The 2019-20 Budget: Proposition 98 Outlook

The 2019-20 Budget: Proposition 98 Outlook MAC TAYLOR LEGISLATIVE ANALYST NOVEMBER 14, 2018 Executive Summary Modest Growth Projected for School and Community College Funding in the Upcoming Budget Year. Each year, the state calculates a “minimum guarantee” for school and community college funding based upon a set of formulas established by Proposition 98 (1988). Under our near-term outlook, the 2019-20 minimum guarantee is up $2.4 billion (3.1 percent) over our revised estimate of 2018-19 funding. After accounting for this increase and backing out various one-time initiatives funded in the prior year, among other adjustments, we estimate the Legislature would have an additional $2.8 billion for Proposition 98 programs in 2019-20. The state could use this funding to cover a 3.1 percent statutory cost-of-living adjustment for school and community college programs (estimated to cost $2.3 billion) and certain other previously scheduled commitments (estimated to cost $57 million). Were the state to fund those increases, about $480 million would remain available for other activities. The Legislature might wish to consider using this remaining funding for one-time initiatives, as doing so would provide a modest buffer in case the minimum guarantee drops after the budget year. The volatility of the minimum guarantee, the possibility of a recession sometime after 2019-20, and the lack of funding in the state school reserve are all reasons the Legislature might wish to budget cautiously in the upcoming year. Table of Contents Introduction ...........................................................................................................................................2 Proposition 98 Funding Estimates ........................................................................................................... 2 Calculating the Minimum Guarantee ....................................................................................................2 Key Economic and Revenue Assumptions ...........................................................................................3 2017-18 and 2018-19 Updates ..........................................................................................................3 2019-20 Budget Planning. ..................................................................................................................5 Outlook Through 2022-23 ..................................................................................................................7 Key Trends in District Budgets ................................................................................................................9 District Funding .................................................................................................................................9 Enrollment Pressures .......................................................................................................................10 Staffing Pressures ............................................................................................................................11 Bottom Line for District Budgets .......................................................................................................14 Appendix. ............................................................................................................................................ 15 analysis full gutter 2019-20 BUDGET INTRODUCTION Test 3 is operative and the guarantee builds upon the guarantee from the previous year. The state Report Provides Our Fiscal Outlook for meets the guarantee through a combination of Schools and Community Colleges. State General Fund and local property tax revenue, with budgeting for schools and the California increases in property tax revenue usually reducing Community Colleges is governed largely by General Fund costs dollar for dollar. Although the Proposition 98, a constitutional amendment state can provide more funding than required, in approved by California voters in 1988 and modified practice it usually funds at or near the guarantee. in 1990. The measure establishes a minimum With a two-thirds vote of each house of the funding requirement, commonly known as the Legislature, the state can suspend the guarantee minimum guarantee. In this report, we examine and provide less funding than the formulas require how the minimum guarantee might change over that year. the next several years and discuss the factors likely “Maintenance Factor” Payments Required to be driving those changes. We then examine in Certain Years. In addition to the three main key aspects of district budgets—focusing on the tests, the Constitution requires the state to track main cost pressures facing districts over the next an obligation known as maintenance factor. The several years. (The 2019-20 Budget: California’s state creates a maintenance factor obligation Fiscal Outlook contains a summary version of our when Test 3 is operative or when it suspends the Proposition 98 outlook, along with the outlook for guarantee. The obligation equals the difference other major programs in the state budget.) between the actual level of funding provided and the Test 1 or Test 2 level (generally whichever PROPOSITION 98 is higher). Moving forward, the state adjusts FUNDING ESTIMATES the outstanding maintenance factor each year for changes in K-12 attendance and per capita This part of the report has five sections. First, we personal income. In subsequent years, when explain the formulas that determine the guarantee. General Fund revenue is growing relatively quickly, Second, we describe our key economic and the Constitution requires the state to make revenue assumptions underlying the near-term maintenance factor payments. The magnitude of outlook. Third, we explain how our estimates of these payments is determined by formula, with Proposition 98 funding in 2017-18 and 2018-19 stronger revenue growth generally requiring larger differ from the estimates included in the June payments. These maintenance factor payments 2018 budget plan. Fourth, we estimate the 2019-20 become part of the base for calculating the guarantee and identify the resulting funding that minimum guarantee the following year. would be available for new commitments. Fifth, Estimates of Minimum Guarantee Revised we forecast changes in the minimum guarantee After Budget Enactment. When the state updates through 2022-23 under two economic scenarios. the relevant Proposition 98 inputs, the guarantee typically changes from the level initially assumed Calculating the Minimum Guarantee in the budget act. Throughout the fiscal year, Minimum Guarantee Depends on Various the state also revises its estimate of each school Inputs and Formulas. The California Constitution district’s allotment under the Local Control Funding sets forth three main tests for calculating the Formula (LCFF) and automatically adjusts funding minimum guarantee. These tests depend upon accordingly. Due to these changes, Proposition 98 several inputs, including K-12 attendance, per funding typically ends up somewhat different than capita personal income, and per capita General the final calculation of the guarantee. Fund revenue (see Figure 1). Depending on the New Process for Finalizing Proposition 98 values of these inputs, one of the three tests Calculations and Truing Up. As part of the June becomes “operative” and determines the minimum 2018 budget plan, the state established a new guarantee for that year. In most years, Test 2 or process to finalize the Proposition 98 calculations. 2 LEGISLATIVE ANALYST’S OFFICE analysis full gutter 2019-20 BUDGET The process begins in May with Figure 1 the administration publishing a proposed final calculation Three Proposition 98 “Tests” of the minimum guarantee for the prior year. This is followed Test 1 Test 2 Test 3 by defined periods for review, Share of General Change in Per Change in General Fund Revenue Capita Personal Fund Revenue public comment, and potential Income (PCPI) legal challenge, with the General guarantee generally becoming PCPI Fund final in November. The state About ADA ADA also established a new true-up 40% mechanism. For those years in Prior-Year Prior-Year which school and community Funding Funding college funding ends up higher than the minimum guarantee, Guarantee based on share Guarantee based on prior- Guarantee based on prior- the state is to credit the funding of state General Fund year funding level adjusted year funding level adjusted above the guarantee to a new revenue going to K-14 for year-over-year changes for year-over-year changes education in 1986-87. in K-12 attendance and in K-12 attendance and Proposition 98 true-up account California PCPI. state General Fund revenue. (technically named the “Cost Allocation Schedule”). Total ADA = average daily attendance. credits in the true-up account are capped at 1 percent of the minimum guarantee. For those slowing trend over the past few years. These wage years in which funding ends up below the minimum and job trends are due, in part, to record low guarantee, the state is to apply any credits in the unemployment. Regarding the stock market, the account toward the amount required to meet the consensus forecast assumes that stock prices— minimum guarantee. If the credits are insufficient which grew rapidly for several years but have been to meet the higher guarantee, the state is required volatile recently—will grow much more slowly to make a one-time “settle-up” payment to moving forward. schools and community colleges for the remaining Near-Term Outlook Assumes Growth in difference. State Revenue. Consistent with our economic assumptions, we estimate that state General Fund Key Economic and revenue will grow in the near term. Compared to Revenue Assumptions the estimates underlying the June 2018 budget Near-Term Outlook Assumes Continued package, we estimate revenues from the state’s Growth of the California Economy. Our economic three largest taxes—the personal income tax, outlook is based on many national economic the corporation tax, and the sales tax—are up forecasts produced by various institutions and $2.6 billion in 2017-18 and $5.1 billion in 2018-19. professional economists that Moody’s Analytics For 2019-20, our outlook assumes revenue from compiles into one “consensus forecast.” This these taxes increases $4.9 billion (3.6 percent) over forecast assumes continued growth of the U.S. the revised 2018-19 level. In all three years, growth economy. Based on this consensus national in the personal income tax accounts for the largest forecast, we develop projections about growth share of the increase. in the California economy. We expect wages and 2017-18 and 2018-19 Updates salaries in California to grow at an above-average rate over the near term, similar to growth over Proposition 98 Minimum Guarantee Down the past few years. We assume that job growth in 2017-18 and 2018-19. Compared with the continues but at a slower rate, similar to the estimates included in the June 2018 budget plan, www.lao.ca.gov 3 analysis full gutter 2019-20 BUDGET we estimate that the minimum guarantee has 2017-18 and $68 million in 2018-19 (see Figure 2). dropped $226 million in 2017-18 and $461 million For 2017-18, the decrease mainly reflects data in 2018-19 (see Figure 2). The main factor from the California Department of Education explaining these drops is a reduction in K-12 showing lower-than-expected LCFF costs, student attendance. Whereas the June budget plan mostly attributable to lower K-12 attendance. For assumed student attendance would be virtually 2018-19, the decrease is mainly attributable to flat over the period, our outlook incorporates more our expectation that community college enrollment recent data showing attendance declines both will not grow as quickly as assumed in June 2018. years. The rest of the decrease in the minimum Lower enrollment typically reduces community guarantee is due to various adjustments the state college apportionment funding. made in September to true up its estimates of Funding Above the Guarantee Credited to the minimum guarantee back to 2009-10. These New True-Up Account. Although school and true-up calculations show that the state did not community college funding is down somewhat create as much maintenance factor as it previously since the adoption of the June budget plan, the assumed in prior years, resulting in a somewhat decrease in the minimum guarantee is much larger. smaller maintenance factor payment being required As a result, funding under our outlook exceeds the in 2017-18. These drops in the minimum guarantee minimum guarantee by $76 million in 2017-18 and occur despite General Fund revenue exceeding $394 million in 2018-19. Under the new true-up June estimates by a few billion dollars each year. procedure, this funding (totaling $469 million) would This is because Test 2 is operative in both years, be credited to the Proposition 98 true-up account. with the guarantee affected mainly by per capita Increases in Local Property Tax Revenue personal income (an input the state locked down Free Up State General Fund. Across 2017-18 in June 2018) rather than changes in General Fund and 2018-19, our estimates of local property tax revenue. revenue are up $892 million over the amounts School and Community College Funding assumed in the June budget plan. This upward Also Down in 2017-18 and 2018-19. Separate revision mainly reflects actual (2017-18) and from changes to the minimum guarantee, our projected (2018-19) increases in the revenue outlook also contains revised estimates of the schools and community colleges are receiving funding allocated to schools and community from former redevelopment agencies. (The state colleges. Relative to the June 2018 budget plan, dissolved redevelopment agencies in 2011-12.) we estimate that funding is down $151 million in This higher property tax revenue does not directly Figure 2 Updating Prior- and Current-Year Proposition 98 Estimates (In Millions) 2017-18 2018-19 June June Budget November Budget November Plan LAO Change Plan LAO Change Minimum Guarantee $75,618 $75,391 -$226 $78,393 $77,932 -$461 K-14 Funding General Fund $53,381 $52,911 -$471 $54,870 $54,230 -$640 Local property tax 22,236 22,556 320 23,523 24,096 572 Totals $75,618 $75,467 -$151 $78,393 $78,325 -$68 Funding Above Guarantee — $76a $76 — $394a $394 a Reflects amount that will be credited to the Proposition 98 true-up account. 4 LEGISLATIVE ANALYST’S OFFICE analysis full gutter 2019-20 BUDGET affect the calculation of the minimum guarantee or Fund revenue. Despite the estimated 3.1 percent total school funding in either year. It does, however, increase, the guarantee still grows less quickly reduce the amount of General Fund revenue that than per capita personal income. Based on the the state must allocate to schools and community way the state has interpreted the Proposition 98 colleges to meet the minimum guarantee. formulas over the past several years, we assume no new maintenance factor is created under 2019-20 Budget Planning these conditions. In the nearby box, we discuss Under Near-Term Outlook, 2019-20 Guarantee how the guarantee could change if General Fund Grows $2.4 Billion Over Revised 2018-19 revenue comes in higher or lower than our outlook Funding Level. As Figure 3 shows (see next page), assumptions. the minimum guarantee grows to $80.8 billion in $2.8 Billion Available for Proposition 98 2019-20, an increase of $2.4 billion (3.1 percent) Priorities in 2019-20. The 2018-19 budget plan compared to our revised estimate of school funding allocated $413 million of Proposition 98 funding in 2018-19. State General Fund and local property within the minimum guarantee for various one-time tax revenue each cover about half of the increase. initiatives. The largest allocations were related to The growth in property tax revenue is due primarily K-12 discretionary grants and startup costs for the to an estimated 6 percent increase in assessed new online community college. The budget plan property values, similar to growth rates the past also relied upon $55 million in one-time savings. few years. Test 1 is projected to be operative Backing out these one-time costs and savings in 2019-20, with the change in the guarantee results in $358 million becoming available for other mainly attributable to an increase in General priorities. These freed-up funds, in combination Effects of Changes in State Revenue on the Guarantee Guarantee Not Especially Sensitive to Revenue Changes in 2018-19. When Test 2 is operative and the state is carrying no maintenance factor obligation (as is the case in 2018-19), the guarantee tends not to be very sensitive to changes in state revenue. We estimate state revenues would need to increase about $1 billion before the guarantee would be affected. Increases in excess of $1 billion would result in the minimum guarantee rising about 40 cents for every additional state revenue dollar, as the operative test would shift to Test 1. On the downside, revenues would need to fall about $400 million before the guarantee would begin dropping. Decreases beyond this threshold would result in the guarantee falling about 55 cents for each dollar of revenue reduction, as Test 3 would become operative. Any changes to the guarantee on the downside would increase the amount credited to the true-up account. Guarantee More Sensitive to Revenue Changes in 2019-20. For 2019-20, Test 1 is the operative test under our outlook. If revenue were to be lower than our estimate by any amount, Test 1 would remain operative and the guarantee would drop about 40 cents for each dollar of lower revenue. The dynamics on the upside are somewhat more complicated. If revenue were to exceed our estimate by even a small margin, Test 3 would become operative. The guarantee is even more sensitive to revenue changes in Test 3 years, typically increasing about 55 cents for each dollar of additional revenue. If revenue were to increase more than $1.5 billion, Test 2 would become operative and the guarantee at that point would no longer increase. (For purposes of this analysis, we assume estimates of the minimum guarantee and General Fund revenue in 2018-19 remain constant. Changes in 2018-19, however, could affect the operative test in 2019-20. We also hold other Proposition 98 inputs constant, though these inputs likely will change somewhat in the coming months as the state receives better data.) www.lao.ca.gov 5 analysis full gutter 2019-20 BUDGET with the $2.4 billion increase from the higher consists of $1.9 billion for LCFF, $164 million for minimum guarantee, provide the state with an other school programs (including $20 million for additional $2.8 billion to allocate for school and State Preschool), and $239 million for community community college programs in 2019-20. college programs (mainly apportionments). Covering Statutory Cost-of-Living Adjustment About Half a Billion Dollars Remaining. In Estimated to Cost $2.3 Billion. When the addition to COLA, the state has indicated its intent minimum guarantee is growing, the state typically to fund several other commitments in 2019-20. provides a statutory cost-of-living adjustment These other commitments total $57 million and (COLA) for certain school and community consist of the following: college programs. For 2019-20, we estimate the • Grants for Fiscally Distressed Districts. K-14 COLA rate is 3.1 percent. The state also In September, the state enacted legislation automatically adjusts LCFF for changes in student indicating that it would provide grants to two attendance. For 2019-20, our outlook assumes fiscally distressed school districts (Oakland K-12 attendance declines 0.04 percent, which Unified and Inglewood Unified) to cover part slightly offsets the cost of providing COLA. After of their operating deficits. The administration accounting for this slight downward adjustment, estimates these grants will cost a total of we estimate COLA to cost $2.3 billion. This amount Figure 3 Proposition 98 Near-Term Outlook (Dollars in Millions) 2017-18 2018-19 2019-20 Minimum Guarantee $75,391 $77,932 $80,765 K-14 Funding General Fund $52,911 $54,230 $55,447 Local property tax 22,556 24,096 25,318 Totals $75,467 $78,325 $80,765 Year-to-Year Change in Funding General Fund $2,596 $1,319 $1,217 Percent change 5.2% 2.5% 2.2% Local property tax $1,153 $1,539 $1,223 Percent change 5.4% 6.8% 5.1% Total funding $3,748 $2,858 $2,440 Percent change 5.2% 3.8% 3.1% General Fund Tax Revenuea $134,494 $139,972 $145,133 Growth Rates K-12 average daily attendance -0.13% -0.29% -0.04% Per capita personal income (Test 2) 3.69% 3.67% 4.70% Per capita General Fund (Test 3)b 9.58% 3.97% 3.65% Operative Test 2 2 1 Maintenance Factor Amount created (+) or paid (-) -$1,201 — — Total outstanding — — — True-Up Account Credit (+) or withdrawal (-) $76 $394 — Cumulative balance 76 469 $469 a Excludes non-tax revenues and transfers, which do not affect the calculation of the minimum guarantee. b As set forth in the State Constitution, reflects change in per capita General Fund plus 0.5 percent. 6 LEGISLATIVE ANALYST’S OFFICE analysis full gutter 2019-20 BUDGET $28 million in 2019-20. (This estimate does these priorities. Regarding employee benefit costs, not account for the additional cost pressure a few districts indicate using their one-time funding the state likely would face from other fiscally to address retirement liabilities, in some cases distressed districts seeking similar treatment.) achieving a significant reduction in their future • New Preschool Slots. The 2018-19 budget retirement-related costs. For community colleges, package funded 2,959 new full-day State the state typically has provided somewhat tighter Preschool slots beginning April 1, 2019. We spending parameters for one-time allotments. estimate the cost to annualize these slots in For example, in recent years, the state has 2019-20 is $27 million. required community colleges to use their one-time allotments specifically for deferred maintenance • Other Operating Support. The state decided and instructional equipment. two years ago to provide temporary operating support for one particular joint powers Outlook Through 2022-23 agency (the Southern California Regional Occupational Center). For 2019-20, the state Many Economic Scenarios Possible Over the is scheduled to provide this agency with a Period. Over the next four years, state General direct appropriation of $2 million. Fund revenue will change due to various economic developments, such as changes in employment If the state were to cover these three and fluctuations in the stock market. Changes in scheduled commitments, we estimate it would General Fund revenue, in turn, can have significant have about $480 million remaining for other effects on the minimum guarantee. In this section, Proposition 98 purposes. we describe how the guarantee would change State Typically Sets Aside Some Funding Each through 2022-23 under two economic scenarios: Year for One-Time Activities. Although the state (1) a growth scenario and (2) a recession scenario. could allocate all available Proposition 98 funding The growth scenario assumes personal income in for ongoing programs, in practice it has tended to California continues to grow and the stock market set aside some funding for one-time activities. The remains about level from today through 2022-23. main advantage of this budget approach is that The recession scenario assumes a moderate it provides a measure of protection against future recession begins early in 2020-21. These two volatility in the minimum guarantee. Specifically, scenarios are intended to be illustrative rather than the expiration of one-time initiatives provides a predictive about the direction of the economy in the buffer that reduces the likelihood of cuts to ongoing coming years. programs if the guarantee were to experience a Under Growth Scenario, Minimum Guarantee year-over-year decline. Over the past six years, the Rises Steadily. The minimum guarantee state has set aside an average of about $700 million increases steadily under the growth scenario from per year for one-time purposes. The exact one-time $77.9 billion in 2018-19 to $89.2 billion in 2022-23 allotment has ranged from a high of $1.2 billion in 2014-15 to a low of $413 million in 2018-19. In (see Figure 4, next page, and the Appendix). The average annual increase is $2.8 billion (3.4 percent). this context, the state’s cushion would be relatively Annual increases of this magnitude likely would be modest even if it allocated the entire $480 million for more than enough to cover the statutory COLA for one-time activities. school and community college programs. Over the State Usually Signals Its One-Time Priorities. past 20 years, the statutory COLA has averaged In recent years, the state has encouraged (but 2.6 percent. Under the current consensus forecast not required) districts to use one-time funding prepared by Moody’s Analytics, the COLA after for certain priorities. The 2018-19 budget plan, 2019-20 is projected to be somewhat lower than for example, suggested school districts use their this historical average—hovering around 1 percent one-time funding for professional development, per year. (We note that the statutory COLA has instructional materials, technology upgrades, and been difficult to predict, with the actual COLA employee benefit costs. Many school districts rate, as locked down in April each year, exceeding indicate they have spent their one-time funds on www.lao.ca.gov 7 analysis full gutter 2019-20 BUDGET Moody’s fall consensus projection the past few reserve are relatively restrictive. Notably, despite years.) strong economic growth over the past several Under Recession Scenario, Minimum years, the state has made no deposit to date Guarantee Drops in 2020-21 and 2021-22. Under into this reserve. Under our growth scenario, the the recession scenario, the minimum guarantee school reserve continues to have a zero balance drops $1 billion (1.2 percent) in 2020-21 and through 2022-23. Were state revenues to increase a further $1.1 billion (1.3 percent) in 2021-22. more than our growth scenario assumes, the rules By 2021-22, the guarantee is about $7.6 billion governing the state school reserve still are such (8.8 percent) below the level in our growth scenario that any balance accumulated before the next (see Figure 4). Under the recession scenario, the recession likely would be small. state not only would be unable to provide COLA in State Could Help Districts Prepare for the 2020-21 and 2021-22, it also would need to reduce Next Recession in Various Ways. The significant spending (assuming it funds at the lower minimum limitations of the Proposition 2 school reserve guarantee). It could do this by making reductions highlight the importance of schools and community to ongoing programs, deferring school and college colleges preparing for the next recession in other payments, or exploring possible fund swaps. ways. The state could help in this regard by State School Reserve Seems Unlikely to (1) setting aside funding for schools and community Provide Much Relief During Next Recession. colleges outside of the Proposition 2 school Proposition 2 (2014) created a special state reserve, (2) allowing and encouraging districts to reserve for schools and community colleges. The increase their local reserves, (3) allocating some Proposition 2 rules for making deposits into this Proposition 98 funding for one-time activities, (4) encouraging districts to pay down their liabilities Figure 4 Minimum Guarantee Differs by Billions of Dollars Under Different Scenarios (In Billions) $90 Growth Scenario $6.5 85 Recession Scenario $7.6 $3.9 80 75 70 2018-19 2019-20 2020-21 2021-22 2022-23 8 LEGISLATIVE ANALYST’S OFFICE analysis full gutter 2019-20 BUDGET (such as deferred maintenance and retiree health design, LCFF provided larger funding increases for benefits), and (5) encouraging districts to be districts with large proportions of disadvantaged cautious in increasing their ongoing spending students and/or historically low funding levels. commitments. Any of these options (or combination Districts receiving the largest LCFF funding of options) could mitigate the reductions districts increases have seen their funding grow more than might otherwise need to make during the next 70 percent per student. By comparison, districts downturn. receiving the smallest LCFF funding increases Property Tax Revenue Projected to Rise. have experienced growth closer to 20 percent per Whereas the minimum guarantee tends to be student. volatile, property tax revenue typically grows at a Per-Student Funding Also Has Grown steadier pace. Under the growth scenario, property Significantly for Community College Districts, tax revenue grows from $24.1 billion in 2018-19 to With Less Variation Among Districts. The $28.5 billion by 2022-23. This increase would be 2018-19 budget provided $7.1 billion for sufficient to cover about 40 percent of the growth community college apportionments, an increase in the guarantee projected over the period. The of about $1.6 billion (30 percent) over the increase in property tax revenue is driven primarily 2012-13 level. Until 2018-19, the state distributed by our assumption that assessed property values apportionment funding at a virtually uniform rate per will increase by 6 percent in 2019-20 and about student. Over the past several years, the state also 5 percent per year from 2020-21 through 2022-23. has provided considerable increases in categorical The slightly slower pace after 2019-20 reflects our funding, which were distributed largely on a expectation that residential home prices and new per-student basis. Given these funding practices, construction will grow more slowly compared with all community colleges have tended to see their the past few years. Under the recession scenario, per-student funding levels rise about the same property tax revenue would grow somewhat less degree, with less variation in their growth compared quickly, though historically it has been much less with school districts. sensitive to economic downturns than the minimum Per-Student Funding Now at All-Time High guarantee. for Both Schools and Community Colleges. In 2018-19, the state provided average Proposition 98 KEY TRENDS IN funding of $11,645 per K-12 student and DISTRICT BUDGETS $7,584 per community college student. (Neither of these rates include funding for the Adult Education Turning to a District Perspective. This part Block Grant.) Adjusted for inflation, these are the of the report has four sections. First, we examine highest levels of per-student funding since the recent changes in school and community college passage of Proposition 98 in 1988 (see Figure 5, district funding. In the next two sections, we next page). The K-12 rate is about $1,000 per discuss districts’ two main cost drivers: student student (9 percent) above the amount school attendance and staffing. In the fourth section, we districts were receiving in 2007-08 prior to the focus on overall district fiscal health and summarize Great Recession. Similarly, the community college the key trade-offs districts face moving forward. rate is about $1,000 per student (15 percent) above its inflation-adjusted 2007-08 level. District Funding Growth Likely to Slow, Distribution Likely to Per-Student Funding Has Grown Significantly Change. Over the past six years, Proposition 98 for School Districts. The 2018-19 budget funding per student has grown by an average provided $61 billion for LCFF, an increase of nearly of about 6.5 percent per year. This is notably $22 billion (55 percent) over the 2012-13 level. As higher than the average historical growth rate of the state phased in implementation of LCFF over 3.8 percent. A significant portion of recent growth the past six years, individual districts experienced has been linked to maintenance factor payments. notably different amounts of funding growth. By As of the end of 2017-18, the state has paid all www.lao.ca.gov 9 analysis full gutter 2019-20 BUDGET Figure 5 Proposition 98 Funding Per Student at All-Time Highs Inflation Adjusted, 2018-19 Dollars $12,000 Schools 10,000 8,000 6,000 Community Colleges 4,000 2,000 1990-91 1994-95 1998-99 2002-03 2006-07 2010-11 2014-15 2018-19 outstanding maintenance factor, such that growth remained essentially flat from 2004-05 through in the minimum guarantee over at least the next few 2013-14, and began declining in 2014-15. The years is likely to be considerably slower (and could primary factor explaining the recent decline is a decline under our recession scenario). For school drop in births, with somewhat lower migration into districts, full implementation of LCFF (reached in the state also having a modest impact. Community 2018-19) also means that future funding increases college enrollment has followed a similar long-term are more likely to come through uniform COLAs trajectory, growing at an average rate of 2.6 percent rather than the differentiated augmentations from late 1980s through early 2000s and remaining districts have received since 2012-13. The situation essentially flat since that time. Compared with is reversed for community colleges. Under the new school districts, however, community college community college apportionment formula (adopted enrollment has fluctuated more notably from year to in 2018-19), some college districts—those with year. This is because community college enrollment relatively good student outcomes and relatively is driven by a more complex set of factors including high numbers of low-income students—can expect not only demographic trends but also college to receive somewhat larger increases than other participation rates, economic cycles, and the districts over the next few years. condition of the state budget. Overall Enrollment Likely to Continue Enrollment Pressures Declining. Our estimates of K-12 attendance are Overall School and Community College based on projections prepared by the Department Enrollment Has Been Declining. School district of Finance in May 2018, with an adjustment to attendance grew at an average annual rate of account for newly available data on 2017-18 2.4 percent from the late 1980s to early 2000s, school attendance. These projections have K-12 10 LEGISLATIVE ANALYST’S OFFICE analysis full gutter 2019-20 BUDGET attendance declining at a relatively modest pace Staffing Pressures over the next few years (see Figure 6). These Districts Have Been Adding Faculty. One way declines are consistent with our assumption that districts have used their funding increases over births and migration into the state will remain at the past several years is to hire additional staff. relatively low levels throughout the outlook period. School districts had about 295,000 FTE teachers in Regarding community colleges, our outlook assumes 2017-18, an increase of about 22,000 (8 percent) the number of full-time equivalent (FTE) students over the 2012-13 level. Coupled with declining declines an average of 0.7 percent per year over enrollment, the statewide student-to-teacher the next four years. This decline reflects two main ratio, in turn, has been dropping over the past sets of assumptions: (1) the traditional college-age several years. In 2017-18, it stood at about population (individuals between the ages of 18 to 21:1—comparable to the level prior to the Great 24) will continue declining due to demographic Recession. Community colleges also are prioritizing trends, despite assuming a slight increase in their adding faculty. College districts had about college participation rate; and (2) the older-adult 36,000 FTE faculty (tenured and temporary) in population (25 years of age and older) will 2017-18, an increase of about 2,100 (6.3 percent) continue declining due to a slight reduction in their over the 2012-13 level. The community college participation rate, despite continued demographic student-to-faculty ratio stood at about 33:1 in growth. Both sets of assumptions reflect trends that 2017-18—slightly below the pre-recession level. have been evident for several years. Districts Have Been Raising Salaries. In Enrollment Trends Vary Notably by Region. addition to hiring more teachers, districts have The overall trend in student attendance masks been increasing staff compensation. We estimate some notable regional variations. Over the past that the average salary and benefit cost of a school several years, school district attendance has district teacher in 2017-18 was approximately decreased in many parts of the state, including $95,000, an increase of about $5,300 (5.9 percent) the Bay Area and portions of northern California, with more pronounced declines in Los Angeles County and Figure 6 Orange County. It has grown, K-12 Attendance Projected to Continue Declining however, in the other parts Annual Percent Change of the state, particularly the Central Valley and some inland and southern regions, 2014-15 15-16 16-17 17-18 18-19 19-20 20-21 21-22 22-23 including Kern, San Joaquin, Sacramento, Fresno, Riverside, and San Diego counties. -0.1 Community college enrollment has decreased primarily in the -0.2 Bay Area and central coast region but has grown notably in southern California. Looking -0.3 forward over the next several years, school attendance is -0.4 projected to continue decreasing and increasing in these same Projections respective areas. -0.5% www.lao.ca.gov 11 analysis full gutter 2019-20 BUDGET over the inflation-adjusted 2012-13 level (see plan began (see Figure 8). The governing board Figure 7). Though the state has less information of CalPERS also is increasing district contribution about trends in community college districts, rates. As of 2018-19, districts’ CalPERS available data suggest that overall compensation contribution rate is 18.1 percent of payroll, up from for faculty has grown at least as quickly as inflation 11.4 percent in 2013-14. CalPERS estimates total since 2012-13. Inflation-adjusted teacher/faculty contributions at $2.5 billion in 2018-19, an increase compensation for both school districts and colleges of $1.1 billion over the 2013-14 level. also is higher today compared to 2007-08 (the CalSTRS Contribution Rates Are Scheduled pre-recession level). to Rise Through 2020-21, Could Rise or Fall Pension Rates and Costs Have Been Growing. Thereafter. For the next two years, districts’ School and community college employees CalSTRS contributions are to continue increasing generally participate in one of two state pension according to the statutory schedule. We estimate systems. The California State Teachers’ Retirement the associated cost increases at about $900 million System administers pension benefits for teachers, in 2019-20 and another $600 million in 2020-21. administrators, and other certificated employees, After 2020-21, CalSTRS can increase or decrease whereas the California Public Employees’ the district rate by up to 1 percentage point per Retirement System (CalPERS) administers pension year, provided the total district rate does not benefits for noncertificated employees. The exceed 20.25 percent. Under CalSTRS’ current 2014-15 budget included a plan to fully fund the projections, the district rate would drop to CalSTRS pension system by increasing contribution 18.2 percent for 2021-22 and 2022-23. These rates for districts, employees, and the state. Under projections, however, assume moderate payroll the plan, district contribution rates increase on growth. If district payroll growth were to slow or a statutory schedule from 8.3 percent of payroll decline—as would likely occur under our recession prior to 2014-15 to 19.1 percent by 2020-21. We scenario—district rates could increase rather than estimate total district contributions at $5.7 billion decrease after 2020-21. This is because district in 2018-19, an increase of nearly $3.4 billion over costs to amortize their share of CalSTRS’ unfunded the amount districts were paying before the funding liabilities are effectively fixed. If payroll were to decline in a recession, those costs Figure 7 would be higher when expressed as a percentage of payroll. Average Teacher Salary and Benefits Growing Over Timea CalPERS Contribution Rates Inflation Adjusted, 2017-18 Dollars Also Are Likely to Rise in Coming $96,000 Years. Districts’ CalPERS rates 94,000 also are likely to increase over the next five years. Between 2018-19 92,000 and 2019-20, CalPERS projects 90,000 that schools’ and community colleges’ contribution rates will 88,000 increase from 18.1 percent to 86,000 20.7 percent—increasing total district contributions by about 84,000 $450 million. By 2025-26, CalPERS 82,000 projects that the district rate will 80,000 have reached 25.5 percent. When 2007-08 2009-10 2011-12 2013-14 2015-16 2017-18 projecting future contribution rates, CalPERS actuaries make a variety a Excludes pension benefits. Level for 2017-18 is estimated. of assumptions—including the rate of return on investments, payroll 12 LEGISLATIVE ANALYST’S OFFICE analysis full gutter 2019-20 BUDGET growth, and inflation. The actual contribution rate agreements to provide health care for their retirees. in the future will be higher or lower than currently The associated annual benefit costs in these projected depending on how future experience districts are growing relatively quickly. Finally, some compares with these assumptions. For example, districts report cost pressure associated with recent the district contribution rate could grow more increases in the minimum wage, with increases slowly than projected if investment returns end for their lowest paid employees placing upward up being higher than the assumed 7 percent. pressure on the rest of their salary schedule. Conversely, the contribution rate could grow more Looking Ahead, Districts Likely to Continue quickly if investment returns are lower than the Facing Staffing-Related Cost Pressures. The assumed 7 percent. cost pressures districts have faced the past few A Few Other Notable Staffing-Related years are likely to continue over the outlook period. Pressures. For school districts, another key Available data indicate that district staffing costs cost pressure relates to special education. Since statewide consistently grow in years when the 2012-13, the number of students qualifying for minimum guarantee is projected to increase. In special education services has increased by about some cases, these staffing pressures also interact 10 percent. Much of this increase is attributable with one another. For example, districts that hire to the growing prevalence of autism, a disability additional staff and grant above-average salary that typically requires districts to provide intensive increases will tend to experience above-average support, often with aides and specialists. Some growth in pension costs because pension school districts and several community college contribution rates are tied to payroll. districts also face large liabilities resulting from their Figure 8 School and Community College Pension Costs Projected to Continue Increasing Annual Employer Contributions (In Billions) $12 Projections CalPERS 10 CalSTRS 8 6 4 2 2013-14 14-15 15-16 16-17 17-18 18-19 19-20 20-21 CalPERS = California Public Employees’ Retirement System and CalSTRS = California State Teachers’ Retirement System. www.lao.ca.gov 13 analysis full gutter 2019-20 BUDGET Bottom Line for District Budgets district credit ratings have been improving over the past several years. Though the state does not School District Fiscal Health Is Relatively have a comparable system of fiscal oversight for Good. The state’s system of fiscal oversight community colleges, their budgets probably are in requires county offices of education to review the similarly good fiscal health. financial condition of their school districts at various Like State Budgeting, District Budgeting points during the year. Under this system, districts Entails Managing Competing Priorities. To receive a “positive” rating if they are projected to remain in good fiscal condition moving forward, meet their financial obligations in the current and school and community college districts will need to subsequent two years, a “qualified” rating if they continue building their budgets with care, arguably may be unable to meet their obligations at some even greater care over the next few years given point during this period, and a “negative” rating if the expected slowing of growth in Proposition 98 they are at imminent risk of being unable to meet funding. Despite the expected slowing of their obligations. During the spring 2018 review, growth, virtually all districts will continue to face more than 97 percent of school districts received staffing-related cost pressures. Many districts also positive ratings. As Figure 9 shows, the share will face pressure to downsize given their continued of districts with qualified or negative ratings is trajectory of declining student attendance. near historic lows. Other evidence of positive Maintaining positive fiscal health in this environment fiscal health comes from school district credit will require districts to balance local priorities ratings. According to S&P Global Ratings, which carefully and expand programs cautiously. rates the majority of the state’s school districts, Figure 9 Share of School Districts in Fiscal Distress at Historically Low Levelsa 20% 15 10 5 2002-03 2005-06 2008-09 2011-12 2014-15 2017-18 a “Fiscal distress” defined as a district receiving a qualified or negative rating from its county office of education. 14 LEGISLATIVE ANALYST’S OFFICE analysis full gutter 2019-20 BUDGET APPENDIX Proposition 98 Outlook Under Two Economic Scenarios (Dollars in Billions) 2018-19 2019-20 2020-21 2021-22 2022-23 Growth Scenario Minimum Guarantee General Fund $54.2 $55.4 $57.1 $58.9 $60.7 Local property tax 24.1 25.3 26.5 27.5 28.5 Totals $78.3a $80.8 $83.7 $86.3 $89.2 Annual Change in Guarantee Amount $2.9 $2.4 $2.9 $2.7 $2.9 Percent 3.8% 3.1% 3.6% 3.2% 3.3% General Fund Tax Revenueb $140.0 $145.1 $149.6 $153.9 $158.7 Growth Rates K-12 average daily attendance -0.3% -0.04% -0.3% -0.3% -0.3% Per capita personal income (Test 2) 3.7% 4.7% 4.6% 3.2% 3.0% Per capita General Fund (Test 3)c 4.0% 3.7% 3.1% 2.9% 3.1% Operative Test 2 1 1 1 1 Maintenance Factor Outstanding — — — — — Recession Scenario Minimum Guarantee General Fund $54.2 $55.4 $53.2 $51.2 $54.1 Local property tax 24.1 25.3 26.5 27.5 28.5 Totals $78.3 $80.8 $79.8 $78.7 $82.7 Annual Change in Guarantee Amount $2.9 $2.4 -$1.0 -$1.1 $4.0 Percent 3.7% 3.1% -1.2% -1.3% 5.0% General Fund Tax Revenueb $140.0 $145.1 $139.4 $134.0 $141.6 Growth Rates K-12 average daily attendance -0.3% -0.04% -0.3% -0.3% -0.3% Per capita personal income (Test 2) 3.7% 4.7% 4.6% 1.1% -1.0% Per capita General Fund (Test 3)c 4.0% 3.7% -4.0% -3.8% 5.7% Operative Test 2 1 1 1 1 Maintenance Factor Outstanding — — — — — Comparison of Scenarios Minimum Guarantee Growth scenario $78.3 $80.8 $83.7 $86.3 $89.2 Recession scenario 78.3 80.8 79.8 78.7 82.7 Differences — — $3.9 $7.6 $6.5 a Includes $394 million in General Fund spending that exceeds the minimum guarantee. We assume this funding is credited to the true-up account and not part of the base for calculating the 2019-20 guarantee. b Excludes non-tax revenue and transfers, which do not affect the calculation of the minimum guarantee. c As set forth in the State Constitution, reflects change in per capita General Fund plus 0.5 percent. www.lao.ca.gov 15 analysis full gutter 2019-20 BUDGET LAO PUBLICATIONS This report was prepared by Kenneth Kapphahn and reviewed by Jennifer Kuhn. The Legislative Analyst’s Office (LAO) is a nonpartisan office that provides fiscal and policy information and advice to the Legislature. To request publications call (916) 445-4656. This report and others, as well as an e-mail subscription service, are available on the LAO’s website at www.lao.ca.gov. The LAO is located at 925 L Street, Suite 1000, Sacramento, CA 95814. 16 LEGISLATIVE ANALYST’S OFFICE