Declaring education his first, second and third priorities, Governor Gray Davis' public school funding dominates his proposed 1999-2000 state budget. However, he said he is disappointed that a shortfall in revenue kept him from doing all he wants.

He tapped budget reserves and reduced spending increases, and said he counts on more money from the federal government to avoid spilling red ink during his first 18 months in office, through the end of the fiscal year that begins July 1.

He kept a campaign commitment and called the Legislature into special session to focus on his $444-million package of education measures, which he labeled READ - "Raise Expectations, Achievement, and Development."

Governor Davis' fellow Democrats, as well as Republicans, heaped praise on the emphasis on accountability for students, teachers, administrators and parents. Accountability, he said, is the "cornerstone" of the plan.

Among the reforms is what the governor called the most stringent high school graduation exam in the nation, starting in 2003. However, critics say the education initiatives are fraught with risk and of relatively limited impact, reaching too few students and schools in a system in need of extensive overhaul.

"This administration's highest priority is to raise expectations and improve achievement in education," the governor said in his January 8 budget message to the state Senate and Assembly, delivered just five days after his inauguration as the state's 37th chief executive. "In the service of these goals, the budget proposes to invest in efforts to ensure that every student in California schools can read by age nine."

The overall proposed budget is $77.5 billion, including general, special and selected bond funds. The general fund, consisting mostly of revenues from personal and business income taxes and sales taxes, would total $60.5 billion, an increase of 3.8 percent over the current year.

Finance Director B. Timothy Gage described the product of less than two months of furious activity since November's election as a "workload" budget. "We have tamped down the rate of growth to essentially live within our means." He said it neither raises new taxes nor provides for new tax relief. It calls for a study of business tax incentives.

Governor Gray Davis

This budget proposal is based on what Mr. Davis and Mr. Gage say is a middle-of-the-road economic forecast. (Gage: "We did not low-ball revenues.") They figured, based on business-as-usual spending and an economic slowdown to moderate growth, that the state would wind up with a $2.3 billion shortfall at the end of the next fiscal year on June 30, 2000.

The current budget year was to end with a $1.2 billion surplus, based on the 1998-99 budget signed by then-Governor Pete Wilson last summer.

The reserve would be drawn down to $415 million to help close the revenue gap, one of six budget-balancing steps that also include reliance on federal largesse and tobacco settlement money, plus more auditors and tax collectors in state tax agencies. These steps are listed in the following table:

Some Republicans, including Craig Brown, former Governor Pete Wilson's finance director, disagreed with Davis administration judgments that the state faces such a serious gap between revenue and spending. (For historical perspective, the 1991-92 recession-era budget year arrived with a record $14-billion revenue shortfall.) Mr. Brown said he would not be surprised to see another April revenue surge from income tax payments that would pad the state's surplus. There was a multibillion-dollar windfall last year.

Everyone, including the new governor, concurs that the January economic forecast should not be considered the final word. They will wait to see how revenues flow - particularly highly volatile personal income taxes, especially capital gains - during the first four months of 1999, then base a revised budget on fresh numbers in mid-May. It is an annual ritual, one that sometimes reduces January budget introductions to preliminary status, loaded with program goals that may or may not be deemed affordable within a few months.

Governor Davis said he hopes the May Revise will be favorable and he can add to his proposed spending on schools, state employee salaries and rebuilding of the budget reserve.

In detailing his budget plans, the governor said he was saddened by circumstances that caused him to limit what he could propose in education and other areas of the budget. He blamed a moderation of the economy that he otherwise said was strong and growing. He said the shortfall came largely from the impact of the sagging Asian economy along with aggressive spending and tax relief passed by the 1998 Legislature and Pete Wilson.

Education
The budget commits about $43 billion from all sources to public schools. That is an increase of $2.8 billion over 1998-99 and equates to 55 percent of California's total spending to educate 5.5 million students. Total per-pupil spending for 1999-2000 would climb to about $7,253, an increase of $494 since 1997-98 and $1,059 since 1996-97.

Reinforcing his pledge to strengthen K-12 education, Davis mapped out over 20 new and continued projects. The primary focus is to improve reading skills, enhance professional quality, and increase school accountability. Following are highlights and their pricetags that total $444 million, amounting to about 1 percent of all that is spent on 8,000 schools in some 1,000 districts.

Reading Initiatives: $186 million.
Intensive Reading Instruction Academies. According to Mr. Davis, children learn to read from kindergarten to the third grade. After that, they read to learn. He plans to spend $75 million to establish Intensive Reading Instruction Academies for K-4 students who lack reading skills. The courses will consist of six-week, four-hour-a-day sessions to be taught after school, on weekends and during summer school.

Governor's Reading Call to Action and Recognition Campaign. To reward schools that allocate more time to reading, he proposes $2 million to offer $5,000 awards to 400 schools that meet specified reading goals. Required reading books will be selected by the state superintendent of public instruction.

Other reading programs include: Classroom Library Purchases, K-4 ($25 million); Secondary School Reading Instruction ($5 million); English Language Learners ($60 million), and English Language Development Test ($14 million), and the Preschool Reading Development Guidelines ($1 million of federal funds).

Enhancing Professional Quality: $51.3 million.
Exemplary Teachers Merit Award. Mr. Davis plans to boost teacher proficiency by awarding $10,000 each to teachers who achieve National Board of Professional Teacher Standards certification.

Teacher Peer Review and Assistance. Approximately $16.8 million of new revenues will be used to allow teachers with exemplary teaching styles to be trained in peer review techniques to assist and evaluate fellow teachers. Principals will consider these reviews in teacher staffing plans. This project will be merged with the current Mentor Teaching Program, and will increase combined project funding to $100 million.

Other professional quality proposals include: Reading Professional Development Institutes ($12 million); Governor's Teacher Scholars ($500,000); Governor's Principal Leadership Institute ($500,000); Community Colleges Teacher and Reading Development Partnership ($10 million); Paraprofessional Teacher Training ($10 million), and the Teacher Credential Fee Waiver ($1.5 million).

Increasing Accountability: $206.3 million.
High School Exit Examinations. One of the governor's most controversial proposals is a plan to administer rigorous high school graduation exit exams that will be "second to none in America." The state Department of Education would receive $2 million to develop an exam that emphasizes reading, writing and arithmetic. Before high school diplomas are granted, public high school students must pass the examination. Gary Hart, Governor Davis' education secretary, said students can take the test numerous times during high school years, not just their senior year. The exam would "make the high school diploma more credible," Mr. Hart said.

Currently about 20 states have exit exams, and a half-dozen others have proposals to adopt them. State Superintendent of Public Instruction Delaine Eastin believes it is too soon to implement such a policy due to a lack of educational consistency. "This is something we could do in 10 to 12 years, when the kids who have entered the current, reformed system in kindergarten are exiting." Contrary to this belief, Stanley Rabinowitz, co-director of an education consulting group in San Francisco, believes "it is an evolution that brings California up to date with trends nationally."

School Accountability. The budget would provide $42 million for 200 California schools that scored at or below the 50th percentile of the 1999 State Testing and Reporting (STAR) test to participate in an effort to redesign their instructional programs. Performance would be based on an academic performance index to be developed by the state Board of Education to measure test scores, attendance rates, graduation rates, etc. Schools would have two years to accomplish goals, with cash bonuses going to successful schools. Those that fail would be subject to penalties ranging up to reassignment of teachers, probation for principals, formation of charter schools or even having the school or district shut down.

Mr. Davis told the Sacramento Press Club on January 14 that he wants a "tough, no-nonsense program that will ask responsibility of everyone." Starting in 2000, he said each school's test scores, attendance rates and graduation rates will be posted on the Internet.

High School Program Enhancement. This proposal would use federal funds to extend class-size reduction funding to ninth graders enrolled in specific English and mathematics courses. Classes would be limited to an average of 20 to 22 students.

Other programs to promote accountability include: Governor's Performance Awards for Schools ($150 million); Community Colleges High School Report Cards ($10.6 million), and the Middle College High Schools ($1.8 million).

Higher Education
There are several proposals to make California's public higher education institutions more accountable in their responsibility to provide well-trained teachers. One proposal is to renegotiate a compact (described as a funding and performance agreement) between the state and jointly with the University of California and the California State University systems to increase higher education standards and productivity.

Expiring this year, the current four-year compact, among other things, granted an annual 4 percent general fund increase to UC and CSU for meeting specific requirements and recommended future fee increases. However, the fee increases were offset by increased general fund allocations. Although the new compact proposes the same 4 percent yearly increase, it would limit fee increases to the annual rise in California per-capita personal income.

The governor also wants to promote accessibility and make college more affordable. He proposes $30 million to continue a 5 percent student fee reduction for another year, but he would increase UC and CSU non-resident tuition by 10 percent.

Mr. Davis compared 1999 to the mid-1970s, when policy-makers ignored property tax protests and the people revolted and passed Proposition 13. "We have to seize the moment," he said, adding that there are only two or three years to improve schools or the voters might pass a private-school voucher initiative "or some other seemingly attractive concept."

The Economy
Although described as strong and growing, the state's economy will expand at a moderate pace, according to the governor's forecast. Personal income growth is projected at 5.1 percent this year and 5.5 percent in 2000, down from 6.4 percent in 1998. Employment growth is expected to average 2.1 percent in 1999 and 2.4 percent the following year, compared to gains of about 3.25 percent in each of the past two years.

California is not immune from national and international economic woes. About 7 percent of California's gross product is sold to Asia, more than double the national proportion. The Asian recession has hurt high-technology manufacturing in California, costing about 15,000 jobs in that sector since last March. However, this decline has been offset by growth in high-tech services, including software for Year 2000 computer update demands.

State general fund revenue will experience a growth rate of 7.1 percent in the budget year ahead, although the underlying rate of growth is 4.7 percent. Non-economic factors accounting for the difference include the state's share of tobacco settlement money and sale of surplus property.

The forecast assumes 5 percent growth in capital gains in 1998 compared to 1997, when this source of revenue increased about 54 percent as a result of changes in federal and state tax law and large stock market gains. Personal income taxes are expected to total $28.5 billion in 1998-99 and exceed $30 billion in 1999-2000. Taxable sales are expected to grow 5.3 percent this year and 5.5 percent in 2000, compared to 5.6 percent in 1998, according to preliminary data.

The third major source of general fund revenue, the bank and corporation tax, is expected to produce $5.9 billion in the current year and $6.3 billion in the budget year. According to preliminary data, the level of profits for the 1997 income year was up 3.5 percent from 1996, and the tax liability was down by 0.9 percent. This is primarily due to usage of tax credits, largely the research and development credit and the manufacturers' investment credit, and S-corporation activity.

Taxes and Business
The governor noted that there has been significant tax incentive legislation passed to encourage business development over the past quarter-century since he came to Sacramento, first as then-Governor Jerry Brown's chief of staff. (The 1975-76 budget's general fund surpassed $10 billion for the first time.) During last year's campaign, Mr. Davis supported repeal of capital gains taxes for investments held at least five years, and he also supported additional research and development tax credits, plus a reduction in the annual tax the state charges companies to operate in the state.

Economic circumstances precluded any of these proposals in his first budget proposal, but the governor said Trade and Commerce Agency Secretary Lon Hatamiya will meet with business groups and other interested parties to review business tax laws with an eye toward supporting job-creating incentives for small and new businesses.

The governor also has announced that a task force will recommend priority projects to improve the state's infrastructure. He wants the business community represented on commissions focusing on education and global competitiveness. He also welcomed formation of California Business for Education Excellence, a coalition of businesses and associations, including Cal-Tax, that will participate in the process to produce quality education.

General and Special Fund Revenues (Dollars in Millions)   Actual   1997-98   Projected 1998-99 %   Change   Proposed 1999-00 %   Change Personal Income Tax $27,925 $28,526 +2.2% $30,175 +5.8% Sales & Use Taxes 19,555 20,673 +5.7% 21,829 +5.6% Bank & Corporation Tax 5,837 5,926 +1.5% 6,295 +6.2% Motor Vehicle License Fees 3,841 3,549 -7.6% 3,256 -8.3% Motor Vehicle Fuel Taxes 2,854 2,951 +3.4% 3,015 +2.2% Other Vehicle & Trailer Fees 1,776 1,824 +2.7% 1,850 +1.4% Insurance Tax 1,221 1,238 +1.4% 1,232 -0.5% Estate Taxes 780 838 +7.4% 878 +4.8% Tobacco Taxes 644 950 +47.4% 1,221 +28.6% Alcoholic Beverage Taxes 271 268 -1.2% 266 -0.5% Horse Racing Fees 84 61 -26.9% 39 -37.0% Regulatory Taxes & Licenses 1,970 2,016 +2.4% 2,090 +3.7% Fees For Services 997 1,061 +6.4% 1,083 +2.1% Other 1,582 1,536 -2.9% 2,154 +40.3% Total Revenues $69,336 $71,417 +3.0% $75,384 +5.6% Transfers 86 6   50   Adjustment to reconcile to           State Controller 2         Total Revenues & Transfers $69,424 $71,423 +2.9% $75,434 +5.6% Source: Governor's Budget Summary

General and Special Fund Spending (Dollars in millions) 1998-99 Estimate 1999-00 Proposed Change Percent Change Education $31,921 $34,117 $2,196 +6.9% K-12 Education  23,706 25,689 1,983 +8.4% Higher Education  8,215 8,428 213 +2.6%                Community Colleges 2,293 2,451 158 +6.9%                University of California 2,624 2,614 -9 -0.4%                Cal State University 2,776 2,791 15 +0.5%                Student Aid Commission 352 386 34 +9.7%                Other 170 186 16 +9.5% Health and Human Services 20,091 20,399 308 +1.5% CalWorks (Welfare Grants)  2,000 1,783 -216 -10.8% SSI/SSP  2,256 2,439 183 +8.1% Medi-Cal  7,399 7,330 -69 -0.9% Other  8,437 8,847 410 +4.9% Corrections 4,527 4,606 79 +1.7% Corrections  3,935 4,078 142 +3.6% Youth Authority  331 343 12 +3.6% Other  261 186 -75 -28.8% Tax Relief 1,022 1,618 596 +58.3% Resources 2,173 1,865 -308 -14.2% State & Consumer Services 936 926 -10 -1.1% Business, Transportation, Housing 4,495 5,351 856 +19.1% Trade and Commerce 156 51 -105 -67.2% Cal-EPA 677 623 -54 -7.9% Legislative, Judicial, Executive 2,201 2,302 101 +4.6% Other 5,208 4,662 -545 -10.5% Total of Departmental Budgets $73,406 $76,521 $3,115 +4.2% Miscellaneous Offsets -$205 -$305 -100 +48.7% PERS Deferral -105 -105 0 0.0% Unidentifiable Savings -100 -200 -100 +100.0% Grand Total $73,201 $76,216 $3,015 +4.1% Source: Governor's Budget Summary

Other Budget Goals
Governor Davis' budget highlights also include:

• State Employee Benefits. He pledged to increase salaries of state employees, most of whom have gone four years without a cost-of-living raise. Depending on collective bargaining, estimates of 1999 pay raises range from 2 percent to 4 percent. There also have been hints that the Davis administration will agree to improve state employee pension benefits, particularly if funds are not available for substantial pay raises.
• Another benefit to California workers is the governor's promise to restore overtime pay for working in excess of eight hours per day.
• Capital Investments. Since California's investment has declined over the past 30 years, the state's infrastructure has lagged behind its population growth. A preliminary report by the Director of Finance indicates that approximately $82 billion will be needed over the next 10 years to fund needed projects. As a result, the governor proposed a Commission on Building for the 21st Century to meet capital project needs. The initial goal is to make recommendations for a multiyear bond package on the ballot in 2000. Meantime, he has proposed $1.1 billion for capital outlay spending (excluding education and transportation). Mr. Davis is proposing $9.8 billion for roads and transportation projects.
• Public Safety. Revising the Citizens' Option for Public Safety (COPS) Program. Specifically, he proposes to earmark $100 million of COPS program funds to exclusively fund 700 officers.

1999-00 Governor's Budget General Fund Summary 1998-99 1999-00 % Change Prior Year Balance $3,076 $1,098   Revenues and Transfers $56,293 $60,272 7.07% Total Resources Available $59,369 $61,370 3.37%         Expenditures $58,271 $60,475 3.78%         Fund Balance $1,098 $895 -18.49%         Reserve for Liquidation of Encumbrances $480 $480           Special Fund for Economic Uncertainties (Budget Reserve) $618 $415 -32.85%   Source: Governor's Budget Highlights

Closing the Gap
Besides using the reserve, several funding sources are proposed.

• Rescheduling expenditures. The governor plans to postpone payments to various entities that implemented state-mandated projects. For example, he proposes to defer a $44 million payment to local governments for flood control projects.
• Refinancing capital projects. By using lease revenue bonds instead of pay-as-you-go general fund allocations, more than $220 million in short-term budget savings could be achieved. The cost of a project is more in the long run, however.
• Requesting more federal funding. The Davis Administration plans to ask the federal government for more money to pay for undocumented felons ($100 million), and health care costs, including $210 million from a change in the federal medical assistance percentage based on population estimates and $122 million for the Family Planning, Access, Care and Treatment Program (Family PACT). In all, California would seek an additional $430 million from the Clinton Administration and Congress.
• Securing tobacco settlement money. As an initial payment from the Master Settle Agreement with tobacco companies, Mr. Davis counts on California getting $560 million in the spring of 2000.
• Collecting more taxes. By hiring 58 Franchise Tax Board and 118 Board of Equalization staff to collect taxes, primarily from non-filers, the governor anticipates $37 million in additional revenues in the budget year, increasing to $59 million by 2002-03.
• Reducing trial court funding. By paying only half of the $96 million that was dedicated to the 23 smallest counties last year to pay for trial courts, the general fund will realize an approximately $48 million savings. The remaining 38 counties would be allotted $62 million.

Although some of these financial sources appear secure, others lack certainty. For example, former Governor Wilson usually got less than he requested in federal funding for the incarceration of undocumented felons. Because of political ties, the Davis Administration expects to have better results, but acknowledges that the additional prison money needs congressional approval. Moreover, the tobacco settlement revenues are iffy. The U.S. Health Care Financing Agency is seeking a portion of these funds. If this allotment is granted, funds to the states will be reduced. However, Davis says he plans to lobby the Clinton Administration on this issue.

Another significant Davis proposal is to restore a pre-1983 mechanism that would allow the Director of Finance to make quarterly spending adjustments to accommodate serious revenue shortages. The governor said 38 states have such a mechanism in place, and likened uncontrolled spending to a speeding train. With a "speeding train without brakes, you can't slow down until you crash."

- Ron Roach is director of communications at Cal-Tax and editor of Cal-Tax Digest. Lisa Martin is policy analyst at Cal-Tax. Steve Kroes is Cal-Tax vice president and director of research.