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Heavy Cash Burden Placed On School Districts

LAO Analyzes Effects of K12 Payment Deferrals

January 27, 2011

The Legislative Analyst’s Office in Sacramento released a report on Monday with an analysis of the effects of K-12 payment deferrals on California school districts.

In the introduction, the report says “Over the last several years, the state has deferred payments to school districts as a way to achieve significant Proposition 98 savings. Since 2007–08, forty-two percent of the K–12 Proposition 98 solution has come from deferrals (with almost 46 percent coming from program reductions and 12 percent from funding swaps). Relying on deferrals has allowed the state to achieve significant one–time savings while simultaneously allowing school districts to continue operating a larger program by borrowing or using cash reserves. As the magnitude and length of payment deferrals have increased, however, school districts have found fronting the cash required to continue operating at a higher programmatic level increasingly difficult. As part of his 2011–12 budget plan, the Governor continues to rely heavily on payment deferrals. His one major budget proposal for K–12 education is a $2.1 billion deferral. In this report, we track the state’s increased use of deferrals, discuss the advantages and disadvantages of deferrals, and highlight several other major factors the Legislature should consider as it decides whether to approve additional K–12 deferrals.”

Among the LAO’s observations:

State Relies Heavily On Deferrals
State law requires that General Fund payments be made to school districts using a “5–5–9” schedule, with 5 percent of annual payments made in July and August and 9 percent of total payments made each month thereafter. Nonetheless, school districts have not received funding according to this schedule due to payment deferrals adopted in recent years. Figure 1 lists all of the state’s existing Proposition 98 deferrals along with the new deferral the Governor proposes. Below, we briefly review each of the deferrals the state has authorized over the last decade. (For more background information on general cash management issues affecting school districts, please see the “Cash Management” section of our February 2009 report, 2009–10 Budget Analysis Series: Proposition 98 Education Programs.)

To Defer or Not Defer?
Given the Governor’s new $2.1 billion deferral proposal, the Legislature is likely to grapple with whether it should approve additional borrowing to sustain a higher level of K–12 programmatic support. To help the Legislature in making this determination, we discuss the advantages and disadvantages of relying on deferrals below.

The Advantages
--Provides One–Year State Savings. Deferrals are appealing because they provide one year of state savings (in the initial year of a deferral) without requiring school districts to reduce their spending. If the deferrals are ongoing (as has been the case), they have no fiscal effect in subsequent years (either savings or cost) for the state. This is because for any given fiscal year the added cost of paying for the amount from the prior fiscal year is exactly offset by the savings from deferring the same amount into the next fiscal year. In essence, a payment deferral allows the state on a one–time basis to authorize a programmatic level for school districts that it cannot afford in that year.

--Minimizes Need for Immediate Programmatic Reductions. Since a deferral does not reduce school districts’ programmatic spending, school districts can continue to operate as if no reduction has occurred. That is, if the state adopts a payment deferral rather than a cut, districts can continue to operate a higher level of program despite the one–time reduction in state spending. For example, under the Governor’s 2011–12 proposal, the $2.1 billion K–12 deferral would allow schools to spend about $350 per student more than if a $2.1 billion cut were adopted. Given this benefit, deferrals could be particularly appealing in 2011–12, as school districts will no longer have federal American Recovery and Reinvestment Act funds available and could face their most difficult year (from both a fiscal and programmatic perspective) since the beginning of the recession.

The Disadvantages
--Authorizes Programmatic Level State Cannot Afford. On the other hand, the major problem with using payment deferrals as a budget solution is that they authorize school districts to operate a program the state cannot afford. Although deferrals help mitigate budget reductions in the short term, they also create a large ongoing out–year obligation. That is, repaying for prior–year deferrals becomes first call on current–year monies. This out–year cost pressure persists until the state “doubles–up” funding in order to retire the deferrals. The use of deferrals also makes the state’s budget information both less meaningful and less transparent. Since deferrals are not reflected as an expenditure in the year in which operations are authorized, the state’s annual budget displays are not truly reflective of the state’s commitments. In addition, deferrals are only helpful to the extent school districts can access cash (internally or externally) in the short term to cover costs. If lenders stop loaning sufficient cash, the state would need to provide an additional $7.3 billion to avoid school district programmatic reductions.

--Results in Cuts the Following Year Unless Funding Increases Sufficiently to Cover Programmatic Costs. Though a deferral prevents programmatic cuts on a one–time basis, programmatic cuts are avoided the following year only if year–to–year growth in funding is sufficient to pay for the deferred payments as well as support all existing programmatic costs. If growth is insufficient to cover these costs, then the state would need to authorize a new deferral to avoid a year–to–year reduction. This is essentially the situation that has occurred over the past few years. Figure 4 shows the K–12 “funding level” versus the “program level” (which includes payment deferrals) for 2009–10, 2010–11, and 2011–12 (as proposed by the Governor). In 2009–10, due to a new payment deferral, the state was able to authorize a program level of $47.1 billion even though it only provided $45.4 billion in actual funding. In 2010–11, school districts would have experienced a notable decline in programmatic funding (from $47.1 billion to $44.8 billion), but the state adopted another deferral such that the actual year–to–year decline was small. Similarly, in 2011–12, the state would need a new deferral to continue supporting the higher programmatic level. In short, the state has been continuing to use new deferrals to support programs in excess of available state funding.

--Places Increasingly Heavy Cash Burden on School Districts. By deferring payments, the state shifts the burden of fronting cash onto school districts, along with potential borrowing costs. To access cash, districts can use existing budget reserves or special funds (although drawing down reserves also results in a loss of earned interest). If internal resources are insufficient, districts can try to borrow from private lenders, the County Office of Education, or the County Treasurer. If districts borrow from other agencies, they are responsible for covering all transaction and interest costs. The current interest rates are at historically low rates, so the costs of borrowing has not been particularly burdensome for districts. These costs, however, could increase notably in the future, thereby increasing the financial burden being placed on districts.

--Districts Must Use Odd Accounting and Borrowing Practices. To maintain higher levels of programmatic spending, school districts must use seemingly questionable accounting and borrowing practices. According to general accounting principles, entities should only count revenue as a “receivable” for a given fiscal year if the funds will be paid within 60 days of the end of the fiscal year. Under the Governor’s proposal, many deferred payments would not be made until September or October, up to 90 or 120 days after the close of the fiscal year. In addition, many school districts must now borrow twice a year to meet short–term cash flow needs, often using funds from one loan to pay for the previous loan. Although they do not violate any laws (and some are actually codified in statute), these practices show the level to which districts have been stretched as a result of lengthy deferrals.

To read the LAO’s complete report, click here.

Source:  Legislative Analyst's Office