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Fiscal Outlook Report Released

LAO Projects Another $2 Billion Drop in Proposition 98 Minimum Guarantee for 2011-2012, Followed By Rebound

November 11, 2010

Editor’s Note: The California Legislative Analyst’s Office (LAO) released a report titled “The 2011-12 Budget: California's Fiscal Outlook” on Wednesday. The report included the following section on Proposition 98 funding.

State budgeting for K–14 education is governed largely by Proposition 98, passed by the voters in 1988. The measure, later modified by Proposition 111 in 1990, establishes a minimum funding requirement, commonly referred to as the “minimum guarantee,” for K–14 education. Both state General Fund and local property tax revenues apply toward meeting the minimum guarantee. Proposition 98 monies support child care, preschool, K–12 education, and the California Community Colleges — accounting for about 70 percent of total funding for these programs. (K–14 education funding also comes from the federal government, other state sources, and various local sources.)

Calculating the Minimum Guarantee

The Proposition 98 minimum guarantee is determined by one of three tests set forth in the Constitution. These tests are based on several inputs, including changes in K–12 average daily attendance, per capita personal income, and per capita General Fund revenue. Though the calculation of the minimum guarantee is formula driven, a supermajority of the Legislature can override the formulas and provide less funding than the formulas require. This happened in 2010–11, with the Legislature suspending Proposition 98 and providing less funding than otherwise required. As a result of the suspension, the state created an out–year Proposition 98 obligation referred to as a “maintenance factor.” When growth in state General Fund revenues is healthier (as determined by a specific formula set forth in the Constitution), the state is required to provide additional funding (make a maintenance factor payment) to build up K–14 funding to the level it otherwise would have been absent the earlier reduction. In essence, the maintenance factor allows the state to attain near–term savings without affecting the long–run level of K–14 support.

Proposition 98 Forecast

Minimum Guarantee Drops in 2011–12 Before Rebounding

The top part of Figure 2 shows our projections of the Proposition 98 minimum guarantee throughout the forecast period. For 2011–12, we project the minimum guarantee will be about $2 billion lower than the 2010–11 spending level due to the expiration of tax increases that temporarily raised tax revenues in 2009–10 and 2010–11. For the rest of the forecast period, we project steady increases in the minimum guarantee of $2 billion to $3 billion each year. Local property tax revenues modestly grow each year of the forecast period. In the last year of the forecast period, we project the Proposition 98 minimum guarantee and local property tax revenues would finally be higher than their pre–recession levels.

Fig2_Prop98

Maintenance Factor Obligation Grows in 2011–12, Remains Large Throughout Period.

Figure 2 also shows both how much maintenance factor is created or paid in each year of the forecast period and the total amount of outstanding maintenance factor. As shown in the figure, we estimate the state will have an outstanding maintenance factor obligation of $9.5 billion at the end of 2010–11. Using the same maintenance factor assumptions as used to build the last three Proposition 98 budgets, $4 billion in new maintenance factor would be created in 2011–12 — resulting in a total outstanding obligation of about $14 billion. During the remainder of the forecast period, the state would make relatively small maintenance factor payments each year. Because maintenance factor obligations grow (akin to an inflationary adjustment) and the required payments are small, we project the state would end the forecast period still having an outstanding maintenance factor obligation of more than $13 billion.

Baseline Costs Much Higher Than Available Resources in 2011–12, Can Be Covered Thereafter.

The bottom part of Figure 2 compares our projection of the year–to–year change in the Proposition 98 minimum guarantee with the amount needed to fund annual increases in baseline costs. As shown in the figure, the minimum guarantee would fall $5.2 billion short of fully funding baseline K–14 costs in 2011–12. (This shortfall would be a few hundred million dollars higher if the Legislature chooses to restore the California Work Opportunity and Responsibility to Kids [CalWORKs] Stage 3 child care program vetoed by the Governor this year.) That is, if the state funded at the minimum guarantee level in 2011–12, school districts and community college districts would face significant programmatic reductions. As shown in the figure, this is due to the decline in Proposition 98 funding in 2011–12 coupled with the cost of backfilling for the loss of one–time 2010–11 budget solutions. These reductions would occur at the same time as school districts exhaust one–time revenues from the federal American Recovery and Reinvestment Act (ARRA) of 2009 and the Education Jobs and Medicaid Assistance Act of 2010. In every subsequent year of the forecast period, the minimum guarantee funding level would be sufficient to cover growth and COLA and still have $1 billion to $2 billion to restore prior budget reductions. By 2015–16, the minimum guarantee would grow to sufficient levels that all growth and COLA costs could be paid and any reductions made in 2011–12 could be restored. Funding would be insufficient, however, to restore reductions made in 2008–09, 2009–10, and 2010–11.

Settle–Up Assumed to Be Paid in Installments Throughout Forecast Period.

For 2009–10, the state provided $1.8 billion less than the minimum guarantee—creating a “settle–up” obligation of that amount. Additionally, for 2010–11, we assume a new $256 million settle–up obligation is created as a result of the Governor’s veto of Stage 3 child care funding (consistent with the administration’s intent). The 2010–11 budget contained a $300 million first payment toward retiring the 2009–10 settle–up obligation. Consistent with this action, we assume the state continues to make $300 million annual payments throughout the forecast period—fully retiring the settle–up obligations in the last year of the forecast.

Major Proposition 98 Issues

We believe the Legislature should be mindful of several major issues as it begins to develop a Proposition 98 budget strategy for the coming fiscal year.

Unresolved Maintenance Factor Issues Quickly Reemerge.

As we discussed in our Analysis of the 2010–11 Budget: Proposition 98 and K–12 Education, conflicting interpretations of the constitutional provisions of Proposition 98 led to uncertainty over the amount of maintenance factor owed at the close of 2008–09. Specifically, disagreement existed regarding whether a maintenance factor was created when Test 1 applied and was lower than Test 2. The 2009–10 Budget Act resolved the issue by declaring that a maintenance factor obligation was created in 2008–09. Current law, however, does not clarify how this situation should be addressed in future years. In our forecast, this particular scenario reemerges in 2011–12, with the state potentially creating a maintenance factor obligation of $4 billion in 2011–12. (As indicated above, our forecast assumes a maintenance factor is created.) Differences of opinion also exist with regards to how maintenance factor payments should be calculated (either on top of the Test 2 level or the Test 1 level, if higher). This particular scenario reemerges in 2012–13, with an impact of about $900 million. (Our forecast assumes the lower Proposition 98 estimate, consistent with the manner in which the minimum guarantee was calculated in the 2009–10 and 2010–11 budgets.)

Potential Reductions on Horizon Suggest Rethinking Recent Deferrals.

Given the potentially sizeable drop in the minimum guarantee next year (absent legislative action to add new revenues), one action the Legislature could take early in the upcoming budget cycle is eliminating the $1.8 billion in K–14 payments deferred until July 2011. (As part of the 2010–11 budget package, the state authorized 2010–11 spending using funds borrowed from 2011–12.) With the projected drop in the 2011–12 minimum guarantee, the recent payment deferrals would translate into K–14 cuts almost double the level otherwise needed in 2011–12. Given most districts have been cautious in increasing 2010–11 program support as a result of the recent deferrals and some districts have been unable to access cash sufficient to support new spending paid for by the new deferrals, many districts would not be significantly impacted in 2010–11 if the new deferral payments were eliminated. In essence, rather than encouraging school districts to hire new staff for half of the 2010–11 school year merely to have the new staff and even more existing staff laid off next year, the state would be encouraging school districts to retain their existing staff levels and plan for fewer layoffs next year. Such action would help minimize the funding cliff that could result next year.

Relying on More Deferrals Increasingly Problematic.

Including the recent deferrals, 17 percent of K–14 program support is paid using funds borrowed from the next fiscal year. In monetary terms, the first $8.2 billion in Proposition 98 funds the state provides each year is paying for K–14 services that local educational agencies already have provided. Though districts are assumed to front the cash to support programs until the state makes payment, some local educational agencies (particularly small districts, districts with negative budget certifications, and charter schools) have had notable difficulty and/or have not been able to front the cash. As a result, for these agencies deferrals increasingly are translating into de facto cuts. For most districts, big and small, cash management has become an increasingly significant issue, with Fiscal Crisis and Management Assistance Teams reporting that the bulk of its district support is now devoted to cash flow management. These issues also are affecting the number of districts with negative or at–risk budget certifications, with 123 school districts in 2007–08 identified as having these certifications compared with 174 districts in 2009–10. Negative certifications in particular can make district borrowing significantly, if not prohibitively, more expensive. For all these reasons, the Legislature may want to avoid adopting new inter–year deferrals as part of its 2011–12 budget strategy as well as monitor district health to determine if more districts could need an emergency state loan in 2011–12.

Help Districts by Maximizing Flexibility and Sending Signals Early.

Though the state might not be able to provide monetary relief to distressed districts, the Legislature can help school districts and CCC districts in various ways. Among the most notable ways are by retaining existing flexibility provisions, extending some of those provisions, and exploring new types of flexibility. Over the last couple of years, districts have reported relying heavily on these flexibility provisions to meet critical local needs and balance their budgets. In general, these flexibility measure expire at the end of 2012–13; yet, under state law, districts currently need to project costs through 2013–14 for budgeting purposes. Thus, another way the Legislature could help districts is by beginning to think about what flexibility rules it wants in place come 2013–14. The Legislature might want to consider fundamental school finance reform that could take a couple years to develop. Starting these conversations now will better position both the state and districts for whatever transition might happen in 2013–14.

 

(Editor’s Note: The LAO’s report also includes the following two paragraphs as part of “Key Considerations for the 2011-12 Budget”)

Sharp Reduction in K–14 Programmatic Spending Already Reflected in Our Forecast.

Because of the expiration of temporary tax increases and other factors, General Fund tax revenues are forecast to decline significantly in 2011–12, which drives down the Proposition 98 minimum funding guarantee in our projections. The Proposition 98 minimum guarantee is forecasted to decline from $49.7 billion in 2010–11 (when the Legislature suspended Proposition 98) to $47.5 billion in 2011–12. The General Fund’s share of Proposition 98 funding is forecast to decline as well—from $36.2 billion in 2010–11 to $34.2 billion in 2011–12.
At the same time, it is expected that schools will have spent most of the billions of dollars of recent, one–time federal stimulus and jobs funding approved by Congress. Accordingly, it may be very difficult for the Legislature to achieve additional Proposition 98 savings as part of its 2011–12 budget package. In other words, if the Legislature funds schools at the forecasted minimum guarantee in 2011–12, it would mean billions of dollars in programmatic cuts to education but not contribute a single dollar to closing the $25 billion budget problem.

(To read the complete Fiscal Outlook by the LAO, click here.)

Source:  Legislative Analyst's Office