McGeorge School of Law

Proposition 57

Analysis of Proposition 57:

The Economic Recovery Bond Act of 2004

By Dean Okimoto
JD, McGeorge School of Law, University of the Pacific
to be conferred December 2004
B.A., Mass Communications, University of California at Berkeley, 1999

Copyright © 2004
by University of the McGeorge School of Law

 

Table of Contents

I. Executive Summary
II. The Law
III. Drafting Issues
IV. Constitutional Issues
V. Public Policy Considerations
VI. Conclusion

I. Executive Summary

Proposition 57, the Economic Recovery Bond Act of 2004, would allow California to remove from the books the currently authorized $10.7 billion deficit-financing bond and carryover 2002-03 deficit. Legislative Analyst's Office, Proposition 57, The Economic Recovery Bond Act). The Act, if adopted would authorize a one-time sale and issuance of bonds in an amount not to exceed $15 billion for the purposes of financing the accumulated state budget deficit. Cal. Assembly 9, 2003 Reg. Sess. 2 (December 12, 2003).

Proposition 57 follows the authorization of a $10.7 billion deficit-financing bond. Legislative Analyst's Office. The $10.7 billion bond was enacted in response to California's General Fund chronic shortfalls between revenues and expenditures since 2001-02, when the economic and stock market downturns caused state revenues to sharply decline. Id.

The goals of the $10.7 billion bond were to "wipe the slate clean" and eliminate the cumulative budget deficit that would have been present at the end of 2002-03. Id. This would allow California to avoid the more severe budget actions that would have been necessary to eliminate the deficit all at once. Id. With California facing another large budget shortfall in 2004-05, Proposition 57's goal is to take off the books the $10.7 billion deficit-financing bond and the carryover 2002-03 deficit. Id.

The repayment of the currently authorized $10.7 billion bond would be based on a multiple-step financing process that "freed up" a revenue stream dedicated exclusively to repayment of the bond. Id. It would result in annual General Fund costs equivalent to one-half cent of the California's sales tax, or about $2.4 billion in 2004-05, and increasing moderately each year thereafter, until the bond is paid in full. Id. Proposition 57 would provide the same bond repayment method as described above, except that the amount of revenues diverted would be equivalent to one-quarter cent of the state sales tax, instead of the one-half cent. Id. The full cost of the bond would continue to be borne by the state's General Fund. Id. Lastly, Proposition 57 would become effective only if Proposition 58 of 2004 on the March 2, 2004, direct primary election is also approved by the voters. Id.

II. The Law

A. Existing Law

1. Background

Proposition 57 is part of a continued response to eliminate California's General Fund cumulative budget deficit. Id. California's General Fund budget assists a variety of programs, including public schools, higher education, health, social services, and prisons. Id. The General Fund has experienced major shortfalls between revenues and expenditures since 2001-02, when the economic and stock market downturns caused state revenues to decline sharply. Id. To deal with these shortfalls, policymakers have reduced program spending, raised revenues, and taken a variety of other measures. Id. Also, the policymakers have engaged in various forms of borrowing from special funds, local governments, and private credit markets. Id.

The major action taken to deal with the projected current-year (2003-04) budget shortfall was the authorization of a $10.7 billion deficit-financing bond. Id. The purpose of the $10.7 billion bond was to "wipe the slate clean" and eliminate the cumulative budget deficit that would have been present at the end of 2002-03. Id. This would allow California to avoid the more severe budget actions that would have been necessary to eliminate the deficit all at once. Id. With California facing another large budget shortfall in 2004-05, Proposition 57's goal is to take off the books the $10.7 billion deficit-financing bond and the carryover 2002-03 deficit. Id.

2. AB 7X (Oropeza)

Assembly Bill 7X (Oropeza) authorized the issuance of up to $10.7 billion of Fiscal Recovery Bonds. Cal. Sen. Rules. Comm., Analysis of AB 9, at 1 (December 12, 2003). These bonds are backed by a temporary half-cent sales and use tax that is scheduled to go into effect on July 1, 2004. Id. However, the AB 7X bonds do not have the general obligation guarantee, and do not require voter approval. Id. Furthermore, debt service payments from the Fiscal Recovery Fund on the AB 7X bonds are subject to annual appropriation. Id.

Also, AB 7X reduces the local Bradley-Burns sales and use tax by a half-cent, while the temporary state tax is in effect. Id. at 1-2. AB 1766 (Assembly Budget Committee), also enacted as part of the 2003-04 California State Budget, replaces the temporarily reduced local sales and use tax revenue with property tax revenue shifted to cities and counties from schools. Id. at 2. In return, the State of California will make schools whole with increased General Fund support, as Proposition 98 required. Id. Ultimately, the cost of repaying the AB 7X bonds is borne by the General Fund. Id. This funding mechanism applies to this bill (Proposition 57), but with the reduced tax shift from one-half cent to a quarter cent. Id.

Lastly, according to the Assembly Third Reading analysis, these Fiscal Recovery Bonds authorized by AB 7X have not been issued. Id. at 4. The bonds are subject to a legal challenge by the Pacific Legal Foundation, which could delay the issuance of these bonds until 2004-05, or may be prevent their issuance entirely. Id.

B. The Effects of Proposition 57

Assembly Bill 9 (Oropeza) authorized Proposition 57 to be submitted to the voters at the March 2, 2004, statewide primary election. Cal. Assembly 9, 2003 Reg. Sess. 3. Voter approval of Proposition 57 would result in the State Treasurer selling up to $15 billion of state general obligation bonds for the purpose of providing financing to the General Fund for the state's cumulative budget deficit as of June 30, 2004, the cost of other General Funds obligations incurred prior to that date, and issuance costs. Cal. Sen. Rules. Comm., Analysis of AB 9, at 2. Furthermore, Proposition 57 requires the State Department of Finance Director to certify the amount of the accumulated California State Budget deficit, and other prior obligations. Id.

Further, Proposition 57 provides that the bonds authorized may be used to refund any Fiscal Recovery Bonds issued under the provisions of AB 7X, enacted as part of the 2003-04 budget. Id. Also, this bill provides that the $15 billion authorized in bonds will be reduced by the amount of any outstanding AB 7X bonds that are not refunded, and by the amount of any state Pension Obligation Bonds, authorized by SB 29X (Senate Budget and Fiscal Review Committee) that have been sold. Id.

Moreover, Proposition 57 provides that principal and interest on the deficit bonds will be paid from the Fiscal Recovery Fund established by AB 7X, enacted as part of the 2003-04 California State Budget. Id. The Fiscal Recovery Fund will also receive revenue from the temporary state sales and use tax that was imposed by AB 7X. Id. On July 1, 2004, the temporary sales and use tax goes into effect. Id. Revenue deposited into this fund cannot be used for any other purpose. Id.

Also, contingent to voter approval, this bill will reduce the rate of the temporary state sales and use tax dedicated to repayment of the deficit bonds from a half-cent to a quarter-cent. Id. at 2-3. Further, this bill will decrease the related temporary reduction in the rate of the local Bradley-Burns sales and use tax from a half-cent to a quarter-cent. Id.

Moreover, this bill pledges the sales and use tax revenues in the Fiscal Recovery Fund to the repayment of the deficit bonds, and provides that the California Legislature may elect to deposit additional revenues into the Fiscal Recovery Fund. Id. at 3. Further, this bill pledges to bondholders that while any bonds are outstanding, the State of California will not reduce the rate of the temporary tax deposited in the Fiscal Recovery Fund. Id.

Furthermore, this bill includes a general obligation backup guarantee that if revenue in the Fiscal Recovery Fund is insufficient to fully pay the principal and interest on the authorized bonds, then the General Fund will make these payments. Id. Also, this bill appropriates revenue in the Fiscal Recovery Fund (or the General Fund if necessary) for principal and interest payments for the authorized bonds, as well as any related costs of establishing reserves, ancillary obligations, and trustee or administrative costs. Id.

Additionally, this bill will end the temporary quarter-cent sales and use tax when all of the bonds authorized under Proposition 57, and any bonds issued under AB 7X have been repaid, or the Fiscal Recovery Fund contains sufficient revenue to fully pay all outstanding bonds. Id.

This bill also establishes a bond committee chaired by the Department of Finance Director, and includes the Governor (or their designee), the State Treasurer, the State Controller, the Secretary of the Business, Transportation, and Housing Agency, the Director of the State Department of Transportation, and the Director of the State Department of General Services. Id.

This bill provides that the bond authorization will become operative only if the voters approve this bond act at the March 2, 2004, statewide primary election, in conjunction with the approval of both a constitutional amendment allowing the sale of bonds to finance the accumulated budget deficit, and Proposition 58, which imposes spending limits, reserve and balanced-budget requirements, and establishes a mid-year budget correction process. Id.

Proposition 57 allows the California State Treasurer to issue and sell $15 billion in bonds to reimburse the General Obligation Bond Expense Revolving Fund. Cal. Assembly 9, 2003 Reg. Sess. 8. The bonds, when sold, will constitute a valid and binding obligation of the State of California, and the full faith and credit of the State of California will be pledged for the payment of both the principal and interest that become due and payable from the bonds. Id. Also, the bonds, when sold, will be secured by a pledge of revenues and any other amounts in the Fiscal Recovery Fund. Id. In other words, these voter approved general obligation bonds of the State of California are called "double barrel bonds." Telephone Interview with Dan Rabovsky, California State Assembly Budget Committee Staff (January 29, 2004) (notes on file with the McGeorge School of Law, University of the Pacific, Capital Center for Government Law and Policy). These "double barrel bonds" have two forms of security: one, the bonds are the general obligation of the State California; thus, the State of California will back up the payment and interest of the bonds issued. Id. Two, the bonds have a dedicated revenue source in a form of a tax to pay off the payment and interest of the bonds that are issued. Id.

The bonds authorized by Proposition 57 shall be prepared, executed, issued, sold, paid, and redeemed in accordance with the State General Obligation Bond Law. Cal. Assembly 9, 2003 Reg. Sess. 9. Successive issues of bonds may be authorized and sold to fund those actions progressively, and it is not necessary that all of the bonds authorized be issued and sold at any one time. Id. at 10. The principal and interest on the bonds and the payment shall be payable from, and secured by, a pledge of all state sales and use tax revenues in the Fiscal Recovery Fund. Id. To the extent that moneys in the Fiscal Recovery Fund are insufficient to make these payments, there shall be collected each year in the same manner and at the same time as other state revenue is collected, in addition to the ordinary revenues of the state, a sum in an amount required to pay the principal and interest on the bonds for which payment is authorized and for which the full faith and credit of the State has been pledged. Id. Proposition 57 provides that all money deposited in the Deficit Recovery Fund, that is derived from accrued interest on bonds sold, shall be reserved in the fund and be available for transfer to the Fiscal Recovery Fund as a credit to expenditures for bond interest. Id. at 11.

Bond financing is a type of long-term borrowing the State of California uses to raise money for various purposes, such as to retire the current budget deficit. California Secretary of the State, Bond Overview, An Overview of State Bond Debt. The state acquires this money by selling bonds to investors. Id. In exchange, the State agrees to repay the principal with interest at a later time. Id. Traditionally, the State has used bonds to finance major capital outlay projects such as roads, educational facilities, prisons, parks, water projects, and office buildings. Id. However, the State has recently used bond financing to help close major shortfalls in its General Fund budget. Id.

General Fund-supported bonds, such as general obligation bonds are paid off from the State's General Fund, which is largely supported by tax revenues. Id. These bonds must be voter approved, and their repayment is guaranteed in the California State Constitution. Id. The State of California's cost for using bonds depends primarily on their interest rates, and the time period the bonds are repaid. Id. For example, most general obligation bonds are repaid over a 30-year period. Id. Assuming current tax-exempt interest rates for such bonds are about 5.25 percent, the cost of repaying the bonds over 30 years will be about $2 for each dollar borrowed; that is $1 for the dollar borrowed and $1 for interest. Id. However, this cost is spread over a 30 year period, so the cost after adjusting for inflation will be about $1.25 for each $1 borrowed. Id.

III. Drafting Issues

There does not appear to be any significant drafting issues. However, in the text of Section 7 of Proposition 57, a severability clause is provided. Cal. Assembly 9, 2003 Reg. Sess. 21. This clause effectuates the severance of provisions that are held to be invalid from the valid provisions. Thus, if an initiative contains a section that is found to be invalid, the court will look to three factors in determining whether the invalid provision(s) can be properly severed from the rest of the bill. Gerken v. Fair Political Practices Comm'n, 6 Cal. 4th 707 (1993). In order to sever the invalid provision(s), the provision(s) must be grammatically, functionally, and volitionally separable. Id.

Here, Proposition 57 contains numerous provisions; thus, it would be difficult to determine whether any of the provisions may be properly severed. Notwithstanding Proposition 57 containing numerous provisions, it appears that Proposition 57 is drafted very well, because most of the provisions refer to existing law. Therefore, even if Proposition 57 contained provisions that are severable, it is unlikely that there will be any challenge.

IV. Constitutional Issues

A. Federal Constitution

Proposition 57 does not raise any federal constitutional issues.

B. State Constitution

On its face, there does not appear to be any state constitutional issues expressly raised by Proposition 57. However, there are three issues of interest that will be discussed.

1. General Obligation Bond

A general obligation bond is "a bond secured by the full faith and credit of the issuing government and backed by revenues from its taxing power." Black's Law Dictionary 179 (6th ed. 1990). California Constitution Article XVI, Section 1.5 allows the California State Legislature to create and establish a "General Obligation Bond Proceeds Fund" in the State Treasury, and provide for the proceeds of the sale of the general obligation bonds to be paid into or transferred to the "General Obligation Bond Proceeds Fund." Cal. Const. art. XVI, § 1.5.

In addition, Section 1.5 of Article 16 of the California Constitution provides that accounts shall be maintained in the "General Obligation Bond Proceeds Fund" of all moneys deposited in the State Treasury to the credit of that fund, and proceeds of each bond issue shall be maintained as a separate and distinct account, and be paid out only in accordance with the law authorizing the issuance of the particular bonds from which the proceeds were derived. Cal. Const. art. XVI, § 1.5. Further, Section 2 of Article 16 of the California Constitution, provides that each measure providing for the preparation, issuance, and sale of bonds of the State of California shall be submitted to the electors in the form of a bond act or statute. Cal. Const. art. XVI, § 2.

Proposition 57 appears to adhere to the California Constitution. Proposition 57 provides that the bonds in the total amount of $15 billion may be issued and sold to provide a fund in order to carry out the purposes of Proposition 57, and to reimburse the General Obligation Bond Expense Revolving Fund. Cal. Assembly 9, 2003 Reg. Sess. 8. Proposition 57 adheres to Section 1.5 of Article XVI of the California Constitution, because in drafting AB 9 the Legislature created and established a Fiscal Recovery Fund in the form of a General Obligation Bond Expense Revolving Fund for the handling of the proceeds from the issuance of the bonds.

Finally, Proposition 57 complies with Section 2 of Article XVI of the California Constitution, because Proposition 57, which provides for the preparation, execution, issuance, and sale of bonds in California, is submitted to the electors in a form of a bond act at the March 2, 2004, statewide primary election. Id. at 3.

2. Single Subject Rule

California Constitution Article II, Section 8(d) states that an initiative measure can embrace only a single subject, or it cannot be submitted to the voters. Cal. Const. art. II, § 8(d) (West 2002). In Legislature v. Eu, 54 Cal. 3d 492 (1991), the California Supreme Court has interpreted the Constitution's single subject rule broadly, holding that so long as the provisions of an initiative are reasonably related to a common theme or purpose, the measure does not violate the single subject rule. In Legislature, the State Supreme Court found that Proposition 140, the Political Reform Act of 1990, did not violate the single subject rule, because the three separate reforms of the proposition were all aimed at the general goal of incumbency reform. Id. The Court stated the issue was not whether each section will be functionally effective, but whether the sections were reasonably germane to the single subject of incumbency reform. Id. at 514.

The provisions of Proposition 57 do not appear to violate the single subject rule. The goals of Proposition 57 are to take off the books the $10.7 billion deficit-financing bond and the carryover 2002-03 deficit. Legislative Analyst's Office. Furthermore, Proposition 58, the California Balanced Budget Act of 2004, which authorized this bond to be within the "single object or work" for which the Legislature may create debt is separately drafted, submitted to, and needs to be independently approved by the voters at the March 2, 2004, statewide primary election. Cal. Assembly Const. Amend. 5, 2003 Reg. Sess. 2 (December 12, 2003).

Although Proposition 57 encompasses a reduction in the amount of revenues diverted from one-half cent to one-quarter cent of the state sales tax, it can be argued that this tax reduction does not fall within the same subject. Further, a reduction in sales tax is not included in this proposition's title, and its relation to an economic recovery bond act is less apparent and even seems to be contrary to the purpose of this Act. On the other hand, diverting sales and use tax revenues for the issue and sale of the deficit bonds is reasonably germane to the repayment of the deficit bonds. Therefore, Proposition 57 does not violate the single subject rule.

3. Urgency Statute

Urgency statutes go into effect immediately upon their enactment. California Constitution Article IV, Section 8(d) defines such statutes as those "necessary for immediate preservation of the public peace, health or safety." Cal. Const. art. IV, § 8(d) (West 2002). Further, it is required that a statement of facts constituting the urgency of such act to be set forth in the text of the bill itself. Id. The California Supreme Court recognized that the Legislature generally takes a liberal view as to what falls under the equally broad classifications of "public peace, health, or safety." Rossi v. Brown, 9 Cal. 4th 688 (1995). Further, the State's high court has found a number of other statutes to be "urgent" within the meaning of the constitutional provision. Id.

Here, the urgency clause in Proposition 57 is set forth in the actual text of AB 9 on page 21. Cal. Assembly 9, 2003 Reg. Sess. 21. Section 9 of AB 9 states the facts constituting the necessity are: "[i]n order to provide funds necessary to reduce the accumulated budget deficit, it is necessary that this act take effect immediately." Id. Because California's General Fund budget assists a variety of programs, such as public school, health and prisons, it can be inferred that California's budget serves the interests of public peace, health, or safety. Furthermore, the voter approved bonds will provide the funds necessary to reduce the accumulated budget deficit, because otherwise the State of California will have to cut funding that goes towards programs for the public peace, health or safety, in order to help reduce the accumulated budget deficit. Therefore, under a liberal view, this statement of facts may suffice to meet the constitutional requirements.

V. Public Policy Considerations

A. Proponents

Proponents of Proposition 57 claim that the State of California government spending is out of control. California Secretary of the State, California Official Voter Information Guide, Analysis of Prop. 57 The Economic Recovery Bond Act of 2004, Arguments and Rebuttals (accessed January 29, 2004). Over the past three years, the State of California spending has significantly exceeded state revenues. Id. Proposition 57, the California Economic Recovery Bond Act will consolidate the state deficit and allow California to get its finances in order, without raising taxes. Id.

Furthermore, Proposition 57 will keep the State of California from running out of money, and will prevent drastic cuts in spending on vital programs, such as education and health care. Id. However, Proposition 57 will not take into effect unless the California voters also approve Proposition 58, the California Balanced Budget Act, which prohibits borrowing to pay deficits ever again, and requires enactment of a balanced budget. Id. Proposition 58 also provides for a fund of up to $5 billion that can be used to pay these bonds off early that Proposition 57 seeks to be approved. Id. Proposition 58 also provides for a reserve of at least $8 billion, which may be used to prevent future deficits. Id.

Last year, $12.9 billion in bonds to retire the accumulated budget was approved by the State. Id. However, the courts have declared one bond issuance to be unconstitutional, and the other bond issuance is under a legal challenge due to the bonds not being approved by the voters. Id. During this time, the State of California has accumulated a large budget deficit. Id. Proposition 57 will legally allow the issuance and sale in order to balance the budget deficit with the approval of the voters. Id.

Without voter approval of Proposition 57, the State of California may be out of money by June 2004. Id. To deal with such a substantial financial problem in a short time frame, the only choices will be to drastically raise taxes. Id. Proposition 57 will allow the State of California to refinance its inherited debt, and give the State time to deal with its ongoing structural deficit. Id. Proposition 57 is the only way to ensure California's financial future. Id.

Together Proposition 57 and Proposition 58 will provide California's leaders the tools necessary to restore confidence in the financial management of the State. Id.

Proponents of Proposition 57 include Superintendent of Public Instruction Jack O'Connell, the California Taxpayers' Association, State Controller Steve Westly, the California Chamber of Commerce, and Governor Arnold Schwarzenegger. Id.

B. Opponents

Opponents argue that the proponents contradict themselves, because they say that spending is out of control. At the same time, the proponents do not want to cut it. Id. Further, the proponents claim that California is already billions of dollars in debt. Id. However, out-of-control borrowing has made California the lowest credit rated state in the nation, which is on par with many Third World countries. Id. Moreover, Proposition 57 will plunge California $15 billion deeper in debt, plus billions more in interest. Id. Furthermore, Proposition 57 will cost an average family more than $2,000 in total debt service. Id.

The opponents also contend that Proposition 57 will buy nothing. Id. It does not pay for a single school, road or park. Id. It does not put a single police on the street or relieve traffic congestion. Id. Proposition 57 merely papers over the huge deficit that Sacramento's politicians created. Id. Rather than cutting the waste from government bureaucracy, and targeting fraud for elimination, the proponents have decided to use the biggest bond in California's history to cover their addiction to spending. Id.

Opponents state that since 1849, California's Constitution has forbidden bonds such as this one from being used to paper over deficit spending. Id. Long-term bonds are supposed to be used for projects that will serve the future generations, such as schools, parks, highways, and water plants. Id. In order to qualify this unprecedented borrowing on the ballot, the same politicians also propose repealing this historic constitutional amendment, and call this new amendment "a balanced budget amendment." Id.

Five years ago, $57.8 billion was spent from California's General Fund. Id. Next year, $90.2 billion will be spent from the General Fund. Id. Rather than an additional billion dollar service debt to the state budget every year for the life of the bond, California needs to suspend their spending mandates, and restore the power that the Governor had from 1939 to 1983 to make mid-year spending reductions. Id.

Sacramento received an important message on the October 7, 2003, election: no new taxes. Id. A no vote on Proposition 57 sends Sacramento another strong message, stop borrowing, stop over-spending, and put the State of California's finances back in order. Id.

The opponents include Senator Tom McClintock and Senator Bill Morrow. Id.

VI. Conclusion

On March 2, 2004, the California State voters will determine whether to enact Proposition 57, the Economic Recovery Bond Act of 2004. Proposition 57 would take off the books the $10.7 billion deficit-financing bond and the carryover 2002-03 deficit. Legislative Analyst's Office . Further, Proposition 57 would authorize a one-time sale and issuance of bonds in an amount not to exceed $15 billion. Cal. Assembly 9, 2003 Reg. Sess. 2.

Public policy considerations warrant voter attention, such as California plunging $15 billion deeper in debt, and the fact that Proposition 57 does not buy any tangible items, such as a school, road or park. California Secretary of the State . Rather, all Proposition 57 does is pay off an already owed debt. Id.

However, if the voters approve Proposition 57 in March, this bond act will consolidate the state deficit and allow California to get its finances in order, without raising taxes. Id. If voters do not approve Proposition 57, then the State of California will have to drastically raise taxes and cut vital state funded programs. Id. Therefore, programs such as education and health care may be cut, and taxes may be raised in order to get the State of California out of its current deficit.

The voters of California must remember, Proposition 57 will not take into effect unless they also approve Proposition 58, the California Balanced Budget Act, as well.