Proposition 2 (the “Rainy Day Fund”) would amend the State Constitution to change how the state pays down debt and saves money in reserves.

BACKGROUND

The state has had budget reserve accounts for many years. It currently has two principal General Fund reserve accounts:

Special Fund for Economic Uncertainties (SFEU)

Article XIII B, Section 5.5 of the California Constitution directs the Legislature to establish a “prudent” reserve that it deems reasonable and necessary. However, the Constitution does not specify the size of the reserve or the conditions under which funds must be placed into the reserve.

The reserve for 2013-14 was included at $1.1 billion in the adopted budget, and later reduced to approximately $700 million based on additional budget actions related to corrections. This general reserve is known as the SFEU.

Budget Stabilization Account (“BSA”)

In 2004, voters passed Proposition 58 to create a new reserve. Currently, Prop. 58 requires the Governor each year to decide whether to let 3% of General Fund revenues (known as the “basic” amount, currently just over $3 billion) go into the BSA reserve. In any year, the Governor can choose to reduce the basic amount and put less or nothing at all into the BSA. Under Prop. 58, these amounts continue to go into the BSA each year until the balance reaches a target maximum, which currently equals $8 billion. (Therefore, it would take three years of the basic amount going into the account for the BSA to reach its maximum level.)

The state can take money out of the BSA with a majority vote of the Legislature. Right now, there is no limit on how much the state can take out of the BSA in a single year.

Education Reserve

Prop. 2 would also create a distinct budget stabilization fund known as the “Proposition 98 Reserve” or Public School System Stabilization Account (PSSSA). The PSSSA would be funded by a transfer of capital gains-related tax revenues in excess of 8% of General Fund revenues. Funds would be appropriated from the PSSSA when state support for K-14 education exceeds the allocation of General Fund revenues, allocated property taxes, and other available resources.

Though Prop. 2 changes when the state would spend money on schools and community colleges, it does not directly change the total amount of state spending for schools and community colleges over the long run.

LOCAL SCHOOL DISTRICT RESERVES

State law requires school districts to keep minimum reserves, though many districts keep reserves that are much bigger than these minimum levels. For most school districts, the minimum reserve ranges from 1% to 5% of their annual budget, depending on their size. School districts save money in reserves for several reasons, such as paying for large occasional expenses (like replacing textbooks) and addressing the uncertainty in future state funding.

If Prop. 2 passes, a new state law would go into effect to set a maximum amount of reserves that school districts could keep at the local level, while the current minimum reserve levels would continue in effect. (Therefore, district reserves would have to be between the minimum and the maximum in these years.) For most school districts, the maximum amount of local reserves under this new law would be between 3% and 10% of their annual budget, depending on their size, a level lower than certain districts currently maintain. This new law would apply only in a year after money is put into the state reserve for schools described above.

It should be noted that the setting of maximum reserves is not part of Prop. 2 itself, but rather was included in a budget trailer bill, which is subject to future legislative change. Very recently several state legislators attempted to introduce new legislation to reverse the budget trailer bill impact on school reserves, but so far this effort has not been successful.

LAO REPORT

The Legislative Analyst’s report indicated that when in a year capital gains-related taxes exceed 8% of total General Fund revenues, then a portion of this excess goes into both (a) the Budget Stabilization Account and (b) the Public School System Stabilization Account. First, a calculation is made as to how much of this excess is allocable to education under the provisions of Prop. 98, and that amount would be eligible to go into the PSSSA if a transfer into that reserve is made for the particular year. The remaining amount of the excess over 8% would be part of the BSA transfer.