May 2020 - Headline vs. Reality

May 8, 2020

You have probably seen headlines about a $53 billion “deficit” in the state’s General Fund budget. That’s a big number, approximately one-third of spending in the current fiscal year. You might think, therefore, that the headline number implies that state spending will have to fall by one third. So, let’s take a closer look.

The headlines you saw were based on documents given to journalists by Governor Gavin Newsom and the California Department of Finance just a week ahead of the official unveiling of the so-called May Revise of the budget for fiscal year 2020-21. Normally, the May Revise is just a relatively small adjustment of the governor’s January budget. It reflects more recent data and developments as the new fiscal year – which begins on July 1 - approaches. However, because of the coronavirus crisis and the resultant major drop in economic activity and tax receipts, the May Revise this time is going to be much more than an iterative adjustment.

Let’s first consider the projected $53 billion “deficit” now projected by the governor. Is that the "deficit" in common English parlance: revenue minus spending during a fiscal year? When you read the actual documents that were given to journalists, $40.9 billion of the $53 billion is what is projected for the 2020-21 fiscal year as a common-parlance deficit. * Of course, that’s still a lot. But the documents also say we have a rainy day fund of $16 billion tucked away, thanks to Jerry Brown, our previous governor. And, in fact, the state has more cash on hand than just the rainy day fund.

Every month, the state controller publishes a cash statement. The latest statement available goes through the end of March. It tells us that the state had on hand something called “unused borrowing resources” totaling about $38 billion (including the rainy day fund). Those resources reside in accounts outside the General Fund which are earmarked for various purposes by the legislature. But in the end, it’s all state cash.

Now, the governor and the Dept. of Finance will point to legal limits on how much of the rainy day fund can be used in 2020-21 and on what can be done with other unused borrowable resources. But creative minds in past budget crises have managed to "relax" such limits. Note, for example, that the economic assumptions underlying the budget are entirely at the discretion of the legislature and governor. Yes, the legislature is required to "balance" the budget on paper, but what's on that paper depends on underlying assumptions. Budget aficionados may recall that when Jerry Brown took over from Arnold Schwarzenegger during the last budget crisis, at one point the legislature passed - and the governor signed - a budget that assumed that a windfall of $4 billion would somehow appear beyond what was then projected for any tax.

The bottom line is that we do have a really big budget problem, but that problem is not well represented by the headline $53 billion. We are not going to cut state spending by a third. There will be big cuts, but not of that magnitude. And those cuts may come in two rounds: the budget enacted in June and a revision over the summer when more information on (delayed) tax filings come in.

For the longer term, the budget outlook depends on whether there is a relatively quick economic recovery. If you think there will be a relatively quick snap-back, then big cuts and one-time fiscal tricks will "solve" the problem and we can stagger with our wounds into a better future. And if you want to make a case for that type of economic response, you can cite evidence that many people who have been laid off at least think they are likely to be recalled to their old jobs. There is some evidence from official labor market data that many unemployed people do have such a belief. A separate Washington Post poll puts that proportion at 77%. **

But you can also take a more pessimistic view. The employer who told his workers they would be recalled may go out of business before that could happen. People who aren't unemployed but have seen gloomy headlines - or who have neighbors and family members who are unemployed - may be reluctant to spend out of fear that they could be next, and they'd better save their money. They may also be reluctant to sit in a restaurant where the waiters are walking around in space suits. In that scenario, the economic damage could be longer-term as it ripples out to industries not immediately affected by the shutdown. One-time budgetary tricks and running down current cash reserves in that scenario won’t be available after a year.

There is also political uncertainty. In the short term, will there be more big bailout spending at the federal level (with the Federal Reserve essentially financing that spending via money creation)? Will there be some significant bailout money for state and local governments? Who will be elected in the next election cycle and what will be the policy result?

The value of the $53 billion headline from the perspective of the governor is that the number is so big that it might scare the legislature into going along with whatever his May Revise proposes. But even that impact is uncertain. There are staff people in the legislature who can do the same analysis as I have done above. The headline may end up providing shock to legislators, but not awe.      

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