June 21, 2013
By Bill Fletcher and Ed Ring
SUMMARY: California’s local governments and agencies spent far more in FYE 6-30-2011, $316 billion, when compared to spending for direct state government operations, $49 billion. Similarly, using realistic assumptions regarding the value of unfunded retirement pension and healthcare obligations, the amount of long-term debt carried by California’s local governments and agencies, $611 billion, is far greater than that carried by the state directly, $237 billion. The current financial reporting practices of California’s state and local governments do not provide adequate, accurate, or timely consolidated data. At a minimum, California’s state and local governments need to require all financial statements to be audited, incorporating proactively the latest GASB standards, with faster deadlines for completion, submittal, and consolidation. With accurate consolidated data on total state and local spending and debt, California’s State Controller or Dept. of Finance should prepare annual “what-if” scenarios for policymakers that display the financial impact of, for example, lower rates of investment returns on the unfunded liability for pension funds, as well as the impact of higher borrowing costs as today’s very low interest rates return to normal.
The conclusion of this study, based not only on extensive review of publicly available data but also on many interviews with financial professionals within state and local government agencies, is that (1) California’s total state and local government debt and annual spending is higher than is generally understood, (2) current financial reporting practices of state and local governments are fragmented, unaudited, use obsolete standards, and are not timely, and (3) policymakers do not currently have the information they need to anticipate and prevent financial problems, especially those facing California’s cities and counties.
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This study attempts to estimate total state and local government spending in California from all sources and show the financial relationships between the various government organizations; state, county, city, school districts, special districts and redevelopment agencies. In discussing California’s finances, it is misleading to focus on the state’s budget that is only about 36 percent of total state and local spending. Most budget discussions are even more narrowly focused on the General Fund that is about 70 percent of the state’s budget and only 25 percent of total spending.
Total state and local spending in the state, $365.1 billion, is about 19 percent of gross state product, a very substantial sum. About 23 percent is paid for by the federal government and the rest is paid for by state and local taxes and fees.
Note that this study uses data for the 2010-11 fiscal year. This is the latest year for which spending by the counties, cities, special districts, and redevelopment agencies are available. Redevelopment agencies were eliminated in 2012 and will be replaced by successor agencies in future reports.
Why do we need to include local spending?
(1) Local spending is greater that spending by the state, especially if local assistance funds are included.
(2) There is very little visibility of developing financial problems at the local level. No one is consolidating spending and deficits at the local level to highlight developing problems.
(3) The state can transfer financial problems to the local level by transferring responsibilities to local government without providing all funding required. The county and city governments have limited opportunities to increase revenues to close any resulting funding gaps.
(4) CalPERS and other pension funds can require the counties and cities to increase pension contributions to cover any pension shortfalls without consideration of their ability to pay. New pension reporting guidelines to be implemented in FY 2013-14 will require more accurate reporting of pension obligations.
(5) Retiree health care expenses are not pre-funded for most public employees during the years they are working. Counties and cities are liable for these expenses but have not accrued for them, much less set aside funds to pay for them.
(6) Refinancing bond debt could be difficult to support in the future if present low interest rates return to normal.
As a result, California’s financial problems are more likely to show up at the local level without much warning as expenses and obligations increase faster than revenues. Potential problems would be aggravated by any financial mismanagement at the local level which would be difficult to spot before becoming serious problems.
Table 1, below, uses data from the California Policy Center’s earlier study, Calculating California’s Total State and Local Government Debt. It shows that nearly three-quarters of the state’s debt and unfunded obligations are at the local level and have limited visibility. Over-indebtedness as well as budget deficits are problems at the local level. A serious problem is the use of borrowed funds to cover current expenses including catch-up payments towards underfunded retirement pension obligations. Equally serious is that, in many cases, retirement health care obligations are unfunded. Pension and retiree health care benefits should be fully funded while an employee is working; these costs should not be passed on to future taxpayers after an employee has retired.
CALIFORNIA’S TOTAL STATE AND LOCAL GOVERNMENT SPENDING
Most spending in the state is at the local level. Table 2, below, shows the total spending at both the state and local level in California for the fiscal year ended June 30, 2011, which is the most recent fiscal year for which data is available. Of the state budget of $131 billion (column 1 total, “State”), about 30 percent is spent directly by the state, state operations, and the remainder is distributed to local government entities as local assistance. Federal funds provide about 23 percent of state and local spending.
The following tables summarize in more detail spending by:
(1) State operations, direct spending by the state, including funds received from the Federal Government (Table 3).
(2) Local assistance, funds allocated to the school districts, counties and cities from the state and federal government (Tables 4 and 5).
(3) Local spending supported by local taxes and fees (Table 6).
There were cases where data showing intergovernmental funding appeared to be inconsistent – that is, the amount of outgoing funding from one government entity was different from the amount reported by the receiving entity. In other cases, such as with K-12 school districts, consolidated financial information was simply not available. We have tried to make careful note of the gaps and inconsistencies we uncovered, as well as what assumptions we were compelled to make as a result.
The state budget for the fiscal year ended June 30, 2011 was $131 billion, but most of that money was passed through by the state to local agencies as local assistance. To determine what portion of the gross budget was actually used for direct state expenditures, detailed information can be found in the Appendix to the California Dept. of Finance’s current state budget summary on Schedule 9, “Comparative Statement of Expenditures.” This link will take you to the Governor’s Budget Summary for 2011-12 which includes actual expenditures for 2010-11.
As shown earlier on Table 2, $39.2 billion (30%) of the gross state budget of $131 billion is retained to fund direct state operations. When federal funding is added, primarily to help fund higher education, total direct state spending rises to $48.7 billion. Table 3, below, categorizes direct state government spending by agency. The columns break this spending out by source of funds. The top three categories of direct state spending are higher education at $14.6 billion, prisons at $9.5 billion, and infrastructure at $7.6 billion.
STATE AND FEDERAL ASSISTANCE TO LOCAL GOVERNMENTS
As shown earlier on Table 2, 68% of state revenues, $88.5 billion, are used to fund local governments and agencies, and 86% of federal funds allocated to the state, $73.2 billion, are distributed to local governments. These funds are allocated for Health and Human Services ($80.8 billion), K-12 education including Community Colleges ($47.9 billion), and Labor and Workforce Development ($20.4 billion) for unemployment benefit payments. A relatively small remainder, $12.5 billion, is allocated to all other local government activities.
As shown on Table 4, below, the total sum of state and federal funds, administered by the state, that flows through to local governments as local assistance ($161.7 billion), is highlighted in yellow. The reason for this is to compare this amount, reported by the state, to the amount on Table 6, also highlighted, that was reported as received from state and federal sources by the local governments and agencies. That amount, $32.7 billion, is the portion of that $161.7 billion that was retained by the counties and cities to fund the costs of administering the programs; the rest, $129 billion, was passed through to fund K-12 education and the Community Colleges, and for entitlements, primarily in the form of Medicaid, welfare, and unemployment compensation.
Table 5 below, shows a complete summary of what appears on the California Dept. of Finance’s “Comparative Statement of Expenditures,” Schedule 9 (ref. FN 1), which is the most comprehensive source we have found that shows how state government funds, along with federal funds administered by the state government, are allocated in California. The first two rows of data contain the totals from Table 3, Direct State Government Funding of $48.8 billion, and Table 4, Local Government Funding of $161.7 billion. Not appearing on the previous tables, because it is unclear whether or not the funds were used at the state or local level, are an additional $3.9 billion in miscellaneous “Capital Outlays” and unclassified spending of $1.3 billion. Altogether the total state and federal funds spent in California during the fiscal year ended June 30, 2011 was $215.7 billion.
LOCAL GOVERNMENT OPERATIONS
The information on Table 6, below, is fairly straightforward, being drawn directly from the Consolidated Annual Financial Reports (“CAFRs”) for California’s 57 counties, 481 cities, 4,772 special districts, and 427 redevelopment agencies. These reports, as referenced in footnotes 2, 3, 4, and 5, are prepared by the California State Controller every year. Because these compilations cannot begin until after the various local entities have themselves completed their annual reports, the most recent data is through the fiscal year ended June 30, 2011. The next set of consolidated annual financial reports is expected from the California state controller in the late summer or early fall of 2013, for the fiscal year ended June 30, 2012. The California State Controller has not issued a consolidated annual financial statement for K-12 and Community College education since 2000. Our assumption is that the $47.9 billion noted on Table 2 under state and federal funds allocated to local agencies for Education captures that amount.
The Governor’s Budget Summary for 2012-13 Figure K12-02 shows actual K-12 spending for 2010-11 of $66.8 billion with $38.1 billion from the state, $9.3 billion from the federal funds, and $19.4 billion from local taxes (Footnote 6). Note that these estimates for state and federal funds for K-12 education don’t match the figures used in the tables that come from Schedule 9 in the same Budget Summary. We were not able to reconcile this and several other apparent reporting inconsistencies.
As noted, the state and federal funds – highlighted in yellow – are not included in the calculation of total state and local government spending in order to avoid double-counting.
The total local taxes, fees, sales of bonds and notes, enterprise activities and other revenues in FYE 6-30-2011 for California was $149.4 billion.
CALIFORNIA’S TOTAL STATE AND LOCAL GOVERNMENT SPENDING – WHERE THE MONEY COMES FROM AND WHERE IT GOES:
The flow of funds through state and local government entities is complex. Table 7, below, constitutes a flow-chart, using the reported amounts as represented on the previous tables according to “sources of funds” (revenue) and “spending agencies” (expenses). The boxes on the left represent the funding agencies, with the total of all of them equal (apart from rounding errors) to the $365.1 billion as shown on Table 2. The largest single source of revenue is state taxes, fees, and bond financings at $131.0 billion, followed by federal contributions to state and local agencies at $84.8 billion. The box in the center at the top, “State Budget,” shows that along with the $131.0 billion in state government revenue, the state administers $9.5 billion of federal funds that go directly to the state government. Of that $140.5 billion, $48.7 billion is used to fund direct state operations including the University of California and the Cal State University systems, and the rest goes to cities and counties as shown on Tables 5 and 6.
The four lower boxes on the left, in the revenue column on Table 7, correspond to the amount of local government revenue sourced locally. This corresponds to the second subtotal in Table 6, “Sources of Funds – Local Revenue.” Note that the box “County Taxes & Fees” includes the sum of $29.8 billion in local county revenues used to fund county operations, plus $19.4 billion that the county retains from property taxes and other local sources to fund K-12 and community college districts. In sum, local agency revenue totaled $149.4 billion in FYE 6-30-2011.
As Table 7 makes clear, California’s local government agencies spend far more than the state does directly. Just K-12 school districts and community colleges (as noted in Table 4, “Education,” plus Table 6 “K-12 & Colleges”) spent nearly 40% more in FYE 6-30-2011, $67.4 billion, than the entire state government including higher education. The total spending (including state and federal funding) for the remaining four categories of local governments (Cities, Counties, Special Districts, and Redevelopment Agencies) totaled another $162.7 billion as shown in the four lower boxes on the right, and also in the row “Total – All Sources” for the first four columns of data on Table 6.
When the amounts showing as expenses in the boxes representing spending agencies on the right on Table 6 are added up, the total, $278.8 billion, does not equal the amount showing as revenue, $365.1 billion (notwithstanding rounding errors which put the total on the flow-chart at $365.3 billion). This is because, as noted in the right margin, an additional $86.3 billion in direct payments to Medicaid, welfare, and unemployment insurance beneficiaries is administered by California’s counties, but does not appear on the State Controller’s consolidated annual financial reports for counties (Footnote 2). When we attempted to tie the $86.3 billion to the amounts showing on Table 1 for “Health and Human Services” (Medicaid and Welfare), $80.8 billion, and “Labor and Workforce Development” (Unemployment Insurance), $20.4 billion, they totaled $101.2 billion, exceeding the $86.3 billion by $14.9 billion. Our discussions with experts on county budgets confirmed that the $14.9 billion was retained by the counties for their costs to administer these programs.
OBSERVATIONS AND RECOMMENDATIONS
Note that there isn’t any year-end financial statement for the state summarizing actual spending for the recently completed fiscal year. Schedule 9 (Footnote 1) is as close as we can get. There is no available reporting of totals for school districts. Reporting for counties, cities, and special districts have a reporting lag of about 15-18 months. The supporting documents for counties, cities, and special districts, their CAFRs, are not all audited as required and some are not completed on time. And they don’t include the basic financial information need to identify developing budget problems at the local level or estimate their ability to support their current and future debt levels and unfunded obligations for retiree pensions and health care.
In preparing this compilation of total California state and local government spending, it became evident that there are few readily available sources of consolidated data. The state and federal sources and uses of funds could only be found in some detail in a lengthy appendix to the California budget (ref. Footnote 1). The only source of consolidated financial information on local agency activities are the state controller’s “CAFR” (Consolidated Annual Financial Report) documents which we used to gather data on counties, cities, special districts and community redevelopment agencies, and these reports lag the fiscal year ends by over two years. For K-12 school districts, the state controller hasn’t produced a CAFR since 2000.
Not only was good data hard to find, but there are inadequate standards in place to reconcile funds distributed, which, for example, appear in the state budget as state and federal aid to counties and cities, with funds received as reported by the receiving agencies. The constraints introduced by the lack of accessible data or standardized reporting formats should caution anyone reviewing any analysis of California’s state and local finances.
While the paucity of available data renders detailed analysis problematic, there are nonetheless useful observations to be made from a global perspective:
- The state and local government spending, $365.1 billion in FYE 6-30-2011 includes the cost of servicing outstanding debt of $382.9 billion – not including unfunded pension and retirement health care liabilities (ref. Footnote 7). As interest rates return to normal, servicing this debt will require an increasing share of government spending.
- If only the officially recognized debt for unfunded retirement pensions and healthcare is added to the outstanding bond debt, the total borrowing of California’s state and local governments is $648.0 billion. If pension funds continue to struggle to achieve average long-term rates of return of 7.0% or more, annual contributions to pension funds will have to be increased and take a larger share of government spending.
- Most state and local government employee retirement heath care obligations are not pre-funded. As more government employees retire with generous retiree healthcare benefits, this will represent an additional claim – not currently accrued – on government revenue. Because these obligations are for services, not relatively predictable monetary amounts, the eventual costs are even harder to forecast than pensions.
- The total state and local government spending of $365.1 billion represents 19.2% of California’s Gross Domestic Product in 2011 (ref. Footnote 8).
- State spending on direct state operations, which includes the University of California and CalState University, $48.8 billion, is exceeded by a factor of more than six-to-one by local agency spending of $298.7 billion.
- While state and local government spending on pensions (not including employee contributions) was only $18.6 billion in FYE 6-30-2011 (ref. Footnote 9), CalPERS has announced a 50% increase to the required contribution (ref. Footnote 10), and it is not clear how much of this – because it is to reduce the unfunded liability and thus not subject to the “50/50” terms of SB 340 (Pension Reform), it could increase those payments by another $13.8 billion, bringing the employer’s pension payments share of the total state and local budgets from the current 5.3% to 9.3%. And it isn’t clear that the state’s pension systems can survive with only a 50% increase in contributions.
Based on these findings, we recommend the following:
- The California Controller should resume preparation of a Consolidated Annual Financial Report for California’s K-12 school districts and community college districts.
- All local government financial statements should be audited and submitted to the state controller under deadlines that permit consolidated data to be available to the public in less than one year after a fiscal year end.
- California’s state and local governments should proactively adopt new GASB standards that require recognition of unfunded pension and health care obligations as long-term debt.
- Either the California Controller’s office or the California Dept. of Finance should compile reports similar to those we have attempted to develop in these studies: Reports that consolidate and clearly communicate the total state and local government spending, deficits, and outstanding debt and make some attempt to identify those counties and cities that are having or are likely to have serious financial problems. Are problems such as those being experienced by Stockton and San Bernardino rare events or an indication of more widespread problems at the local level?
- The state legislature should mandate all state and local government organizations begin pre-funding all retirement commitments, including retirement health care. To better ensure that budgets aren’t unexpectedly consumed by dramatic and unexpected increases to these annual funding obligations, the state legislature should require more conservative investment return assumptions to be adopted, especially by the pension funds.
- Either the California Controller’s office or the California Dept. of Finance should compile “what-if” analyses showing the impact of lower rates of investment returns on the unfunded liability and annual required contributions to state and local pension funds and retirement health care funds.
1 – California Budget FAQs, Program Expenditures by Fund 1976-77 to 2013-14 – California Dept. of Finance, Schedule 9 – Comparative Statement of Expenditures. The total expenditures as noted on Table 3 can be found on page 37 of the Appendix. The subtotals are sprinkled throughout the details by expenditure category, beginning on page 19.
2 – Counties Annual Report, FYE June 30, 2011, Figure 3 – California State Controller
3 – Cities Annual Report, FYE June 30, 2011, Figure 1- California State Controller
4 – Special Districts Annual Report, FYE 6-30-2011, Figure 3 – California State Controller
5 – Community Redevelopment Agencies Annual Report, FYE 6-30-2011 – California State Controller
6 – Governor’s Proposed Budget Summary 2012-13 signed January 5, 2012. The chart is on page 133 Figure K12-02 Sources of Revenue for California’s K-12 Schools.
7 – Calculating California’s Total State and Local Government Debt, Table 7 – California Policy Center
8 – California GDP and Personal Income 2011 – U.S. Dept. of Commerce, Bureau of Economic Analysis
9 – Public Retirement Systems Annual Report for the fiscal year ended June 30, 2011, Figure 12, page xxii – California State Controller
10 – CalPERS rate hike: 50 percent over six years, CalPensions.com, March 25, 2013
On Table 1, the total unfunded pension and retiree healthcare liabilities were allocated between state and local government entities by prorating the full-time headcounts per state and local government in California, referencing the U.S. Census Bureau’s 2011 data for California’s state and local government. Official reports typically reference CalPERS and CalSTRS pension liabilities as state liabilities, when many cities, counties and local agencies participate in CalPERS, and school districts participating in CalSTRS are also local entities.
About the Authors:
William Fletcher is a business executive with interests in public finance and national security. He retired as Senior Vice President at Rockwell International where most of his career was spent on international operations and business development for Rockwell Automation. Before joining Rockwell, he worked for Bechtel Corporation, McKinsey and Company, Inc., and Combustion Engineering’s Nuclear Power Division, and was an officer and engineer in the U.S. Navy’s nuclear program. His international experience includes expatriate assignments in Hong Kong, Europe, the Middle East, Africa and Canada. In addition to his interest in California’s finances, he is involved in organizations dealing with national security and international relations. Fletcher is a graduate of Tufts University with a BS degree in Engineering and a BA degree in Government. He also graduated from the U.S. Navy’s Bettis Reactor Engineering School.
Ed Ring is the research director for the California Policy Center and the editor of UnionWatch.org. Before joining the CPPC, he worked in finance and media, primarily for start-up companies in the Silicon Valley. As a consultant and full-time employee for private companies, Ring has done financial modeling and financial accounting for over 20 years, and brings this expertise to his analysis and commentary on issues of public sector finance. Ring has an MBA in Finance from the University of Southern California, and a BA in Political Science from UC Davis.