Below is an overview of the Governor’s May Revision provided by Capital Advisors Group:

The following is Capital Advisors Group‘s initial analysis of the Governor’s May Revision with a focus on the K-12 education components and impacts to California charter schools.
Overall State Revenues Continue to Improve – The Governor recognizes the continued growth in the state’s economy by revising his estimate of state revenues to reflect a net increase of $2.4 billion for 2014-15.
The revised revenue estimates reflect a private sector unemployment rate that has returned to pre-recession levels and continued revenue improvements from the top three sources: sales and use tax, personal income tax, and corporation tax.
It will be interesting to see if the Legislative Analysts Office (LAO) agrees with the Governor’s estimates. Some folks are already opining that the estimates may be low. Legislators have remarked in recent days that they are aware the Governor’s prior budget proposals have assumed lower levels of revenue than actually materialized – essentially making the argument that they may not want to be so conservative this time around. Obviously, one of the Governor’s claims to fame is his ability to constrain the Legislature’s tendency to overspend. Given the election year dynamics, we think the Governor is in a good position to continue holding the leash. If that is true, the May Revision doesn’t give the Legislature much to play with in terms of additional funding since the bulk of additional funding in the May Revision is being tapped to expand MediCal – which will be difficult for Democrats to oppose.
If the LAO disagrees with the Governor and opines that the estimates are low, we can expect some lively debate and negotiations over the next month. We expect their analysis in the coming days.
Governor’s Proposition 98 Estimate Reflects Minor Changes – The Governor’s estimate of the changes to the Prop 98 estimates for the prior year, current year, and budget year are minor, but important. Overall, the May Revision reflects a net $242 million increase in the Prop 98 guarantee over three years, as compared to the January proposal. Specifically, the May Revision reflects Prop 98 at the following amounts:
· 2012-13 – $57.8 billion (down $547 million from January)
· 2013-14 – $58.3 billion (up $1.5 billion from January)
· 2014-15 – $60.9 billion (down $700 million from January)
It will be interesting to see if the LAO agrees with the Administration’s estimates of the multi-year Prop 98 estimates.
Rainy Day Fund and Prop 98 Reserve
The Governor’s May Revision proposes a Rainy Day Fund and Proposition 98 Reserve that reflects the compromise that was worked out with legislative leaders. The proposal also includes a component to provide resources to pay down California’s long-term debts.
The General Fund (GF) revenues that will be transferred into the Budget Stabilization Account, the formal name of the Rainy Day Fund, will be calculated in two ways:
1. 1.5% of GF revenues in each fiscal year
2. GF revenues collected as part of the personal income tax on capital gains income, when those revenues exceed 8% of total GF revenues
These transfers will be made until the fund reaches a maximum of 10% of GF revenues.
The revenues transferred in this way will be used in several ways:
Rainy Day Fund
Prop. 98 Reserve
Withdrawal from, or suspension of, the Rainy Day Fund and the Prop. 98 reserve are permitted under limited circumstances if there is a budgetary emergency, a natural disaster or if spending remains at or below the highest level of spending over the last three years, adjusted for inflation and cost-of-living.
Debt Obligations: Between 2015-16 until 2029-30 half of the non-Prop 98 revenues transferred would be used to discharge debt obligations (e.g., Prop. 98 settle up, inter-fund loans, claims for mandated costs prior to 2004-05, and unfunded pension liabilities).
This revised Rainy Day proposal reflects a compromise worked out between Legislature and Governor Brown. Aside from one recent informational hearing held by the Assembly Budget Committee, this deal was largely worked out behind closed doors and has been made public as part of Governor Brown’s May Revision. The proposal is aimed at addressing California’s revenue volatility and inadequate reserves.
The proposal is in bill form in Assembly Constitutional Amendment X2 1 (ACA X2 1), carried by former Speaker John A. Perez; the bill was presented to the Senate Budget Committee on May 14. In that hearing the author indicated that there are further amendments pending on this bill. A more comprehensive analysis of this proposal will follow as soon as those additional amendments are available.
To take effect, the proposal would need to pass the legislature and be passed by the voters. If enacted, it would replace the current Rainy Day Fund (Prop. 58) and amend ACA 4, which is set to go before voters this November.
Fully Paying-Off Inter-Year Deferrals – Consistent with his January Budget proposal, the Governor continues to focus on paying off the state’s debt by the end of 2014-15. However, the mix of the one-time and on-going money is used to pay down these deferrals is changed.
Ambitious STRS Proposal – Easily the most significant K-12 education budget change contained in the May Revision, the Governor proposes to eliminate the unfunded liability associated with the California State Teacher Retirement System (CalSTRS) over the next 32 years; that unfunded liability is estimated by the Administration to be in excess of $74 billion.
As we have expected of any such proposal, the funding proposed to make the system whole comes from three sources:
1. Direct contributions by the state
2. Increased contributions from school employees covered by CalSTRS; and
3. Increased contributions from school employers
Details on each of these three sources are provided below. The Governor’s proposal is aggressive, places more than 60% of the funding burden on employers, and will certainly be the subject of additional discussion in the Legislature.
1) The state will cover approximately $20 billion of the total $74 billion by increasing its contribution rate from the current 3.04% of total employee compensation to 3.45% in 2014-15, 4.89% in 2015-16, and 6.33% in 2016-17 and beyond until the unfunded liability is discharged. This level of contribution from the state reflects the shortfall in CalSTRS funding that existed when a long‑term sustainable funding plan was put in place in 1990. In other words, the state feels that it has an obligation to contribute to the discharge of liabilities incurred prior to 1990, but not of those liabilities incurred after that point in time; the Administration argues that it is particularly not responsible for that portion of the liability created by benefit increases granted in 1998 and after.
The state will also continue to fund a supplemental inflation protection program or COLA in an amount equal to 2.5% percent of total employee compensation.
2) School employee contributions will cover approximately $8 billion of the total $74 billion through increases in the contribution rate. Because of existing statutory protections on employee contribution rates, the Administration is proposing to guarantee the (currently optional) supplemental inflation protection program in exchange for contribution rate increases. That rate is proposed to increase from the current 8% of compensation to 8.15% in 2014-15, 9.2% in 2015-16, and 10.2% in 2016-17 and beyond until the unfunded liability is discharged. These rates will apply to employees who entered the system prior to the 2013 enactment of the California Public Employees’ Pension Reform Act (PEPRA). For those employees who entered the system after the enactment of PEPRA the rate would increase to and be capped at 9.21%.
3) School employer contributions will cover approximately $47 billion of the total $74 billion, also through increases in the contribution rate. That rate is proposed to increase from the current 8.25% of compensation to 9.5% in 2014-15, and then will increase by an additional 1.6 percentage points each year until the rate reaches 19.1% in 2010-21; the 19.1% contribution rate will stay in place from that point on. There is no proposal to provide additional resources to school employers in order to fund this increase in costs.
The burden that an increase in the employer contribution rate from 8.25% to 19.1% places on local educational agencies is clear. According to the Department of Finance, the increase from the current rate of 8.25% to 9.5% in 2014-15 will cost districts $350 million, which translates to more than $55 per pupil as a statewide average (note that the impact in different districts may differ according to both the number of covered employees and compensation levels). To provide context for this level of cost increase, recall that the mid-year trigger cuts implemented in late 2011/early 2012 totaled $328 million. Because the first year increase in contribution rate is held at 1.25 percentage points, the budget impact in later years would be even greater.
Independent Study Reform – The Governor makes some edits to his January proposal to reform the state’s Independent Study (IS) law.
In January, the Governor proposed creating a “coursed-based” IS program option for LEAs, essentially allowing schools to claim ADA for students based upon course completion, an alternative to the traditional assignment-based IS. In the May Revision, the Governor removes a requirement from the January proposal that would have required the teacher, under the “course-based” IS option, to meet with students on a weekly basis. Additionally, because the Governor caught flack from the CDE over essentially possible for schools to receive 100% ADA under this option, the Governor revises the proposal to allow LEAs to claim the ADA but also applying the statewide excuses absence rate (so no LEA could receive 100% ADA).
Lastly, the May Revision changes the Governor’s IS reform proposal related to “site-based blended learning” to utilize a universal learning agreement that would apply to all students enrolled in the same course or courses.
The Legislature has opted not to include the IS proposal in the budget process and has instead opted to use SB 1143 (Liu) as the policy vehicle for these discussions. We have been working closely with the Administration and Senator Liu, chair of the Senate Education Committee, as she shepherds the bill through the Legislature. The changes to IS law contained in the bill, if enacted, would be a huge relief to LEAs in the state with students enrolled in IS programs. The most recent version of the bill amended-out the “site-base blended learning” option and instead focused on changes to current IS law and adding the “course-based” IS option. Staff in the Legislature have been resistant to the “site-based blended learning” option. The bill recently passed out of the Senate Education Committee with a bipartisan, unanimous vote.
High-Speed Internet Access For Smarter Balanced Assessments – While the Governor’s proposal does not contain additional one-time funds for Common Core implementation, he does use a little bit of the increased Prop 98 funding ($26.7 million) for a one-time increase in funding for the K-12 High Speed Network; the funding will be used to study broadband access in the state and provide grants to LEAs to expand networks based upon need.
LCFF Low Income Counts – The May Revision proposes some flexibility related the issue of determining, for LCFF purposes, the number of students receiving free or reduced-priced meals at Provision 2 and 3 schools.
The proposed solution is largely consistent with a resolution we have been advocating for since August. It would authorize Provision 2 and 3 schools to establish a base-year eligibility no less than every four years, provided that the school annually updates the count for newly enrolled (or dis-enrolled) students during the intervening years. It would also require the SPI to revise the LEA’s three-year rolling average of unduplicated counts (used to calculate LCFF) using 2014-15 instead of 2013-14, if doing so would increase the LEA’s rolling average.
K-12 Mandate Block Grant – The Governor proposes to increase funding for the block grant by $1.6 million due to increased ADA and adding three additional mandates to the block grant (Parental Involvement, Williams Case Implementation, and Developer Fees). This is in addition to two mandates proposed to be added to the block grant in January.
The Governor wants to pay off the state’s mandate backlog in 2016-17 and 2017-18. He counts this debt in his overall “Wall of Debt.” It is important to remember that the mandate obligations incur interest – making the later payoff is a bad deal for the state, but this means that those LEAs with outstanding claims will actually make some money off the delay if the claims are reimbursed.
Prop 39 Energy Efficiency Programs – The Governor decreases the amount of energy efficiency funding available to K-12 schools by $9 million to reflect a decrease in related revenue.
No Funding for Transitional Kindergarten (TK) – Not surprisingly, the Governor’s proposal does not contain funding for TK. However, we expect this to be a focus in final budget negotiations with the Legislature because Senate Pro Tem Darrell Steinberg is pushing hard for this to be included in his last budget as Senate leader. The lack of significant additional funding in the Prop 98 guarantee will likely hinder Steinberg’s effort.
Additional One-Time Common Core Funds? – Despite continued growth in state revenues, the Administration does not propose to provide another round of one-time funds for Common Core implementation. Some are encouraging a serious conversation about potentially taking two-years to pay off the inter-year deferrals and using some one-time money in 2014-15 for another round of Common Core funding.
What’s Next? – Over the next month, the Legislature will hold their final budget subcommittee hearings and each house will pass a budget bill that will go to the two-house Budget Conference Committee to put together a final budget bill that will ultimately go to the Governor. For every day after June 15 that the Legislature does not send a budget to the Governor, Legislators forfeit pay. We expect an on-time budget.
We expect the Governor, Senate Pro Tem, and Assembly Speaker to begin meeting privately soon. Additionally, because Democrats lack 2/3 control in the Senate, any components of the budget that would require 2/3 votes (The rainy day fund is an example of a 2/3 requirement; however, most parts of the budget impacting education would not require 2/3 vote) will mean Republican support will be necessary and would likely bring Senate Minority Leader Bob Huff (R-Diamond Bar) into the fold. We expect Democrats to do everything in their power to avoid issues that require 2/3 vote.
Thank you to Capital Advisors Group for their permission to distribute the above information.

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