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THE ECONOMIC RECOVERY BOND ACT
Legislative Bond Act

THE QUESTION

Should the state of California borrow 15 billion dollars ($15,000,000,000) through the sale of bonds to provide financing for California's budget deficit?

BACKGROUND

California's Recent Budget Problems. California's General Fund budget supports a variety of programs, including public schools, higher education, health, social services, and prisons. The General Fund has experienced chronic shortfalls between revenues and expenditures since 2001-02, when the economic and stock market downturns caused state revenues to decline sharply. To deal with these shortfalls, policymakers have reduced program expenditures, raised revenues, and taken a variety of other measures. They have also engaged in various forms of borrowing from special funds, local governments, and private credit markets.

Deficit-Financing Bond. One of the key actions taken to deal with the projected current-year (2003-04) budget shortfall was the authorization of a $10.7 billion deficit-financing bond. The purpose of this bond was to "wipe the slate clean" and eliminate the cumulative budget deficit that would have existed at the end of 2002-03. This would allow the state to avoid the more severe budget actions that would have been necessary to eliminate the deficit all at once. The repayment of the currently authorized bond would be based on a multiple-step financing process (see box, "Repayment of Deficit Bonds," for details). It would result in annual General Fund costs equivalent to one-half cent of California's sales tax--or about $2.4 billion in 2004-05 and increasing moderately each year thereafter--until the bond is paid off (in about five years).

This deficit bond is currently being challenged in court and has not yet been issued. (In the meantime, the carryover 2002-03 deficit is being financed through short-term borrowing, which is due to be repaid in June 2004.)

Projected Shortfall in 2004-05. The state is facing another large budget shortfall in 2004-05, which we estimate will be in the general range of $15 billion. This estimate assumes that the currently authorized $10.7 billion deficit-financing bond is sold and that the carryover 2002-03 deficit is thereby taken off the books. Absent the bond proceeds from this sale, the budget shortfall would be much larger.

PROVISIONS

This proposition puts before the voters authorization for the state to issue a bond of up to $15 billion to deal with its budget deficit. The bond authorized by this measure would be used in place of the deficit-financing bond authorized last year by the Legislature.

Repayment of Proposed Bond. The repayment of the bond would result in annual General Fund costs equivalent to one-quarter cent of California's sales tax revenues, compared to costs equivalent to one-half cent of sales tax revenues for the currently authorized bond. In addition, certain funds transferred to the state's Budget Stabilization Account (created in Proposition 58 on this ballot, if approved) would be used to accelerate the repayment of the bond. The measure includes a backup guarantee that if the sales tax revenues dedicated to the bond are insufficient to pay bond principal and interest in any year, the General Fund will make up the difference.

This measure would become effective only if Proposition 58 on this ballot is also approved by the voters.

Note: The currently authorized $10.7 billion deficit bond does not require voter approval or have any general obligation guarantee, and its debt service payments are subject to annual appropriation by the Legislature. Proposition 57 authorizes the sale of a general obligation bond. General obligation bonds require approval by the voters; their repayment is guaranteed in the state Constitution and is not subject to annual approval.

For more information about bond financing, the state's current debt situation, and the impact of the bond propositions on this ballot, see "An Overview of State Bond Debt" on page 5.

FISCAL EFFECT

The fiscal effects of the proposed bond are summarized in Figure 1, and compared to the currently authorized deficit-financing bond. The proposed bond would result in near-term budgetary savings compared to the bond authorized in current law, but added annual costs over the longer term. Specifically:

Near-Term Savings. The proceeds from the proposed bond would be up to $4 billion more than from the currently authorized bond. This would provide the state with up to $4 billion in additional one-time funds to address its budget shortfall. The state would also realize near-term savings related to debt service on the bond. This is because the payments would be based on one-quarter cent of annual sales taxes instead of one-half cent. As a result, annual General Fund costs would be one-half of the currently authorized bond for the next few years.

Longer-Term Costs. The near-term savings would be offset by higher costs in the longer term. This is because the proposed bond would be larger ($15 billion versus $10.7 billion) and it would take longer to repay. As indicated in Figure 1, the proposed bond would likely take between 9 and 14 years to pay back, compared to a 5-year period for the currently authorized bond.

WHAT A YES OR NO VOTE MEANS

A YES vote means the state could sell $15 billion in bonds to pay existing budgetary obligations.

A NO vote means the state would not sell $15 billion in bonds but could instead sell $10.7 billion in bonds as previously authorized by the Legislature to pay a smaller level of existing budgetary obligations.

SUPPORTERS SAY

• The California Recovery Bond and the California Balanced Budget Act, Proposition 58, together will give California's leaders the tools necessary to restore confidence in the state's financial management.
• Without this bond, California may be out of cash by June. The only choice will be to drastically increase taxes. Proposition 57 will let us refinance our inherited debt and give the state time to deal with its ongoing structural deficit.
• For three years, state government spending has significantly exceeded revenues, creating a deficit. This measure will consolidate the deficit and allow California to get its finances in order without raising taxes.
• Proposition 57 will keep the state from running out of money and prevent drastic cuts in vital programs like education and health care.
• This bond act will not take effect unless Proposition 58, the California Balanced Budget Act, is approved, prohibiting any further borrowing to pay deficits. Proposition 58 also provides for a fund of up to $5 billion to pay these bonds off early and a reserve of at least $8 billion to prevent future deficits.

OPPONENTS SAY

• Since 1849, California's Constitution has forbidden bonds like this from being used to paper over deficit spending. In order to put this unprecedented borrowing on the ballot, politicians propose repealing this historic constitutional provision and have the audacity to call it "a balanced budget amendment."
• Five years ago California spent $57.8 billion from its general fund. Next year, it will spend $90.2 billion. We need to rein in spending.
• Our state is billions of dollars in debt. California has the lowest credit rating in the nation because of its out-of-control borrowing. Proposition 57 plunges us $15 billion deeper in debt plus billions more in interest. Total debt service from Proposition 57 will cost an average family more than $2000.
• Proponents contradict themselves. They say spending is out of control, but at the same time say they don't want to cut it.
• Long-term bonds usually pay for building projects that will serve coming generations. This bond doesn't buy a single school, road, or park.

SUPPORT AND OPPOSITION

Official ballot arguments in support are signed by Arnold Schwarzenegger, Governor, State of California; Larry McCarthy, President, California Taxpayers' Association; Allan Zaremberg, President, California Chamber of Commerce; and Carl Guardino, President, Silicon Valley Manufacturing Group.

Official ballot arguments in opposition are signed by California State Senator Tom McClintock and California State Senator Bill Morrow.

FOR MORE INFORMATION

Supporters

Join Arnold, 916-442-7757, www.joinarnold.com

Opponents

Senator Tom McClintock, 916-448-9321, tommcclintock.com

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