently run multiple years, and their funding likewise carries over; therefore, the increased encumbrance balance is not unexpected.

Since the state’s encumbrance balance ballooned in FY 2000–2001, the balance has been steadily declining, but still remains high. Appendix V lists the departments with the largest balances as of June 30, 2003, and the monitoring, if any, related to the balances.

Twelve departments reported that they monitor their encumbrances internally, via periodic sharing and interpreting of CALSTARS reports between accounting/budgetary personnel and program personnel. The lone exception is the Office of Criminal Justice and Planning, which no longer exists as a separate entity; the Office of Emergency Services has assumed responsibility for its fiscal affairs.

Government Code Section 12460 requires SCO to report the state’s financial condition on Budgetary/Legal Basis (BLB) and on a Generally Accepted Accounting Principles (GAAP) basis. Specifically, Section 12460 states:

[An] annual report shall be prepared in the manner that will account for revenues and expenditures on the same basis as that of the Governor’s Budget and the Budget Act. The format of the budgetary legal report shall be prepared as closely as possible in accordance with Generally Accepted Accounting Principles.

The code section further states:

Until the Controller’s records, the Budget Act and information provided by each state department and agency based on the state’s accounting system will permit the conversion to Generally Accepted Accounting Principles, the Controller shall issue an additional report prepared strictly in accordance with Generally Accepted Accounting Principles.

Exhibit 36 illustrates the state’s FY 2002–2003 fiscal activity as reported in the Governor’s Budget Summary (GBS) and by SCO on a BLB and GAAP basis. As indicated, differences exist among the three methods resulting in significant differences in fund balance.

The primary difference between the GBS and the SCO BLB is the recognition of $9.2 billion in bond proceeds. Although the GBS accrues the bond proceeds and recognizes the bond proceeds as revenue in FY 2002–2003, SCO did not accrue or recognize the bond proceeds as revenue until the bonds were issued in FY 2003–2004.

The GBS reporting is based on a budgeting or planning perspective and, as with any plan, includes assumptions for differing fiscal scenarios. The Administration anticipated the bonds would be issued; therefore, the funding would be available and the spending plan was developed based on this anticipated revenue source. On the other hand, SCO did not record the revenue until the bonds were issued. Both are accurate given their different purposes and perspectives. Although the reported difference is significant in FY 2002–2003, the two presentations are usually consistent with each other. Moreover, GBS Schedule 7 annually reconciles the ending GBS General Fund balance to the ending SCO General Fund balance; therefore, differences between the two presentations are annually resolved and disclosed.

As also illustrated, a significant difference also exists between the SCO BLB and the SCO GAAP basis. Exhibit 37 reconciles the differences between the presentations.