Jan. 9 (Bloomberg) -- California Governor Jerry Brown proposed a record $106.8 billion budget as state coffers brim with the biggest surplus in more than a decade, setting up a fight with fellow Democrats who want more spending.

The 75-year-old Brown, who may seek a fourth term this year, called for an 8.5 percent increase from current spending, with $11 billion to pay off loans that papered-over previous deficits, and $1.6 billion in reserves, while increasing funds for schools, welfare and health care for the poor. Brown also said he’ll back a constitutional amendment to stockpile unpredictable capital-gains taxes and deal with looming shortfalls in public pensions.

“This year the news is very good, but by no means are we out of the wilderness yet,” Brown said today at a briefing.“We must be very prudent in how we spend public funds.”

California has seen its fiscal health improve with higher income- and sales-tax levies Brown persuaded voters to approve in 2012, better-than-expected capital-gains revenue from profits in stocks and spending curbs under the governor last year.

Investors and credit-rating companies are watching to see whether Democrats use the money to prepare the biggest issuer of municipal bonds to better weather future downturns.

Democrats, who control the Legislature and can override a Brown veto, have their eyes on new programs. Senate President Pro Tem Darrell Steinberg of Sacramento, for instance, wants to expand transitional kindergarten to children as young as 4 years old, at a cost of almost $1 billion annually by 2020. That’s not included in Brown’s proposal.

‘Spend It’

“It is the nature of politics that when there is extra money, politicians will spend it,” said Tom Metzold, co- director of munis for Eaton Vance Management, speaking before the budget was released. The Boston-based firm oversees about $28 billion of city and state debt. “When there isn’t enough money, they cut to balance and we tend to let the pendulum swing too far in each direction.”

State and local governments are poised to increase spending this year, adding to the U.S. economic expansion, even as their federal counterpart cuts back. Outlays by state and local authorities will add about 0.2 percentage point to gross domestic product in 2014, according to a forecast by economists at Morgan Stanley in New York.

Issuing IOUs

California has seen a sharp turnaround from the past decade, when it was seen as ungovernable, facing budget gaps that exceeded $100 billion combined, and was forced to issue IOUs to pay bills.

“The state’s fiscal history is riddled with budgets that made permanent obligations -— both spending increases and tax cuts -— based on temporary revenue increases,” Brown said in an letter to lawmakers. “After these spikes in revenues disappeared -— as they always do -— the state was forced to cut programs and raise taxes.”

His budget projects that the state will have $6 billion of additional revenue in the fiscal year that begins July 1. It spends 9 percent more on schools and 10.5 percent more on public universities. Health and human services will get an additional $460 million.

Proposed Spending

Brown also proposed spending $500 million to build more prisons and local jails, and said he’d ask a panel of federal judges to grant a two-year extension to their deadline for California to reduce its inmate overcrowding.

The governor said he intends to pay off early the remaining $1.6 billion from the $15 billion of deficit bonds former Governor Arnold Schwarzenegger championed after voters ousted Democrat Gray Davis over his handling of state finances.

Brown proposed using $250 million from state-sold carbon allowance auction proceeds, required by law to be spent on greenhouse gas emissions-cutting efforts, to help jump-start construction of a high-speed rail line linking San Francisco and Los Angeles. He borrowed $500 million from the auction proceeds last year and plans to repay a fifth of that this coming year.

Brown estimates that the state owes as much as $217 billion in public-employee pension and health care costs. He dedicates none of the additional revenue toward that debt, including the $80 billion gap facing the California State Teachers’ Retirement System that, if left unattended, will leave the fund broke within 30 years. Brown said he intends to work with lawmakers this year to come up with a plan to pay down some of that liability.

Constitutional Amendment

The governor said he would push for a constitutional amendment similar to one proposed by Assembly Speaker John Perez, a Los Angeles Democrat, that would require the state to funnel surplus revenue from capital-gains taxes into a reserve fund to avert cuts when the economy sags.

It would to set aside excess funds when revenue from capital gains exceeds 6.5 percent of projections. Once the reserve tops 10 percent of general-fund spending, which pays for most basic services -- about $97.8 billion in the fiscal year that ends in June -- the excess could be spent on one-time needs.

The proposal would replace one already on the ballot. That plan, favored by Republicans and opposed by public-employee unions, would fill the reserve whenever all tax revenue exceeds 3 percent of general-fund spending. Democrats can alter the ballot measure using their two-thirds majority.

Credit Rating

The state’s fiscal turnaround led Standard & Poor’s last January to raise California’s credit rating to A, its sixth- highest level. It was the first time it lifted the state since 2006. Fitch Ratings followed in August with a boost to A, the state’s highest score from Fitch since 2009.

Investors demanded as little as 0.3 percentage point of extra yield to buy California debt instead of benchmark munis in October, the least since 2008, data compiled by Bloomberg show. The state’s bonds beat the $3.7 trillion local-debt market for a fourth straight year, the longest streak since 1999, S&P data show. While the whole market has lost 2.6 percent last year, California debt was down 1.8 percent.

As California’s credit ratings have been lifted and state officials began forecasting surpluses about a year ago, municipal investors have viewed the state as a safer bet, said Bud Byrnes, president and chief executive officer of RH Investment Corp., a municipal-bond trading company in Encino, California.

The perceived risk of California debt always was overblown, he said by telephone.

“Now we’re arguing over a surplus,” he said. “That’s a whole lot different than arguing over a deficit.”

Instant Insights /

Brown proposes record California budget of $106.8 billion

More From HR Executive

Related Stories

Recommended For You