MOORLACH UPDATE — Masking Fiscal Problems — December 10, 2018

The audited financial statements for California’s municipalities should be publicly released soon, if not already, for the fiscal year ended June 30, 2018.

This year’s Comprehensive Annual Financial Reports (CAFRs) will now include the unfunded liability for retiree medical benefits. This may take the independent Certified Public Accounting firms performing the audits a little more time as they acquire the actuarial documentation to support the amounts to be reported on the balance sheets.

Aren’t you glad you have a CPA as your State Senator? The two CAFRs I’m most anxious to see are the ones for LAUSD and the State of California (which is usually released in late March).

Why LAUSD? Because it has the largest unrestricted net deficit of any California school district, at $10.9 billion (see MOORLACH UPDATE — Los Angeles County School Districts — December 2, 2018). And reporting the retiree medical unfunded liability on the balance sheet means it will increase LAUSD’s deficit by another $15 billion (see https://reason.org/commentary/los-angeles-unified-school-district-unfunded-retiree-health-benefit-liability-nears-15-billion/).

R Street understands the magnitude of this serious fiscal dilemma at all levels below that of the state of California and provides its perspectives on the upcoming budget forecast in the piece below (also see MOORLACH UPDATE — Optimistic Budget or Not? — November 18, 2018).

A recent Patch piece is referred to (see MOORLACH UPDATE — Public Schools Financial Crisis — November 3, 2018). It mentions California’s Financial Crisis & Management Assistance Team (FCMAT). Our research is indicating those school districts that utilize FCMAT for emergency loans usually request amounts that are at a minimum two times, with most multiple times more, the size of their unrestricted net deficits.

Oakland Unified’s unrestricted net deficit in 2003 was $48.7 million when it was loaned $100 million. South Monterey County Joint Union High’s unrestricted net deficit was less than $2 million when it borrowed $13 million.

It looks like LAUSD will have an unrestricted net deficit of $25 billion! If it comes to the state for a loan from FCMAT, where will Sacramento find $50 billion to lend it?

Of course, previous emergency FCMAT loans were made when CAFRs did not include pension and retiree medical unfunded liabilities. So, maybe the loan amount will be lower. But, even if the loan is for the 2017 net unrestricted deficit of $10.9 billion, the amount will be staggering. It makes me wonder, should the teachers union for LAUSD really be contemplating a strike when its district is on the ropes? And, will LAUSD then suck all the air out of California’s projected surplus?

Surplus masks deep fiscal problems, especially in school districts

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Steven Greenhut

Western Region Director, State Affairs

https://www.rstreet.org/2018/12/10/surplus-masks-deep-fiscal-problems-especially-in-school-districts/

As Gov. Jerry Brown heads into the sunset, he leaves California’s general-fund budget in remarkably sound shape, according to an analysis last month from the nonpartisan Legislative Analyst’s Office. “It is difficult to overstate how good the budget’s condition is today,” the LAO reported, pointing to a $14.5 billion reserve by the end of next year and touting an additional $14.8 billion in funds that can be used for myriad budget commitments in the new session. “By historical standards, this surplus is extraordinary,” it added. Such good news is indeed unusual and extraordinary.

The governor’s critics have rightly picked some nits with this good-news story. If there’s so much available cash, they ask, why did the governor last year increase gasoline taxes and vehicle-license fees? Brown led the charge for a 2012 proposition (Prop. 30) that boosted sales and income taxes, but economic growth had pushed budget surpluses above the amounts collected by the new taxes. Yet tax increases remain state lawmakers’ first-reach answer to every problem – with little effort expended on stretching the dollars the state already receives.

But there’s a bigger concern beyond Democratic lawmakers’ budgeting priorities and reliance on tax hikes. The real question: Should Californians really be so optimistic about the fiscal health of the state government? We’re all happy to see the surplus, but the answer is no — largely because it’s a mirage. The budget surplus doesn’t take into account the size of California’s unfunded pension and medical liabilities for public employees. Those debts are accounted for separately and that picture is decidedly less optimistic. The problem keeps getting worse because lawmakers continue to ignore it, preferring to instead bask in the more superficial good news.

“We literally owe trillions that isn’t being discussed,” explained Todd Royal, in a recent column in Fox and Hounds Daily. “Just the estimated payments on public employee pensions in California will increase from $31 billion in today’s dollars to $59 billion in 2024; and this number is based on non-recessionary conditions or a major correction in the stock market. And California immediately needs $800 billion to over $1 trillion worth of infrastructure repairs, upgrades and new construction.” He pointed to estimates from the California Policy Center last year pegging the total state and local debt for bonds, pensions and other post-employment benefits at $1.3 trillion, which is more than half of California’s Gross State Product.

For even more sobering news, state Sen. John Moorlach, the Costa Mesa Republican best known for predicting Orange County’s 1994 bankruptcy, released a study documenting the dire financial conditions facing California’s school districts. “About two-thirds of California’s 944 public school districts run negative balance sheets,” he explained in an October report. That amounts to 85 percent of California’s school districts. “This simple metric shows the most distressed districts could soon reach a tipping point into insolvency and receivership.” That compares to the approximately two-thirds of California cities and 95 percent of counties with negative balance sheets. Several school districts, including Los Angeles Unified, Fresno Unified, San Diego Unified and Santa Ana Unified are in “severe distress,” according to the senator’s analysis.

As a reporter for Patch noted, “Moorlach’s report focused on the Unrestricted Net Position (UNP), an accounting function contained on a school district’s balance sheet portraying what is essentially the net worth of its general fund – the account from which it pays salaries, benefits, administrative costs, maintenance of school buildings and other general operating expenses such as insurance, consulting services and travel.” Some critics dismissed that accounting measure by noting that it has little impact on a district’s day-to-day operations, but Moorlach argued that this is an important measure for determining the degree to which unfunded liabilities are crowding out public services.

Under Proposition 98, the state promises a particular amount of funding to K-14 school districts based on a formula. The Legislative Analyst’s Office also analyzed school budgets and was somewhat less optimistic than it was regarding the general-fund budget. It predicted a 3.1 percent increase in funding in the coming year and offered this caution: “The volatility of the minimum guarantee, the possibility of a recession sometime after 2019 20, and the lack of funding in the state school reserve are all reasons the Legislature might wish to budget cautiously in the upcoming year.”

Caution is a key word for the incoming Legislature, which will be more strongly Democratic than the outgoing Legislature after the blue wave crashed in California during the recent midterm elections. Democrats will hold solid supermajorities in the Senate and Assembly and are likely to face renewed pressure for increased spending, higher salaries and benefits for public employees, and on new programs that will involve the hiring of many more state workers.

Whenever the state has a budget surplus, powerful public-employee unions seek higher pay and benefits for their members. Yet the surplus, however welcome and impressive, pales in comparison to the off-budget liabilities and debts. The fiscal good news is a relief, but must be viewed in context. If state lawmakers are unwilling to address the unfunded liabilities, they should at least do no harm – and not use the surpluses as an excuse to go on a spending spree that makes the state’s long-term financial problems even more difficult to solve.

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