The California Institute
For Federal Policy Research
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SPECIAL REPORT -- FY99 Budget

Volume 5, Bulletin 4 -- February 2, 1998

To expand communications between Washington and California, the California Institute provides periodic faxed bulletins regarding current activity on Capitol Hill which directly impacts our state. Bulletins are published weekly during sessions of Congress, and occasionally during other periods. The e-mail edition is made possible in part by a computer server donation from Sun Microsystems.



CONTENTS OF THIS ISSUE:

IMMIGRATION
SOCIAL SERVICES AND WELFARE
EDUCATION
FDA
TAXATION PROPOSALS
DEFENSE
RESEARCH, DEVELOPMENT AND SCIENCE
NASA
TRANSPORTATION
INTERIOR



SPECIAL EDITION -- FY1999 ADMINISTRATION BUDGET REVIEW

    While it is still too early to determine the full impact of every proposal on California, especially with regard to issues for which full details were not provided, the following discussion tries to assess the President's FY99 Budget proposals from a California perspective.  This analysis was prepared after only a few hours of analyzing more than two thousand pages of budget documents, thus this information is preliminary at best.
    Many new proposals are slated to be underwritten by revenues derived from a tobacco settlement, a process which may prove to be controversial.  The President assumes $10-16 billion per year in tobacco settlement funds as federal revenues over the next five years.  California would be impacted less by a tobacco tax than any other state -- California's 15% smoking rate is the lowest of any state and is well below the national average of more than 25%.
    The budget assumes a growth rate in the nation's economy of 2.0% through the year 2001, when it assumes a rise to 2.4%.   These levels do not differ substantially from those projected previously by the Congressional Budget Office.  Other of the Administration's economic assumptions are somewhat, though not significantly, more optimistic than those of CBO, including slightly lower long-term unemployment, moderately lower interest rates, and a slightly lower rise in the consumer price index, a measure of inflation.
    The President's budget can be accessed through the Government Printing Office website at: http://www.access.gpo.gov/su_docs/budget/index.html.

IMMIGRATION
    Incarceration Reimbursement -- As in the FY98 budget, the President's budget again proposes $500 million to reimburse the states for the costs of incarcerating undocumented criminal immigrants.  ($350 million would be funded under the State Criminal Alien Assistance Program, and $150 million under the Violent Offender Incarceration and Truth in Sentencing programs.)  Last year, through the efforts of the California congressional delegation, Congress appropriated $600 million for FY98, of which California is expected to receive over 50%.  However, California alone spends over $500 million annually to incarcerate undocumented criminal aliens.
    Border Control --  The budget again requests substantial increases in the INS budget to continue border control efforts.  The President is requesting an additional $103 million to increase by 1,000 the number of Border Patrol agents.  Another $109 million in additional funding is being requested for other border and enforcement enhancements, including improved identification and deportation of illegal aliens.
    Food Stamps -- The Agriculture Department's budget also includes $535 million to restore food stamp benefits to about 730,000 legal immigrants who lost these benefits under the 1996 welfare reform law.   Roughly 40% of the nation's legal immigrants reside in California.
    Children's Health Insurance -- Under the budget's proposal to expand health insurance coverage of children, the Administration proposes giving the states the option of covering legal immigrant children entering the U.S. after August 1996 under their Medicaid or Children's Health Insurance Program (see below).  The funding level requested is $25 million in FY99, growing to $65 million in FY03.

SOCIAL SERVICES AND WELFARE
    Children's Health Insurance Program -- The budget proposes expanding the Children's Health Insurance Program (CHIP), established under the Balanced Budget Act (BBA) of 1997, to provide health insurance to low-income children.  An additional $24 billion over five years will be available to the states to pay for this coverage.  States submitting an approved plan will receive an enhanced federal Medicaid matching rate.  California, which has already submitted its plan, will be eligible to receive a federal matching rate of 65%, rather than the 50% it currently receives.  The budget proposal will also give the states the option of covering legal immigrant children who entered the United States after August 1996.
    In addition, the budget proposes $900 million over five years for a children's health outreach program to identify those children currently eligible, or made eligible under the CHIP program, who are not enrolled in Medicaid.  Presently, states have the option of using "qualified entities," such as Head Start Programs to determine presumptive eligibility for Medicaid.  Under the Administration's budget, states would be able to expand qualified entities to include other organizations, such as public schools, and child care resource and referral centers.
    Medicaid -- The budget, however, also proposes reducing from 50% to 47% the Federal match rate for Medicaid administrative costs, on the basis that states will begin to charge Medicaid for administrative costs that were formerly charged to Aid to Families with Dependent Children, and are now included in the TANF block grants.
    Disproportionate Share Hospital allotments, which were reduced under the BBA, would not increase under the Administration's budget.
    Child Care --  The budget also calls for expanding the Child Care and Development Block Grant by $7.5 billion over five years to help low- and moderate-income parents meet child care costs.  Funds would be allocated to the states based on a matching formula and distributed by them to families to help pay for child care provided by relatives, neighbors, and day care homes and centers.  California's 2.7 million children under the age of five constituted 14.2% of the nation's total, significantly above the state's 12% of the population.
    TANF Funding for the Temporary Assistance to Needy Families program is requested at $17 billion, an increase of $298 million over last year.
    Head Start -- Head Start funding is requested at $4.7 billion, an increase of $305 million from FY98.   The proposal calls for the addition of 30,000-36,000 more children to the program, to bring total enrollment to about 860,000 children.  Despite a large share target children, California historically has received a relatively low percentage of Head Start funds, roughly 11.4% in 1996.  The program will be examined soon by Congress.

EDUCATION
    The President's FY99 budget calls for a 5.9% increase in funding for the Education Department, from $29.4 billion last year to $31.2 billion.  Among the major funding requests are:
    Title I and Poverty Programs -- Title I grants (education for the disadvantaged) would increase by $392 million to a total funding level of $7.8 billion, if the President's budget became law.  The entire increase in funding would be allocated through Concentration Grants and Targeted Grants.  In addition, $442 million would be allocated for other programs aimed at urban and rural schools in high poverty areas to help improve the quality of teaching, recruit more teachers, and encourage college enrollment.
    With more than 20% of its children living in poverty, and housing 15% of the nation's poor children, California should be a significant recipient of Title I money.  However, factors in the formula for distributing Title One funds have historically worked to reduce California's share of Title One funding (10.8% in 1996).  A scientifically-sound effort to end the use of outdated poverty data figures was foiled last year by opportunistic Senators from shrinking states.  A National Academy of Sciences review of another alternative counting method is expected later this year.
    Class Size Reduction -- The President's budget calls for a $1.1 billion initiative to hire and train 100,000 new teachers over seven years to reduce class size to an average of 18 pupils in grades one through three.  In 1996-97, California began reduction of class sizes to no more than 20 students for grades K-3, and last year expanded the program to the fourth grade.  The proposal also calls for $20 billion in interest-free bonds for new school construction.  California, however, is limited in its ability to pass bond measures because of high voter approval thresholds.
    Upgrading Technology -- The budget requests $666 million for various programs aimed at improving technology accessibility and use in elementary and secondary schools. $475 million would be allocated to the Technology Literacy Challenge Fund for the purchase of computer hardware and software, access to the Internet, and training teachers in the use of technology.
    Bilingual and Immigrant Education -- The budget requests $232 million for bilingual education programs, an increase of 17% over last year.  The Bilingual Education Professional Development program would be doubled from $25 million to $50 million to fund certified bilingual education and English-as-a-second-language teachers.  California has among the most varied student home language bases of any state.  The budget also proposes maintaining the recent increase to $150 million for the Immigrant Education formula grant program, roughly one-third of which comes to California.
    Student Assistance Programs  -- A total of $51 billion in financial aid is requested, up $2 billion over FY98.  An increase of $249.1 million is requested for the Pell Grant program to up the maximum award of grants to students from $3,000 to $3,100.  At a total funding level of $7.6 billion, the program would be able to make grants to over 3.9 million low-income students.  In addition, $900 million, an increase of $70 million, is requested for the work-study program.
    Vocational Education and Rehabilitation -- $1.2 billion is requested for Vocational Education Basic Grants, and $106 million for Tech-Prep Education, which funds programs linking secondary and postsecondary, and vocational and academic instruction to prepare individuals for high-tech careers.  Funding for Vocational Rehabilitation State Grants of $2.3 billion is requested, roughly the same as last year's funding.
    School-To-Work -- $250 million is requested for the School-to-Work Opportunities program to bring together educators, businesses, and others in the community to design new education programs that link classroom work to future careers.

FDA
    The Food & Drug Administration's program level would increase 18% from $1.063 billion to $1.25 billion.  The increase is mainly targeted to food safety issues and the youth tobacco prevention initiative.  The budget also includes about $281 million from user fees, such as those authorized under the Prescription Drug User Fee Act (PDUFA), which helps fund additional personnel to expedite the drug approval process.  California is home to one third of the nation's biomedical industry.

TAXATION PROPOSALS
    Section 127 Education Assistance Exclusion -- Under certain circumstances, educational assistance provided by an employer to an employee is excluded from the employee's gross income for tax purposes.  Last year's budget limited the exclusion to expenses up to $5,250 for undergraduate courses only.  The President's request this year would extend the exclusion to cover graduate degree courses as well.  This expansion is very important to California's high technology industry where continuing advanced education is critical.  The undergraduate exclusion would cover courses beginning before June 1, 2001; the graduate level exclusion would only apply to courses begun after June 30, 1998 and before June 1, 2001.
    R&D Tax Credit -- The budget proposes to extend for one more year (from 7/1/98 through 6/30/98) the tax credit for Research and Experimentation (a.k.a. research & development).  The proposal, however, does not request a permanent extension which would grant greater security in making long-term R&D decisions to companies eligible for the credit.  Nevertheless, a one-year extension would be beneficial to California, which has a high concentration of research-intensive companies.
    Foreign Source Income - - Generally, when a U.S. manufacturer sells products abroad, half of the income generated is considered domestic source (earned in production activities, etc.) and half of the income is considered foreign source and, thus, subject to a foreign source tax credit.  However, the taxpayer can use a method more favorable than this 50/50 rule if it shows that more than half of its economic activity occurred in a foreign country.  The President's budget states that this benefits U.S. multinationals over U.S. exporters that conduct all their business activities in the U.S.  The budget proposes to change this rule to reduce the amount of export sales income that multinationals may treat as foreign source income by requiring that the allocation be based on actual economic activity.  The proposed change would be effective for tax years beginning after the date of enactment.
    Tax Credit for Employing Welfare Recipients -- The budget proposes to extend for one year, until May 1, 2000,  the tax credit given to employers who hire welfare recipients.  The credit is 35% of the first $10,000 in wages paid in the first year, and 50% of the first $10,000 in wages paid in the second year of employment.  California is home to 20% of the nation's welfare recipients.
    Child Care -- The budget proposes raising the maximum child and dependent care tax credit for individual taxpayers from 30% to 50%, and would create a 25% tax credit for employer-provided child care up to $150,000 per year.  California has a large and fast-growing population of children aged 0-5.  In 1996, California's 2.7 million children under the age of five constituted 14.2% of the nation's total -- well above our 12% share of the nation's overall population.
    Low Income Housing Tax Credit -- The budget proposes increasing the low-income housing tax credit from $1.25 per capita to $1.75 per capita.  Because of California's high housing values, the ceiling on the credit has been a significant problem for the state and an increase would be advantageous -- the state has received four times as much demand for the tax credit than it has had in available funds.  An Ensign- Rangel bill, H. R. 2990, would authorize an increase to the $1.75 per capita level but would also index that level for inflation.
    Semiconductors -- The budget proposes a 10% tax credit for semiconductor manufacturers who install systems to recover or recycle 99% of certain greenhouse gases.  California would be poised to make good use of this credit due to its large semiconductor industry.
    Energy Efficient Homes -- The Administration proposes a 1% tax credit (up to $2,000) for the purchase of a highly energy efficient home, though California's high housing values may limit the incentive to purchasers in the state.

DEFENSE
    The FY99 Department of Defense budget is proposed at $257.3 billion, while the overall national defense budget, including the defense portion of DOE, would total $270.6 billion.  This would represent a slight increase over the FY98 appropriated level of $267.6 billion, though a decline of 1.1% in real terms when adjusted for inflation, and is roughly the same current-dollar level as in 1997.
    Procurement -- Budget authority for Pentagon procurement is proposed to rise from $44.8 billion to $48.7 billion in 1999, and would rise significantly in out years, to $54.1 billion in 2000, and would remain above the $60 billion level from 2001 to 2003.  Despite aerospace cutbacks, California continues to win a large share of federal defense procurement contracts.  Included in procurement spending is a boost in the Air Force accounts for airlift aircraft (including the California-built C-17) from $1.7 billion to $2.6 billion.
    DOD Research -- DOD accounts for research, development, testing and evaluation (RDT&E) would see a slight decline under the 1999 Administration budget, followed by a larger drop for the following three years.  Basic research would receive some increase in 1999, but development would decline by a larger amount. (Interestingly, while DOD development would decline, development accounts at NIST are slated for an increase.)
    Base Closures -- Echoing requests made previously, the Pentagon stated its desire for further base closings, with a first round in 2001 and a second in 2005.  California bore the brunt of the first four rounds of base closings, shouldering 60% of the nation's net job reductions despite having only 15% of the nation's personnel when the closure rounds began in 1988.

RESEARCH, DEVELOPMENT AND SCIENCE
    Science, research, development, and related subjects are a primary focus of the Administration's FY99 budget.
    Defense -- In contrast to boosts in other research, defense R&D would decline slightly in 1999 to $36.1 billion under the President's budget and would drop below $34 billion for 2000 through 2002.  California receives as much as 25% of defense R&D spending, so this decline would be a blow to the state's defense industry and research universities.
    National Science Foundation -- The NSF is proposed to receive an increase from $3.5 billion in 1999, rising slowly to $4.3 billion by 2003.  California receives more than 15% of NSF funding.  Among the increases proposed in the NSF budget is a 30% boost for infrastructure support in the physical and mathematical sciences, which may be used for a Caltech/MIT project known as LIGO, or the Laser Interferometer Gravitational Observatory.
    National Institutes of Health -- The budget proposes to increase the budget authority for the National Institutes of Health (NIH) by $1.15 billion in 1999, from $13.6 to $14.8 billion, and would eventually see the level rise above $20 billion by 2003.  California is home to one third of the U.S. biomedical industry and the state houses some of the nation's premier medical research universities.  Both sectors could benefit from increased NIH spending.
    Fusion -- Unfortunately, the president's budget proposes to decrease federal fusion research expenditures from $232 million in FY 1998 to $228 million in FY 1999, and would then project it to decline to $200 million by FY 2003.  Even last year's figure is well below the mid-90's high water mark for fusion, which was more than $350 million.  California is a perennial winner of fusion funding.  The budget documents specify a commitment to support the DIII-D program and the ITER (International Thermonuclear Experimental Reactor) program, both of which are California based.
    National Ignition Facility -- The Department of Energy's weapons activities would receive a substantial increase in the 1999 budget request, from $5.3 billion to $5.6 billion.  These accounts include the National Ignition Facility which is under construction at Lawrence Livermore National Laboratory.
    Energy Science -- The energy sciences budget would increase from $2.27 billion to $2.49 billion, including a $13 million increase (from $678 million to $691 million) for the high energy physics program, a substantial portion of which goes to the Stanford Linear Collider and the B-Factory at the Stanford Linear Accelerator Center.  A large increase is proposed for basic energy sciences, which would rise from $665 million to $836 million in FY1999.

NASA
    The National Aeronautics and Space Administration (NASA) would receive $13.5 billion under the Administration's FY99 proposal, a slight cut from $13.6 billion the year before, but much less of a decline than had previously been feared.  It has been estimated that California receives between 20% and 30% of NASA spending.
    At NASA, the budget assumes a slight decline in funding for space science, level funding for the space station, and a slight increase in the space shuttle program.  The space science account includes funds for the continuation of the Cassini mission to Saturn and the Space Infrared Telescope Facility (SIRTF).  A substantial cut is proposed for NASA's earth sciences account, from $1.6 billion to $1.37 billion.
    NASA's aeronautics and space transportation technology budget is slated for a decrease of more than $100 million, from $1.42 billion to $1.31 billion.  Text comments suggest that the Administration may assume an increase in industry participation in the funding for this category, which includes the X-33 and X-34 reusable launch vehichle demonstrators.  The Administration notes its desire to set aside $760 million in placeholder funds in the outyears to pursue new vehicles based on the outcome of these programs.
    The NASA Ames Research Laboratory in Sunnyvale is reported slated to receive a $48 million increase in funding, some of which will be applied to the SOFIA (Stratospheric Observatory for Infrared Astronomy) project, an airborne infrared telescope mounted inside a modified Boeing 747.

TRANSPORTATION
    Congress let the nation's transportation and mass transit laws expire at the end of FY97 without adopting a similar long-term authorization measure to take its place.  ISTEA distributed federal dollars to the states for the national highway system, mass transit, congestion mitigation and air quality programs, highway safety programs, demonstration projects, and a state infrastructure bank pilot program.  In lieu of a long-term reauthorization measure, Congress adopted a short-term measure that allowed states to use their unobligated balances and appropriated $5.5 billion in new transportation spending.  The ISTEA extension expires 87 days from today on May 1, 1998.
    The President's FY99 budget follows the federal transportation system ISTEA set into place and its funds are allocated according to the Administration's ISTEA reauthorization proposal, NEXTEA.  Overall, the budget proposes over $43 billion for Department of Transportation programs.
 
 FEDERAL HIGHWAY ADMINISTRATION -- The President's budget calls for continued funding of the Federal-aid Highways programs including the Surface Transportation Program, the National Highway System, Interstate Maintenance, the Bridge Program, and the Congestion Mitigation and Air Quality Improvement Program.  Proposed obligation limitations for the Federal-aid Highway programs is $23 billion, the same amount enacted for these programs for FY98.  The following are some budget issues of particular interest to California:
    Donor State Bonuses --  Again, the President's budget calls for the elimination of the Donor State Bonus.  No funding for this program was provided in FY98.  California pays a little over 10%, the most of any state, of all the money paid into the Highway Trust Fund which funds the nation's highway and transit programs.  The bonus is a formula equity tool which apportions funds to states that will contribute more to the Highway Trust Fund than they will receive in allocations.  In FY96, California received almost $102 million, approximately 23.5% of the total distributed as bonuses.  As funding equity remains an issue in the ISTEA debate, proposals to address problems faced by donor states will need to be addressed.
    Congestion Mitigation and Air Quality Improvement (CMAQ) The Department of Transportation proposes an increase in funding for meeting national standards for clean air.  One of the California ISTEA Task Force's goals, the President's FY99 budget proposes $1.26 billion for CMAQ, up slightly from the $1.25 billion appropriated for FY98.  Given that California received about 15% of federal CMAQ dollars in FY96, increased CMAQ funding is good news for California.
    Demonstration Projects -- The President's FY98 budget called for almost $300 million in cuts for surface transportation demonstration projects, however, California has historically received only about 5.7% of the demonstration project dollars.  The FY99 request calls for a new program to fund nationally significant transportation projects through a $100 million Transportation Infrastructure Credit Enhancement Program.
    State Infrastructure Banks -- Created as a pilot program under ISTEA, State Infrastructure Banks (SIBs) were designed to support bond financed projects and to attract state, local, and private sources of capital to increase investment in the nation's surface transportation infrastructure.  Picked by the Department of Transportation as one of ten states in 1996 to try this innovative finance technique, California is working to create the Transportation Finance Bank (TFB).  Since 1996, the SIB program has expanded to 39 states.  Congress appropriated $150 million in FY97 but only $6 million in FY98.  The President's budget request $150 million from the Highway Trust Fund (previous appropriations came from the general fund) to expand the program for FY99.
    Border Infrastructure --  Though ISTEA established no specific program to fund border and trade-related transportation infrastructure, states could use Motor Carrier Safety Assistance Program (MSCAP) funds and federal-aid for some capital investments and enforcement initiatives to construct and repair transportation border infrastructure.  Between 1991-1996, California has received on average 5.3% of MSCAP funds.  With the state's present and future economy closely involved in trade, and the present burdens on California's border infrastructure resulting NAFTA, many border states argued for a designated trade and border infrastructure program that would allow the costs of trade agreements to be borne nationally.  The President's FY99 budget proposal creates a second $45 million program dedicated to border infrastructure, in addition to the Administration's NEXTEA proposed border and trade infrastructure program, to match FY98 funding of $90 million.  Moreover, the Administration proposes $100 million in budget authority ($67.5 million grant program for strategic safety investments; $7.5 million incentive grants for states with effective commercial vehicle safety programs) for the Motor Carrier Safety Program, a $15 million increase over FY98.
    Research and Technology -- The President's FY99 budget proposal includes almost $500 million for the Intelligent Transportation Systems Program (ITS) and other research improvement programs.
    Emergency Relief -- Given California's propensity for earthquakes, floods, and fires, all federal disaster programs have immediate relevance for the state.  The Administration's proposal provides $100 million for the FHWA program that funds the repair of federal-aid highways and bridges damaged in natural disasters.  However, in recent fiscal years, Congress has appropriated additional funds to meet needs in excess of the budgeted amount.  In FY 97 and FY98, Congress provided a combined $800 million in supplemental federal aid.

 FEDERAL TRANSIT ADMINISTRATION -- Down slightly from FY98 (about 1.3%), the President's FY99 budget calls for almost $4.8 billion in spending for transit programs.  Of the 18.4 cent per gallon federal gas tax, a 2.85 cent portion is allocated for the mass transit account of the highway trust fund.  Transit funds are distributed by grant and by need.  The President's FY99 budget plans to distribute $3.6 billion through formula programs for transit capital expenses (in areas under 200,000 population the formula funds may also be used for operating expenses).  The Administration proposes combining current discretionary programs for buses and the fixed guideway modernization program under the formula program, and expanding the definition of capital to include preventive maintenance to give maximum flexibility for transit operations.
    Over the last six years, California has received about 14% of federal transit dollars.  A shift away from federal transit funding or a change in its allocation could alter California's share of federal transportation funding.  The following are some of the major proposals regarding federal transit funding:
    Major Capital Investments -- The Administration's budget will reduce budget authority for discretionary projects in FY99 from the amount appropriated in FY98.  The President's proposal provides $876 million in new funding, amounting to a little over $1.2 billion to fulfill federal commitments to projects, almost cutting in half the amount of funds distributed by discretionary grant in FY98.  Funding proposals for California projects are:
    BART/SFO Airport Extension -- $100,591,375 ($29.9 million appropriated in FY98)
    Los Angeles MOS-3 Project  -- $100 million ($61.5 million in FY98)
    Sacramento LRT Extension    --  $24,129,556 ($20.3 million in FY98)
    San Jose Tasman LRT Project -- $38,669,214 ($21.4 million in FY98)

    Access to Jobs and Training -- The Administration also proposes a $100 million grant program for states, local governments, and non-profits to plan and provide transportation services to assist people moving from welfare to work.
    National Transit Planning and Research Programs -- $44 million is requested in funding for programs designed to develop innovative transit technologies and support the Transit cooperative Research program, the National Transit Institute, and University Transportation Centers.

INTERIOR
    Headwaters Forest -- The budget singles out the acquisition of 7,500 acres of old-growth redwoods and adjacent lands in the Headwaters Forest in Humboldt County as a "high priority" for the Administration and shows $114 million for FY99 and $228 million for FY98 for completing this and other Department of Interior land acquisitions.
    Bay-Delta -- The President's proposal again calls for full funding of the Bay Delta restoration proposal at $143.3 million.  However, last year Congress only appropriated $85 million, based on concerns that the plans for implementing the restoration project were not sufficiently developed to ensure that the full funding level could be spent.
    Salton Sea -- There is no line item request for funding to clean up the Salton Sea.  At its briefing, Interior stated that there is money available in the general budgets of the Fish and Wildlife Service and the  Bureau of Land Management to cover funding if Congress should pass authorization and appropriations legislation on it this year.

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