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BUDGET OUTLOOK

PURPOSE

This Budget Outlook summarizes the fiscal assessment of the State, CSU System, and campus for 2005-06, which formed the context and basis of the RPP Task Force‘s planning and recommendations to the President. The Outlook attempts to be comprehensive and takes into consideration a wide range of information and activities evolving over an eight-month period. In spite of best efforts, the external factors influencing the outcome are often difficult to predict and the final allocation may differ from projections.

INTRODUCTION

The sources for this budget outlook include the Governor's Budget, the Legislative Analyst's Office, the Department of Finance, the CSU Board of Trustees, the Chancellor's Office, and enrollment and financial projections about our own campus. These sources tend to fall into four categories: the Executive Branch of State Government; the Legislative Branch of State Government; the CSU system, and the campus.

THE EXECUTIVE BRANCH OF STATE GOVERNMENT

NATIONAL AND STATE ECONOMIC FORECAST

Generally, there is significant momentum for the U.S. and California economies. For nearly three years following the 2001 downturn, the U.S. economy has expanded at a slow and moderate pace. The economic growth in 2004 was driven by a sharp acceleration in business spending and continued above-average gains in consumption. The current expansion has been characterized by intense competition and a major focus by businesses on reducing costs and finding efficiencies. Over the recent expansion period, these actions have boosted productivity gains, restrained inflation, and contributed to large increases in business profits. But, at the same time, the intensive focus on costs and efficiencies also translated into extremely slow improvement in labor market conditions, as businesses remained reluctant to add to their payrolls. Economists had become concerned that the lack of hiring would eventually undermine consumer confidence, leading to a downward spiral in spending and output in the economy. However, these concerns eased once employment slowly started to grow in 2004. Inflation accelerated in 2004, but the increase was relatively mild in view of the dramatic jump that occurred in energy and raw material prices.

Despite high energy prices and the lack of strong job growth, most recent indicators suggest that the national economy is entering 2005 with significant momentum. Retail spending is up 8 percent, the largest gain since 1999. Housing starts increased to nearly million, which is the strongest since 1978. Business conditions remain solid, with the pace of sales and orders in many regions accelerating late in the year. The Federal Reserve reports that businesses plan to further increase hiring and capital spending in 2005.

The California economy also strengthened in 2004. Although job growth is lagging slightly behind other states, broad economic measures like personal income and taxable sales grew more quickly. Exports of made-in-California merchandise posted a good gain after declining for three years. It is expected that businesses will step up the pace of hiring, which will result in acceleration in wages and jobs. Residential construction increased again and new business incorporations accelerated. California's home markets remain strong, with sales and price levels at all-time highs.

The Governor's original budget forecast in January assumed that both the U.S. and California economies would expand at a moderate pace throughout most of 2004 and continue in 2005. But economic output will more than likely slow some in 2005. As shown in Table 1, real U.S. Gross Domestic Product (GDP) growth is projected to shift down from 4.4% in 2004 to 3.3% in 2005, and further to 3.0% in 2006. This reflects a slightly slower pace in consumer spending and business investment, partly offset by improvement in the foreign trade deficit.

The overall sales and output growth of California businesses will continue at a solid but moderating pacer over the next two years, reflecting slowdowns in consumer and business spending. Personal income growth is projected to expand by 5.5% in 2005, or about the same pace as 2004. Payroll employment growth is projected to increase in both 2005 and 2006. Housing permits are expected to remain above the 200,000 unit pace in 2005 reflecting continued strong demand in moderate-priced regions of the state.

It is expected that California 's economic recovery will continue to strengthen in 2004, with growth in employment, personal income, and taxable sales accelerating from 2003. The Department of Finance projects that jobs will be growing, employment growth will increase, and growth in total state personal income will improve, clearly putting the economy back on track. The unemployment rate, a lagging indicator, will continue to improve, but will more than likely remain close to 6.2%. State personal income is projected to increase by an estimated 5.6% in 2004 before mildly accelerating to a 5.8% pace in 2005.

GOVERNOR'S PROPOSED BUDGET – JANUARY 2005

When the 2005-06 Governor's Budget was presented to the Legislature on January 10 th, the projected General Fund budget gap was slightly more than $9 billion, most of which represented an ongoing structural imbalance between current law revenues and expenditures in 2005-06 and beyond. To achieve balance in 2005-06, the Governor proposed spending reductions in nearly every part of state government. Left unaltered, the operation of Proposition 98 would have crowded out all available general funds, and would have resulting in deeper and more severe cuts to health and human services programs. Last year, the education community joined in postponing $2 billion in what Proposition 98 would otherwise have provided in 2004-05 ($1.1 billion) and in 2005-06 ($1.17 billion).

Table 2 reflects the General Fund's condition under the budget's original assumptions and proposals.

• Revenues. Revenues and transfers are projected to grow from $74.8 billion in 2003-04 to $78.2 billion (exclusive of any economic recovery bond proceeds) in 2004-05, and further increase to $83.8 billion in 2005-06 – an increase of 7.1%.

• Expenditures. Expenditures are projected to increase from $82.3 billion in 2004-05 to $85.7 billion in 2005-06 – an increase of 4.2%.

• Operating surplus (revenues in excess of expenditures). The cumulative year-end reserve is projected to be $500 million.

REVENUES (Table 3):

A key determinant of California's current budget outlook is the strength of state revenues. California revenues began recovering in 2003 and showed solid growth in 2004. The budget reflects an overall increase in General Fund revenues for the past and current years combined, as well as a projected increase for 2005-06 in the three major taxes: personal income tax, sales tax, and corporate tax.

For 2005-06, the Governor's budget forecasts that General Fund revenues and transfers will be $83.8 billion in the budget year, a $5.6 billion or 7.1% increase from 2004-05.

• California 's personal income tax, the single most important determinant of state revenues, is expected to contribute about 50% of all General Fund revenues in 2005-06. Current projections estimate revenues will increase by 8.6% in 2004-05, and then increase again in 2005-06 by another 8.6%.

• Sales and use tax, the General Fund's second largest revenue source accounting for about one-third of the revenue total, is expected to increase from $23.8 billion in 2003-04 to $25.02 billion in 2004-05, and then a slight gain in 2005-06 to $26.9 billion. About 70% of the tax is remitted by retailers, while the remaining 30% is directly paid by businesses who themselves consume or use the products being taxed. With the passage of Proposition 57, $15 billion of Economic Recovery Bonds were sold to fund the accumulated State budget deficit. To repay these bonds, a new temporary .25% sales tax was imposed, with revenues dedicated to repayment of the bonds. Once these bonds are repaid, this tax will end and the local government general purpose sales tax rate will return to 1%, from 0.75%. Revenues from this 0.25% sales tax rate are estimated at $1.167 billion in 2004-05 and $1.358 billion in 2005-06.

• Corporation Tax (CT) revenues are expected to contribute nearly 11% of all General Fund revenues in 2005-06. The franchise tax and the corporate income tax are levied at an 8.84% rate on profits. Banks and other financial institutions subject to the CT pay an additional 2% tax on their net income. The key determinant of CT receipts is the strength of corporate profits reported on California tax returns by businesses. While these profits have been hit hard by the economic downturn in recent years, it appears that profits will expand slightly over the current year.

EXPENDITURES

The General Fund is the main source of support for state programs. But, before examining the programmatic details of the Governor's spending plan for 2005-06, it is useful to provide some perspective on the historical expenditure trends. The table below shows that total general fund spending increased moderately between 1993-94 and 1998-99, then jumped by nearly 33% between 1998-99 and 2000-01. In contrast, spending then remained relatively flat for the next three years with some growth in 2004-05 and 2005-06.

In the absence of corrective actions to slow spending growth, and the policy changes proposed, the State would spend $92.6 billion General Fund in 2005-06. At the same time, the baseline estimate of resources available in 2005-06 is $84.2 billion. In addition, the Budget recognizes the need to provide for a reserve of $500 million and fund other adjustments totaling $170 million General Fund. Thus in the absence of any policy changes to close the budget gap, the gap would have been $9.1 billion. This gap is due to: (a) an operating deficit in 2004-05 of $1.7 billion, (b) a gap between the growth in baseline expenditures and revenues of $5.2 billion, (c) the loss of $2 billion of Economic Recovery Bonds that were used to help fill the gap in 2004-05, and (d) $170 million for other adjustments.

Program Cuts/Savings

The budget contains approximately $7 billion in program reductions and related cost savings in the current and budget years combined. The Governor is proposing to hold Proposition 98 spending roughly at the 2004-05 level which results in savings of slightly over $1.1 billion in each of the current and budget years. The budget also proposes to suspend the Proposition 42 transfer of $1.3 billion in sales taxes on gasoline from the General Fund to transportation funds. In the social services programs, the budget proposes a $1.1 billion reduction primarily in grant savings. Other program cuts/savings include $.8 billion in employee pensions, $.6 billion general government.

Economic Recovery Bond

This category accounts for about $1.7 billion new borrowing and $1.3 billion from debt-service savings.

Transfers and Other Revenues

The remaining reductions and savings are related to a variety of proposals throughout the budget including the package of Medi-Cal reforms, elimination of the senior citizens' property tax assistance program and across the board cuts to state operations.

Table 4 summarizes the Governor's proposals for 2005-06 General Fund spending by major program area. The spending plan reflects a decline of $2 billion or 2.5% from the current year's level. Over one-half of the expenditures is dedicated to education, with K-14 Proposition 98 education accounting for nearly 42% of the total budget plan and Higher Education closer to 6%. Combined, health and social services programs account for nearly one-third, while spending on youth and adult corrections accounts for about 8.2% of the total.

HIGHER EDUCATION (UC and CSU) OUTLOOK

The 2005-06 Budget proposes combined general fund support for CSU and UC of $5.4 billion, which represents an 3.8% increase in state support as compared to the prior year. Recognizing that both the UC and the CSU are integral to California's economic well-being, the Governor is supporting a Higher Education Compact that was signed in spring 2004. This agreement provides funding stability and preserves educational quality over the next six fiscal years with increases in base budget allocations (including increases for salaries and mandatory costs), enrollment, student fees, and other key program elements through 2010-11. In exchange for this long-term stability, both segments committed to improving or preserving successes in student and institutional outcomes.

MAY REVISION TO THE GOVERNOR'S BUDGET

Each year, the Department of Finance re-exams and revises its projection of revenues after the tax period has closed. This forecast, known as "the May Revision", provides updated economic and revenue forecasts, as well as the latest caseload, enrollment and population information for programs in the health and welfare, education and public safety areas. The May Revision has traditionally been considered to be an important milestone in the budget process and it is usually the benchmark for the final budget.

The updated revenue estimates contained in the May Revision reflected a restored faith in the California economy. Revenues are increasing in the estimated 2004-05 personal income tax and in the 2005-06 corporate tax categories. The state's unemployment rate had dropped a full point from 6.4% a year ago to 5.4% in the April 2004 report. Most impressive was the fact that the populations of those receiving assistance from the state have declined, allowing further budget savings. The effect of economic growth on personal income tax, corporation tax, sales tax, and other tax revenues yields about $3.7 billion more in one-time revenues than projected in January.

In January, the Governor proposed a budget which addressed an estimated $9 billion shortfall through significant program savings in Proposition 98 education, social services, and state employee compensation. It also relied on significant amounts of new borrowing, including the sale of $1.7 billion of the remaining deficit-financing bonds authorized by Proposition 57, and the suspension of the Proposition 42 transfer of General Fund sales taxes to transportation.

Since the revenue improvement contained in the May Revision is largely in the form of temporary dollars, the Governor has proposed that most of the expenditures also be one time in nature. The May Revision proposes to reduce the amount of new or existing budgetary debt by $2.5 billion, primarily through eliminating the planned 2005-06 sale of deficit-financing bonds and prepaying one-half of the vehicle license fee loan, which is due in full to local governments in 2006-07. The revised plan also proposes to increase funding for programs by a net amount of $1.7 billion.

The May Revision maintains full support for the Higher Education Compact as presented in the January Budget. In addition, the Governor has augmented the budget by $250,000 to increase the number of students seeking a math or science teaching credential. In addition, the Governor approved a CSU request to utilize $26 million of General Obligation Bond funds to extend the useful life of many CSU facilities.

THE LEGISLATIVE BRANCH OF STATE GOVERNMENT

Upon issuance of the Governor's proposed budget, the budget committee of each house of the Legislature assigns a subcommittee to analyze and develop independent recommendations regarding the budget. The parent committees adopt the subcommittee's recommendations, which are then sent to the floor of the respective house for action. After the Assembly and Senate have adopted budget plans, a Joint Conference Committee comprised of members from both houses is assembled to resolve differences between the two versions of the budget. Once a compromise budget plan has been developed and ratified by both the Assembly and Senate, it is presented to the Governor for signature.

As of this writing, the Senate and Assembly budget subcommittees have approved the Governor's proposed budget. The Budget Conference Committee began their deliberations on June 1 and anticipates completing their recommendations by mid June. As of this writing, a compromise has not yet been reached.

THE CALIFORNIA STATE UNIVERSITY

The 2005-06 Governor's Budget (as revised in May 2005) provides the CSU with an additional $224 million for the coming year and will encompass the following budget increases:

• Enrollment (8,103 FTES Growth) $63.7 million
• Compensation (3.5% pool effective July 1, 2005) $88.1 million
• Mandatory Costs – Health, Space, Insurance $40.8 million
• Financial Aid $23.3 million
• Deferred Maintenance, Libraries, Technology $ 7.9 million
• Math and Science, Teacher Preparation $ .2 million

This budget was developed in the context of a multi-year commitment to higher education, whereby the UC and the CSU would accept the budget cuts in 2004-05 in exchange for budget support in subsequent years. The agreement, which begins in 2005-06 and continues through 2010-11, provides base funding increases of 3% for the first two years, 4% for 2007-08 and 5% thereafter. Further, enrollment growth funding of 2.5% annually is provided for the duration of the agreement. In return for these funding commitments, the CSU will provide comprehensive annual reports on a variety of student outcome-based performance measures, as well as measures of resource utilization and student data. The agreement also calls for student fee increases in each of the next three years, resulting in undergraduate fees increasing by an average of 10%. With respect to graduate student fees, the UC and the CSU would make progress toward setting the fees at a rate 50% higher than undergraduate rates to better reflect the higher cost of instruction and relative value of the graduate education to the students. Further, the student fee policy contained in the Compact assumes that the UC and the CSU will retain student fee revenue without a corresponding reduction in State funds which, together with State funds would provided each year, will be used to help meet their budgetary needs as well as help the segments recover from the past three years of budget cuts.

LOCAL CAMPUS CONDITIONS

The Chancellor's Office issued preliminary campus budget allocations and enrollment targets in March 2005, reflecting a $20 million increase in state support for Long Beach . This increase in resources includes an expected $8.6 million in revenues from the proposed State University Fee increase.

For 2005-06, our enrollment target has been provisionally set at 27,551 Full Time Equivalent Students (FTES), representing a 2.4% increase over our funded enrollment target for 2004-05. CSULB is located in the center of a high-growth area and our student demand remains high, particularly for seats in the freshman class. CSULB freshman applications have grown about ten percent for each of the past several years and there is no sign of slowing. Because of this tremendous demand, it is possible that the system office may make a modest increase in our enrollment target.

In response to the expected change in the campus budget, our local planning process developed a strategy that would allows for continued protection of the instructional capacity, and multi-year recovery allocations to the instruction and non-instructional units.

Budget Strategy and Campus Recovery Plan

• In recognition of the poor budget climate over the past several years, the university has operated conservatively and has accumulated a reserve of one-time temporary funds. Given the severity of the budget cuts for the current year (2004-05) and based on the assumption that the budget outlook would improve, RPP recommended that the campus use some of the temporary funds to augment the base budget in order to protect instructional capacity and to buffer some, but not nearly all, of the budget cuts in non-instructional areas.

• During 2004-05 $9 million of temporary funds was applied to mitigate the budget reductions, including using accumulated savings from each division.

• For 2005-06, the plan is to continue this mitigation strategy with $7.8 million of temporary funds. To the extent divisions further accumulate savings at the end of this fiscal year, we are expecting these savings to be applied towards recovery and in doing so will advance the restoration of services that were lost or diminished over the past three years. Consequently, in 2005-06, we will apply $2.343 million of new, discretionary general funds to restore base budgets and backfill with temporary reserves to protect our instructional capacity. Also, since non-instructional budgets bore the majority of the budget cuts over the past three years, we will make a modest improvement in the budget relief for these divisions.

To close the funding gap over time and eliminate our dependency on temporary funding, we have agreed that after providing base funding to meet additional faculty costs associated with enrollment increases, all new, base discretionary funds will be applied to restore prior year, cumulative budget cuts rather than to invest in new initiatives.