The 2021-22 Budget: The Fiscal Outlook for Schools and Community Colleges

The 2021-22 Budget: The Fiscal Outlook for Schools and Community Colleges Summary Dramatic Rebound in the Outlook for School and Community College Funding. 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). When the state enacted the budget in June, it had anticipated steep declines in state revenue and the minimum guarantee. Based on the much stronger revenue projections in our outlook, we estimate the 2020-21 guarantee is up $13.1 billion (18.5 percent) over the June budget act level. We estimate the 2021-22 guarantee is up another $595 million (0.7 percent) over our revised 2020-21 estimate. Under a law enacted in June, the state also would be required to make a $2.3 billion supplemental payment on top of the guarantee in 2021-22. After accounting for various baseline adjustments—including prior-year revisions, a 1.14 percent statutory cost-of-living adjustment (COLA), and required deposits into the Proposition 98 Reserve—we estimate the Legislature has $13.7 billion in one-time funds and $4.2 billion in ongoing funds available for allocation in the upcoming budget cycle. Legislature Will Face Major Budget Decisions in the Coming Year. Under our outlook, the state has enough one-time funds to reverse all of the payment deferrals it implemented in the June 2020 budget plan. By paying down deferrals, the Legislature could improve cash flow for schools and community colleges and reduce pressure on future Proposition 98 funding. Regarding ongoing funds, we think the Legislature should reassess the supplemental payments after reviewing all of its budget priorities. The funding decline these new payments were intended to address no longer exists, and the minimum guarantee is projected to grow faster than the cost of the COLA over the next several years. Regardless of its decision about supplemental payments, the Legislature might want to set aside some 2021-22 funding for one-time activities. Such an approach creates a buffer that helps protect ongoing programs in case the guarantee drops in the future. Potential uses for this one-time funding include addressing student learning loss, paying down future pension costs, and building reserves. GABRIEL PETEK LEGISLATIVE ANALYST NOVEMBER 2020 analysis full gutter 2021-22 BUDGET INTRODUCTION Report Provides Our Fiscal Outlook for the Proposition 98 guarantee in 2019-20 and Schools and Community Colleges. State 2020-21 differ from the June 2020 estimates. budgeting for schools and the California Community Next, we estimate the 2021-22 guarantee. Fourth, Colleges is governed largely by Proposition 98. we examine how Proposition 98 funding could The measure establishes a minimum funding change through 2024-25. Finally, we identify the requirement for K-14 education commonly known amount of funding that would be available for new as the minimum guarantee. This report provides commitments in the upcoming year and describe our estimate of the minimum guarantee for the some issues for the Legislature to consider as it upcoming budget cycle. The report has five parts. prepares to allocate this funding. (The 2021-22 First, we explain the formulas that determine Budget: California’s Fiscal Outlook contains an the minimum guarantee and review the key abbreviated version of our Proposition 98 outlook, actions and assumptions in the 2020-21 enacted along with the outlook for other major programs in budget. We then explain how our estimates of the state budget.) BACKGROUND Calculating the Guarantee provide less funding than the formulas require that year. The state meets the guarantee through a Minimum Guarantee Depends Upon Various combination of General Fund and local property tax Inputs and Formulas. The California Constitution revenue. sets forth three main tests for calculating the Proposition 98 minimum guarantee. Each test takes into Figure 1 account certain inputs, including Three Proposition 98 Tests General Fund revenue, per capita personal income, and student Test 1 Test 2 Test 3 attendance (Figure 1). Whereas Share of General Change in Per Change in General Test 2 and Test 3 build upon the Fund Revenue Capita Personal Fund Revenue Income (PCPI) amount of funding provided the previous year, Test 1 links school General PCPI Fund funding to a minimum share of General Fund revenue. The About ADA ADA 40% Constitution sets forth rules for Prior-Year Prior-Year comparing the tests, with one of Funding Funding the tests becoming operative and used for calculating the minimum guarantee that year. Although the Guarantee based on share Guarantee based on prior- Guarantee based on prior- of state General Fund year funding level adjusted year funding level adjusted state can provide more funding revenue going to K-14 for year-over-year changes for year-over-year changes than required, in practice it usually education in 1986-87. in K-12 attendance and in K-12 attendance and California PCPI. state General Fund revenue. funds at or near the guarantee. With a two-thirds vote of each house of the Legislature, the state ADA = average daily attendance. can suspend the guarantee and 2 LEGISLATIVE ANALYST’S OFFICE analysis full gutter 2021-22 BUDGET Legislature Decides How to Allocate associated costs. In these cases, the COLA for Proposition 98 Funding. Whereas LCFF (and other K-12 programs) is reduced to fit Proposition 98 establishes a minimum funding within the guarantee. Though statute is silent on level, the Legislature decides how to allocate this community college programs, the state generally funding among specific school and community aligns the COLA rate for these programs with the college programs. Since 2013-14, the Legislature K-12 rate. has allocated most funding for schools through the Proposition 98 Reserve Deposits Required Local Control Funding Formula (LCFF). A school Under Certain Conditions. Proposition 2 district’s allotment under this formula depends (2014) created a state reserve specifically on its size (as measured by student attendance) for schools and community colleges—the and the share of its students who are low income Public School System Stabilization Account or English learners. The Legislature allocates (Proposition 98 Reserve). The Constitution requires most funding for community colleges through the state to make deposits into this reserve under apportionments. A college’s apportionment funding certain conditions. The most notable conditions depends on its enrollment, share of low-income are strong year-over-year growth in the guarantee students, and performance on certain outcome and above average revenue from capital gains (see measures. the box on the next page). The state made its first At Key Points, State Recalculates Minimum deposit into the reserve in 2019-20, but rescinded Guarantee and Certain Proposition 98 Costs. this deposit after revising its estimate of the The guarantee typically changes from the level minimum guarantee downward. initially assumed in the budget act as the state Proposition 98 Reserve Deposits Linked updates the relevant Proposition 98 inputs. The With Cap on School Districts’ Local Reserves. state continues to update these inputs until May A state law enacted in 2014 and modified in 2017 of the following fiscal year. The state finalizes its sets a cap on local school district reserves after calculation of the guarantee through a process the balance in the Proposition 98 Reserve reaches known as certification, which involves the a certain threshold. Specifically, the cap applies if publication of all underlying inputs and a period the balance in the Proposition 98 Reserve in the for public review and comment. The most recently previous year exceeded 3 percent of Proposition 98 certified year is 2018-19. The state also revises its funding allocated for K-12 schools that year. Once estimates of certain school and community college the cap is operative, medium and large districts costs, including LCFF and apportionments. When (those with more than 2,500 students) must student attendance estimates change, for example, limit their reserves to 10 percent of their annual the cost of LCFF tends to change in tandem. expenditures. Smaller districts are exempt. The School and Community College Programs law also excludes certain categories of reserves, Typically Receive COLA. When the minimum including reserves that are legally restricted to guarantee is growing, the state generally specific activities and reserves set aside by a funds a COLA for LCFF, community college district’s governing board for specific purposes. apportionments, and certain other programs. In addition, the law allows a district facing The COLA rate is based on a national price index “extraordinary fiscal circumstances” to receive an designed to reflect the cost of goods and services exemption from its county office of education for up purchased by state and local governments across to two consecutive years. To date, the cap has not the country. Prior to 2019-20, the Legislature been operative. approved funding for the COLA through the Recap of 2020-21 Budget Plan annual budget process. The 2019-20 budget plan implemented a new policy for LCFF. Under Enacted Budget Assumed Significant Drop this policy, LCFF receives an automatic COLA in the Minimum Guarantee. The emergence of unless the minimum guarantee—as estimated in the coronavirus disease 2019 (COVID-19) led to the enacted budget—is insufficient to cover the an abrupt recession beginning in March 2020. By www.lao.ca.gov 3 analysis full gutter 2021-22 BUDGET Key Rules Governing the Proposition 98 Reserve Deposits Predicated on Four Main Conditions. To determine whether a deposit is required, the state first determines whether all of the following conditions are met: • Revenues From Capital Gains Are Relatively Strong. Deposits are required only when the state receives an above-average amount of revenue from taxes paid on capital gains (a relatively volatile source of General Fund revenue). • Test 1 Is Operative. Test 1 years historically have been associated with relatively strong growth in the minimum guarantee due to strong growth in state revenue. • Formulas Are Not Suspended. If the Governor declares a “budget emergency” (based on a natural disaster or slowdown in state revenues), the Legislature can reduce or cancel a reserve deposit. Additionally, if the Legislature votes to suspend the minimum guarantee, any required deposit is canceled automatically. • Obligations Created Before 2014-15 Are Retired. Proposition 2 (2014) specified that no deposits would be required until the state paid certain school funding obligations (known as “maintenance factor”) that it accrued during the Great Recession. The state met this condition starting in 2019-20. Amount of Deposit Depends Upon Additional Formulas. If the state determines that the conditions for a deposit are satisfied, it performs several calculations to determine the size of the deposit. Generally, the size of the deposit tends to increase when revenue from capital gains is relatively high and the guarantee is growing quickly relative to inflation. More specifically, the deposit equals the lowest of the following four amounts: • Portion of the Guarantee Attributable to Above-Average Capital Gains. The state calculates what the Proposition 98 guarantee would have been if the state had not received any revenue from “excess” capital gains (the portion exceeding the historical average). Deposits are capped at the difference between the operative guarantee and the hypothetical alternative guarantee without the excess capital gains. • Difference Between the Test 1 and Test 2 Levels. Deposits are capped at the difference between the higher Test 1 and lower Test 2 funding levels. • Growth Relative to the Prior Year. The state calculates how much funding schools and community colleges would receive if it adjusted the previous year’s funding level for changes in student attendance and inflation. (The inflation factor is the higher of the statutory cost-of-living adjustment or growth in per capita personal income.) Deposits are capped at the difference between the Test 1 funding level and the inflation-adjusted, prior-year funding level. • Room Available Under a 10 Percent Cap. The Proposition 98 Reserve has a cap equal to 10 percent of all funding allocated to schools and community colleges. Deposits are only required to the extent the existing balance is below this threshold. Withdrawals Required When Guarantee Is Growing Relatively Slowly. Proposition 2 requires the state to withdraw funds from the Proposition 98 Reserve if the minimum guarantee is not growing quickly enough to support the prior-year funding level, as adjusted for student attendance and inflation. The Legislature can allocate withdrawals for any school or community college programs. 4 LEGISLATIVE ANALYST’S OFFICE analysis full gutter 2021-22 BUDGET May, the administration had revised its previous July through November period. The total amount revenue estimates down $42 billion across 2019-20 deferred equates to about one-fourth of the General and 2020-21. These declines, combined with Fund allocated for LCFF, community college higher costs for the state’s safety net programs— apportionments, and special education. Other than including Medi-Cal and California Work Opportunity implementing deferrals, the enacted budget largely and Responsibility to Kids—resulted in a held school and community college programs $54.3 billion shortfall in the state budget. Regarding flat. (The budget did not include funding for the Proposition 98, the lower revenue estimates led to statutory COLA of 2.31 percent for 2020-21.) significant reductions in the minimum guarantee. New Supplemental Payments Set to Begin The June 2020 budget plan assumed the guarantee in 2021-22. The 2020-21 budget plan included a would drop $3.4 billion (4.2 percent) in 2019-20 statutory provision to accelerate school funding and $10.2 billion (12.5 percent) in 2020-21 relative significantly in future years. This provision has to the 2019-20 level estimated in June 2019. two components. First, it requires the state to Budget Plan Relied Heavily on Payment make temporary payments equal to 1.5 percent of Deferrals. As a significant part of its effort to annual General Fund beginning in 2021-22. These address the budget shortfall, the state reduced payments will continue until the state has paid school and community college funding to the $12.4 billion—the difference between the June lower estimates of the minimum guarantee. 2020 estimates of the guarantee for 2019-20 and It implemented these reductions primarily by 2020-21 and the amount of funding schools and deferring $12.5 billion in payments for LCFF, community colleges could have received if state community college apportionments, and special revenues had continued to grow. (Technically, the education. (When the state defers payments from obligation equals the difference between the Test 1 one fiscal year to the next, it can reduce spending and Test 2 funding levels in those years.) Second, while allowing districts to maintain programs by it requires the state to increase the minimum share borrowing or using cash reserves.) These deferrals of General Fund revenue allocated to schools and began with a $2.2 billion shift from the end of community colleges from 38 percent to 40 percent 2019-20 to the following fiscal year. For 2020-21, on an ongoing basis. This increase is set to phase the budget plan maintained these deferrals and in over the 2022-23 and 2023-24 fiscal years. The implemented $10.3 billion in additional deferrals. supplemental payments are on top of the existing Under the modified payment schedule, portions of minimum guarantee, and the state can allocate the payments otherwise scheduled for the months them for any school or community college purpose. of February through June will be paid over the 2019-20 AND 2020-21 UPDATES Rapid Rebound for Many Parts of the surpassed its pre-pandemic level in August, and Economy. In the spring of 2020, due to the many technology companies—including several COVID-19 pandemic, millions of Californians lost headquartered in California—have experienced their jobs, businesses closed, and consumers strong growth. Despite these improvements, deeply curtailed spending. By the summer, the some parts of the economy remain depressed. economy had begun to improve. Employment Employment in the leisure and hospitality sector, in the state started to recover. New business for example, is about one-third lower than its creation accelerated in July and has remained pre-pandemic level. Many low-wage workers—who relatively strong. By October, consumer spending experienced job losses at much higher rates than had recovered to within roughly 10 percent of its high-wage workers—remain unemployed. (We pre-pandemic level. Some parts of the economy provide more information on these trends in The have done particular well. The stock market 2021-22 Budget: California’s Fiscal Outlook.) www.lao.ca.gov 5 analysis full gutter 2021-22 BUDGET Significantly Higher Revenues Compared operative in both years, with the increase in the With June Assumptions. Tax collections for the General Fund share of the guarantee equating to state’s three largest taxes—the personal income about 38 percent of the higher revenue. Regarding tax, the corporation tax, and the sales tax—have local property tax revenue, our estimates are been very strong over the past several months. essentially unchanged from June in 2019-20 Between August and October, collections were and slightly higher in 2020-21. The increase up 9 percent compared with the same period in 2020-21 reflects faster growth in assessed the previous year and 22 percent compared with property values and additional revenue attributable June 2020 estimates (Figure 2). Tax collections at to the dissolution of redevelopment agencies. the end of 2019-20 also exceeded expectations. These property tax increases yield dollar-for-dollar Across the entirety of each fiscal year, we estimate increases in the minimum guarantee. (When General Fund tax revenues are up more than $4 billion in Figure 2 2019-20 and nearly $34 billion in 2020-21 relative to the June Tax Collection Well Ahead of Budget Act 2020 estimates. Although these Total 2020-21 Collections to Date increases might seem at odds Personal Income, Corporation, and Sales Taxes (In Billions) with high levels of unemployment, $70 they are consistent with the more stable employment picture 60 f a o c r c h o i u g n h t - i f n o c r o a m la e r w ge o r s k h e a r r s e , w of h s o t ate 50 Actual Collections tax payments. Re P vi r s o e p d o U si p ti o S n i g 9 n 8 i f G ic u a a n r t a ly n . tee 40 Budget Act Assumptions 30 Compared with the estimates Through October, tax collections are 22 percent included in the June 2020 budget 20 ahead of the budget act assumption. plan, we estimate the minimum guarantee is up $1.6 billion 10 in 2019-20 and $13.1 billion in 2020-21 (Figure 3). These July August September October increases are due almost entirely to our higher General Fund revenue estimates. Test 1 remains Figure 3 Updating Prior- and Current-Year Estimates of the Minimum Guarantee (In Millions) 2019-20 2020-21 June November June November Budget Plan LAO Estimate Change Budget Plan LAO Estimate Change Minimum Guarantee General Fund $52,656 $54,310 $1,655 $45,066 $57,818 $12,752 Local property tax 25,022 24,973 -49 25,824 26,157 333 Totals $77,678 $79,283 $1,606 $70,890 $83,975 $13,085 General Fund Tax Revenue $138,685 $143,012 $4,328 $118,666 $152,176 $33,510 6 LEGISLATIVE ANALYST’S OFFICE analysis full gutter 2021-22 BUDGET Test 1 is operative, changes in local property tax relates to LCFF. Whereas the June budget had revenue directly affect Proposition 98 funding. They assumed LCFF costs would increase by more do not offset General Fund spending.) Similar to the than $300 million on a year-over-year basis, our June budget, we also assume the state addresses estimate reflects a year-over-year decrease of a recent issue related to property tax allocations in $112 million. Our estimate reflects several factors, certain counties (see nearby box). including lower attendance costs carrying forward Program Costs Down Across 2019-20 and from 2019-20 and continuing attendance declines 2020-21. For the prior and current year, we also in 2020-21. We also account for the temporary update our estimates of costs for LCFF and changes to attendance funding included in the June other Proposition 98 programs (Figure 4). For 2020 budget plan, which limit the conditions under 2019-20, the latest available data show costs which growing districts can receive funding for are down slightly ($28 million) from the state’s higher attendance. previous estimate. For 2020-21, we estimate Proposition 98 Reserve Deposit Required in costs are down $476 million. This drop mainly 2020-21. Under the June 2020 budget plan, the Figure 4 Additional Spending Required to Meet Guarantee in Prior and Current Year (In Millions) 2019-20 2020-21 June November June November Budget Plan LAO Estimates Change Budget Plan LAO Estimates Change Minimum Guarantee $77,678 $79,283 $1,606 $70,890 $83,975 $13,085 Funding Allocations Local Control Funding Formula (LCFF) $62,707a $62,676 -$31 $63,037 $62,565 -$473 Other K-14 programs 17,151a 17,154 3 18,167 18,164 -3 Savings from payment deferrals -2,181 -2,181 — -10,314 -10,314 — Proposition 98 Reserve deposit — — — — 1,529 1,529 Totals $77,678 $77,649 -$28 $70,890 $71,943 $1,053 Settle-Up Payments — $1,634 $1,634 — $12,031 $12,031 a Amounts adjusted for Chapter 110 (SB 820, Committee on Budget and Fiscal Review), an August trailer bill that reduced LCFF cost estimates and allocated the savings for additional school meal reimbursements. Property Tax Estimates Assume State Resolves a Recent Issue Schools and community colleges receive a portion of their property tax revenue through local accounts known as Educational Revenue Augmentation Funds (ERAF). These accounts, created in the early 1990s, facilitate various property tax shifts between educational agencies and other local governments (including cities, counties, and special districts). As we described in a report earlier this year, a few counties have been allocating a portion of their ERAF revenues in ways that seem contrary to state law and shift too much revenue from schools to other local agencies. On a statewide basis, the total amount of revenue at issue is nearly $350 million per year. In response to these findings, the Legislature adopted trailer legislation requiring the State Controller to issue instructions for the allocation of these revenues by December 31, 2020. The legislation also allowed the Controller to obtain an expedited court order for any county not complying with its new instructions. We assume these provisions result in this revenue being allocated to schools and community colleges. www.lao.ca.gov 7 analysis full gutter 2021-22 BUDGET Constitution did not require any deposit into the the Legislature to reduce or cancel the reserve Proposition 98 Reserve because the state was deposit.) projecting weak revenue from capital gains and State Required to “Settle Up” to Meet the the minimum guarantee was declining. Under our Guarantee. After accounting for increases in the outlook, however, $1.5 billion of the growth in the minimum guarantee, lower program costs, and the guarantee is attributable to excess capital gains newly required reserve deposit, we estimate that revenue. In addition, the year-over-year growth in spending is $1.6 billion below our estimate of the the guarantee is well above the rate of inflation. 2019-20 guarantee and more than $12 billion below Under these conditions, a $1.5 billion reserve our estimate of the 2020-21 guarantee. Across deposit is required. (Our estimate assumes the the two years, the state would be required make deposit is not suspended. On June 25, 2020, the one-time payments totaling $13.7 billion to settle Governor declared a budget emergency related up for the difference. The Legislature could allocate to the COVID-19 pandemic, potentially allowing these payments for any Proposition 98 purposes. 2021-22 ESTIMATES Guarantee Estimated to Grow Slightly Over to $2.9 billion—nearly 4 percent of our estimated Revised 2020-21 Level. Under our outlook, the funding for schools. By exceeding the 3 percent guarantee grows to $84.6 billion in 2021-22. threshold, it also would make the district reserve Relative to the 2020-21 enacted budget level, this cap operative the following year (2022-23). (For increase is substantial—$13.7 billion (19.3 percent). this calculation, we assume the state allocates Compared with our revised estimate of 2020-21, 89 percent of all Proposition 98 funding to schools however, the increase is only $595 million and 11 percent to community colleges, consistent (0.7 percent). Test 1 is operative, with the growth with its historical practice.) Based on the latest in the guarantee attributable to steady growth in available data, we estimate that 129 of the medium local property tax revenue, partially offset by a small and large districts that would be subject to the decline in General Fund revenue relative to our cap hold reserves exceeding 10 percent of their revised 2020-21 estimate (Figure 5). (Our General expenditures. The total amount above the cap Fund revenue estimates reflect our main economic is $1.3 billion—approximately one-third of the forecast, discussed in the next section.) reserves held by these 129 districts. Districts Supplemental Payment Estimated at affected by the cap could respond by reclassifying $2.3 Billion. On top of growth in the minimum their reserves to avoid the 10 percent limit, seeking guarantee, we estimate the state is required to exemptions from their county offices of education, make a supplemental payment of $2.3 billion. This or spending down their reserves. payment represents the first installment toward the Guarantee Is Moderately Sensitive to temporary component of supplemental payments Changes in Revenue Estimates. We examined (the ongoing component begins the following year). how the minimum guarantee would change if state Including this payment, total Proposition 98 funding revenue comes in higher or lower than our outlook in 2021-22 is up $2.9 billion (3.4 percent) over the assumptions. In general, the sensitivity of the revised 2020-21 level. guarantee depends on which Proposition 98 test Proposition 98 Reserve Deposit Triggers is operative and whether another test could District Cap in 2022-23. Under our revenue become operative with higher or lower revenue. estimates, the state is required to make a Under our outlook, Test 1 is operative in Proposition 98 Reserve deposit of $1.4 billion in 2020-21 and 2021-22. Test 1 is likely to remain 2021-22. This deposit, coupled with the 2020-21 operative even if revenues differ significantly from deposit, would bring the balance in the reserve outlook assumptions, largely due to declining student attendance (a trend that tends to favor 8 LEGISLATIVE ANALYST’S OFFICE analysis full gutter 2021-22 BUDGET Test 1 compared with the other two tests). In Test 1 years, the Figure 5 guarantee changes about 40 cents Proposition 98 Near-Term Outlook for each dollar of higher or lower General Fund revenue. LAO Estimates (Dollars in Millions) Changes in Revenue Also 2019-20 2020-21 2021-22 Influence Reserve Deposits. Revised Revised Projected Although the minimum guarantee Minimum Guaranteea would change in response to General Fund $54,310 $57,818 $57,285 higher or lower revenues, the size Local property tax 24,973 26,157 27,285 of the Proposition 98 Reserve Totals $79,283 $83,975 $84,570 deposit also would change. Change From Prior Yeara Changes in the required deposit General Fund -$435 $3,507 -$533 would tend to mitigate changes Percent change -0.8% 6.5% -0.9% Local property tax $1,197 $1,184 $1,127 in the amount available for school Percent change 5.0% 4.7% 4.3% and community college programs. Total guarantee $762 $4,691 $595 In a scenario where revenue Percent change 1.0% 5.9% 0.7% increases a couple billion dollars Supplemental Paymentb — — $2,262 in 2021-22 (with no change in Total Funding With Supplemental Payment $79,283 $83,975 $86,831 2020-21), at least a portion of the Change from prior year 762 4,691 2,857 increase likely would have to be Percent change 1.0% 5.9% 3.4% deposited into the reserve. The General Fund Tax Revenuec $143,012 $152,176 $150,778 required deposit also would tend to Growth Rates grow in scenarios where revenue K-12 average daily attendance -0.5% -0.5%d -0.5% increases in both the current and Per capita personal income (Test 2) 3.9 3.7 -1.7 budget years. On the downside, a Per capita General Fund (Test 3)e -0.1 7.0 -0.7 drop in revenues and the minimum Operative Test 1 1 1 guarantee would tend to reduce Proposition 98 Reserve the size of the required reserve Deposit (+) or withdrawal (-) — $1,529 $1,352 deposits. Although this reduction Cumulative balance — 1,529 2,882 would cushion school and a Excluding supplemental payment. community college programs, the b Consists entirely of General Fund. c relatively small size of the deposit Excludes nontax revenues and transfers, which do not affect the calculation of the minimum guarantee. d For the purpose of calculating the minimum guarantee, Chapter 24 of 2020 (SB 98, Committee on Budget and Fiscal means this buffer would disappear Review) deems the change in attendance in 2020-21 to be the same as the change in 2019-20. quickly. (Our analysis holds all e As set forth in the State Constitution, reflects change in per capita General Fund plus 0.5 percent. other Proposition 98 inputs Note: No maintenance factor obligation is created, paid, or owed over the period. constant, though changes in these inputs also could affect the guarantee and the size of the deposit.) OUTLOOK THROUGH 2024-25 Proposition 98 Funding build upon the average of numerous forecasts prepared by professional economists. This Certain Assumptions Underlie Our Main “consensus forecast” anticipates the national Economic Forecast. To develop our main economy will grow slowly over the next several economic forecast for the next several years, we www.lao.ca.gov 9 analysis full gutter 2021-22 BUDGET years. Regarding the state economy, we assume they are subject to many uncertainties. Questions employment does not recover to pre-pandemic about the COVID-19 pandemic—such as whether levels until at least 2025. We expect wages and the spread of the virus worsens and to what salaries to recover more quickly, however, because extent vaccines or treatments become available— high-wage workers have experienced relatively few significantly increases these uncertainties compared job losses. We also assume that housing markets, with previous forecasts. which have rebounded sharply from the early Modest Growth in the Guarantee Under months of the pandemic, remain strong. Although Our Main Forecast. Under our main forecast, these assumptions reflect our best assessment, the minimum guarantee grows to $91.2 billion in Figure 6 Proposition 98 Funding Under LAO Main Forecast (Dollars in Billions) 2020-21 2021-22 2022-23 2023-24 2024-25 Inputs and Calculations Minimum Guaranteea General Fund $57.8 $57.3 $57.0 $57.7 $59.8 Local property tax 26.2 27.3 28.6 30.0 31.5 Totals $84.0 $84.6 $85.6 $87.8 $91.2 Supplemental Payments — $2.3 $4.5 $5.3 $6.3 General Fund Tax Revenueb $152.2 $150.8 $150.0 $151.8 $157.1 Growth Rates K-12 average daily attendance -0.5% -0.5% -0.5% -1.0% -1.3% Per capita personal income (Test 2) 3.7 -1.7 3.4 4.6 4.3 Per capita General Fund (Test 3)c 7.0 -0.7 -0.5 1.3 3.7 Outcomes With Supplemental Payments Total Proposition 98 Funding $84.0 $86.8 $90.1 $93.0 $97.5 Annual growth 4.7 2.9 3.3 2.9 4.5 Percent 5.9% 3.4% 3.8% 3.2% 4.8% Operative Test 1 1 1 1 3 Proposition 98 Reserve Deposit (+) or withdrawal (-) $1.5 $1.4 — -$0.3 — Cumulative balance 1.5 2.9 $2.9 2.6 $2.6 K-14 Share of General Fund Tax Revenue 38.0% 39.5% 41.0% 41.5% 42.0% Outcomes Without Supplemental Payments Total Proposition 98 Funding $84.0 $84.6 $85.6 $87.8 $91.2 Annual growth 4.7 0.6 1.0 2.1 3.5 Percent 5.9% 0.7% 1.2% 2.5% 3.9% Operative Test 1 1 1 1 1 Proposition 98 Reserve Deposit (+) or withdrawal (-) $1.5 $1.3 — -$0.9 — Cumulative balance 1.5 2.8 $2.8 1.9 $1.9 K-14 Share of General Fund Tax Revenue 38.0% 38.0% 38.0% 38.0% 38.0% a Excluding supplemental payments. b Excludes nontax 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. 10 LEGISLATIVE ANALYST’S OFFICE analysis full gutter 2021-22 BUDGET 2024-25, an increase of $7.3 billion compared with for reductions in some smaller property tax the 2020-21 level (Figure 6). The average annual components. (In the nearby box, we explain increase is $1.8 billion (2.1 percent). Test 1 is how the recent passage of Proposition 19 could operative, with most of the increase attributable have a minor positive effect on our property tax to our estimates of higher local property tax estimates.) General Fund revenue, by contrast, revenue. Our property tax estimates are driven accounts for a relatively small share of the increase primarily by projected growth in assessed property in the guarantee because the state’s three largest values ranging from 5.5 percent to 5.8 percent taxes grow at an average annual rate of less than per year. These estimates reflect the recovery 1 percent. in home prices, sales, and construction activity Notably Faster Growth With Supplemental over the past several months. They also account Payment Included. By 2024-25, the supplemental Property Tax Changes Under Proposition 19 Background on Property Tax Assessment. The taxable value of a residential property generally depends on its purchase price, adjusted for inflation by up to 2 percent per year. When a property changes ownership, its taxable value resets to its purchase price. These rules have a few exceptions. Eligible homeowners (generally consisting individuals who are over age 55 or severely disabled, or whose property has been damaged by a natural disaster) can move within the same county and keep paying the same amount of property taxes if their new home is less expensive than their old one. Some counties extend this policy to homeowners moving from other counties. Eligible homeowners can generally use this rule once in their lifetime. Another exception relates to inherited properties. It allows properties to pass from parents to children with no increases in taxes. Changes Under Proposition 19. Proposition 19, recently approved by voters in the November election, expands the conditions under which eligible homeowners can sell their property and keep their lower tax bills. Specifically, the new rules allow these homeowners to (1) move anywhere in the state, (2) purchase more expensive homes (in these cases, homeowners would pay somewhat higher taxes), and (3) use these special rules up to three times in their lifetime. These new rules take effect on April 1, 2021. Proposition 19 also narrows the exception for inherited properties. Under the new rules, inherited properties can avoid reassessment only if the children receiving those properties use them as primary residences or for farming. In addition, the new rules provide for partial reassessment of inherited properties worth more than $1 million. These limitations take effect on February 16, 2021. Minor Increases in Property Tax Revenue Likely. Expanding the exception that allows eligible homeowners to sell their properties and keep paying the same property tax bill will tend to reduce property tax revenue. On the other hand, narrowing the exception for inherited properties will tend to increase property tax revenue. Overall, the increases in property tax revenue are likely to outweigh the decreases. We estimate that schools and community colleges could gain tens of millions of dollars per year over the next few years. (Other local governments also will receive higher property tax revenue.) These gains are on top of the property tax growth projected in our outlook. Over time, these gains could grow to a few hundred million dollars per year. Regarding Proposition 98, these gains would function like existing school property tax revenue. Specifically, they would increase the minimum guarantee in Test 1 years and offset required General Fund spending in Test 2 and Test 3 years. www.lao.ca.gov 11 analysis full gutter 2021-22 BUDGET payments total $6.3 billion per year. Under our most likely to occur. The light shaded area would main forecast, overall Proposition 98 funding, reflect notable departures from the assumptions including the supplemental payment, increases by in our main forecast. A major departure might be $13.6 billion from 2020-21 to 2024-25 (Figure 7). tied to a series of negative developments (such as The average annual increase is $3.4 billion delayed vaccine deployment, widespread business (3.8 percent). As a share of the state budget, total failures, or instability in rental housing markets) or General Fund spending on schools and community series of positive developments (surge in consumer colleges grows from 38 percent to nearly spending, smooth transition of unemployed 42 percent over the period. workers back to their jobs, or major new federal Uncertainty in Our Proposition 98 Estimates fiscal stimulus). The estimates of the guarantee Increases Over Time. Over the coming years, the in the figure also assume growth in property tax minimum guarantee will vary from the estimates revenue. This growth offsets much of the decline reflected in our main forecast. The most uncertain in the guarantee that otherwise would occur when input is General Fund revenue. To explore this General Fund revenue is significantly less than our uncertainty, we examined the extent to which main forecast. As the figure shows, the uncertainty revenues might end up above or below the in our estimates increases each year of the outlook estimates in our main forecast. For this analysis, period. we looked at how much revenue forecasts Reserves tended to differ from actual revenues over the last 50 years. We then used this historical relationship Proposition 98 Reserve Balance Relatively to determine the likely range of revenues over the Steady Under Main Forecast. Under our main next several years. Figure 8 displays our estimate forecast, the balance in the Proposition 98 of the guarantee (including the supplemental Reserve remains relatively steady after 2021-22. payment) under the various revenue ranges. The formulas would require a small withdrawal in The dark shaded area shows what the minimum 2023-24, but no other deposits or withdrawals guarantee would be under the revenue scenarios during the outlook period. At the end of 2024-25, the balance in the Proposition 98 Reserve is $2.6 billion. Reserve Figure 7 deposits likely would be somewhat Supplemental Payments Increase Funding Significantly higher if the guarantee were to Increases Relative to 2020-21 Under Main Forecast (In Billions) grow faster and somewhat lower if the guarantee were to grow $14 more slowly. Deposits also can be Supplemental Payments extremely sensitive to changes in 12 Minimum Guarantee capital gains revenue. Even if overall 10 state revenues follow the trajectory in our main forecast, the required 8 deposits or withdrawals could be higher or lower than our estimates. 6 (We also assume the Legislature does not suspend or reduce any 4 deposits otherwise required by the Constitution.) 2 Local Reserve Cap Would Remain Operative for a Few 2021-22 2022-23 2023-24 2024-25 Years. As the minimum guarantee grows, the balance in the Proposition 98 Reserve decreases 12 LEGISLATIVE ANALYST’S OFFICE analysis full gutter 2021-22 BUDGET as a percentage of school Figure 8 funding. Under our main Proposition 98 Funding Estimates forecast, the balance would Become More Uncertain Over Time drop from nearly 4 percent in (In Billions) 2021-22 to just below 3 percent in 2024-25. As a result, the The shaded regions on this graph show how the minimum guarantee (including the supplemental district reserve cap would payments) might differ from our main forecast, given the potential for changes in state revenue. Our estimates suggest the guarantee is more likely than not to be in the inner shaded area. The be operative for three years guarantee is less likely to be in the outer shaded area, and very unlikely to be beyond the shaded area. beginning in 2022-23. $120 Program Costs Statutory COLA Projected to Remain Relatively Low. Our 110 assumptions about the statutory COLA rate also reflect the consensus forecast. Compared 100 with the historical average of 2.6 percent, the current consensus projections are 90 relatively low. Specifically, the LAO Main projected rates are 1.14 percent Forecast 80 in 2021-22, 1.36 percent in 2022-23, 1.56 percent in 2023-24, and 1.51 percent in 70 2024-25. In practice, the rates 2018-19 2019-20 2020-21 2021-22 2022-23 2023-24 2024-25 can swing notably from year to year and sometimes diverge from broader trends in the economy. Over the previous four years, for example, the driven primarily by the large drop in employment statutory COLA rate has varied from 0 percent to in spring 2020. In subsequent years, we assume a 3.26 percent despite relatively steady growth in the recovery in employment results in overall migration economy. into and out of the state returning to lower and K-12 Attendance Projected to Continue steadier levels. Declining. School attendance has been declining Net Cost of COLA and Attendance Changes slowly since 2014-15. We project this decline will Around $900 Million Per Year. Under our main continue over the outlook period and accelerate forecast, funding the statutory COLA for school somewhat beginning in 2023-24. Our estimates and community college programs would cost primarily reflect declining births in California—a roughly $1.2 billion per year over the outlook trend that began more than a decade ago and period. Declines in K-12 attendance, by contrast, accelerated somewhat in 2018. This reduction would reduce costs for most school programs by in births is due to a few factors, including the roughly $300 million per year. Accounting for both state having fewer adults of child-rearing age. adjustments, the net increase in costs is roughly Regarding migration, we assume higher levels of $900 million annually. net outmigration from the state in 2020 and 2021, www.lao.ca.gov 13 analysis full gutter 2021-22 BUDGET KEY CONSIDERATIONS Several Important Issues in the Year Ahead. The most notable adjustment relates to deferrals. In this part of the report, we highlight a few issues The enacted budget obtained $10.3 billion in for the Legislature to consider as it begins planning one-time savings from the payment deferrals that for the upcoming budget cycle. Specifically, we began in 2020-21. Although our outlook assumes (1) analyze the amount of new funding available those deferrals continue in 2021-22, the state for school and community college programs, receives no savings because it is not shifting any (2) describe upcoming changes in district pension additional payments. The $10.3 billion increase in costs, and (3) comment on a few of the issues in Figure 9 reflects the cost of replacing the one-time our outlook. savings with ongoing funds in 2021-22. (It does not reflect the additional one-time costs the state Funding for New Commitments would incur to eliminate the deferrals and restore State Could Cover COLA and Make New the regular payment schedule.) We also estimate Commitments in 2021-22. Figure 9 shows our that covering the 1.14 percent statutory COLA estimate of the changes in costs and funding would cost $870 million. After accounting for these relative to the 2020-21 enacted budget level. cost increases, the required reserve deposit, and Figure 9 Funding Available for New Commitments in 2021-22 Changes From 2020-21 Enacted Budget 2021-22 Funding for Total Funding New Commitments $86.8 billion $4.2 b Supplemental $2.3 b Payment Statutory COLA (1.14 percent) Proposition 98 Reserve Deposit $0.9 b Backfill One-Time $1.4 b Deferral Savings $10.3 b $13.7 b Minimum Guarantee Baseline 2020-21 Adjustments a Enacted Budget $70.9 billion $-0.8 b Funding Growth a Consists primarily of one-time expenditures expiring in 2021-22 and lower baseline costs for the Local Control Funding Formula. COLA = cost-of-living adjustment. 14 LEGISLATIVE ANALYST’S OFFICE analysis full gutter 2021-22 BUDGET growth in funding, we estimate the Legislature (Salary and staffing decisions affect pension costs has $4.2 billion available for new commitments in because the contribution rates are based on a 2021-22. Of this amount, $2.3 billion is attributable percentage of district payroll.) to the supplemental payment and $1.9 billion to Much Larger Increase in Pension Costs growth in the minimum guarantee. Expected in 2022-23. After the one-time rate Funding for New Commitments Grows Over relief expires, district pension costs are expected Outlook Period. Under our main forecast, the to grow significantly. For 2022-23, the underlying average annual COLA costs (roughly $900 million) contribution rates currently are projected to grow are notably lower than the average annual increase more than 2 percent of pay for CalSTRS and in the minimum guarantee ($1.8 billion) and nearly 4 percent of pay for CalPERS. Depending the annual increase including the supplemental on district decisions about salaries and staffing, payment ($3.4 billion). Due to these differences, the the associated cost increase is likely to range from amount of funding available for new commitments $1.3 billion to $1.7 billion. A cost increase of this grows over time (Figure 10). Focusing on the magnitude exceeds the additional funding districts guarantee alone, the available funding grows to are likely to receive from the statutory COLA that more than $7 billion by 2024-25. Including the year. supplemental payment, the available funding grows LAO Comments to more than $13 billion. Greatly Improved Outlook for School and District Pension Costs Community College Funding. Although the state Pension Costs Likely to Increase by a Few economy remains below pre-pandemic levels by Hundred Million Dollars in 2021-22. Rising many measures, the rebound in state revenues pension costs have been a significant factor and the minimum guarantee is remarkable. Prior affecting district budgets over the past several to 2020-21, the largest increase in the guarantee years. Required district contributions to the relative to the enacted budget level occurred in California State Teachers’ Retirement System 2014-15, when the guarantee increased $6.3 billion (CalSTRS) and the California Public Employees’ (10.3 percent). The $13.1 billion (18.5 percent) Retirement System (CalPERS) have grown from increase in the 2020-21 guarantee under our $3.5 billion in 2013-14 to $8.4 billion in 2019-20. (Nearly Figure 10 all school and community college Funding for New Commitments Grows Over Time employees are covered by one (In Billions) of these two pension systems.) To address rising costs, the state $14 allocated more than $3 billion 12 non-Proposition 98 General Supplemental Fund to provide temporary cost 10 payments relief over the 2019-20 through 8 2021-22 period. Due to this relief, district pension costs are 6 expected to be roughly flat from 4 Amount by which guarantee exceeds 2019-20 to 2020-21. In 2021-22, program costsa 2 district costs are likely to increase by at least $200 million. To the 2021-22 2022-23 2023-24 2024-25 extent districts provide raises or hire additional staff, pension a Assumes existing programs are adjusted for the statutory cost-of-living adjustment and cost increases could be a couple attendance changes. hundred million dollars higher. www.lao.ca.gov 15 analysis full gutter 2021-22 BUDGET outlook would far surpass this record. Moreover, trade-offs with other parts of the state budget. As the revised 2020-21 guarantee would represent an we describe in The 2021-22 Budget: California’s all-time high on an inflation-adjusted basis. Fiscal Outlook, the state faces an operating deficit Legislature Could Pay Down All Existing over the next several years, despite a significant Deferrals. One core decision facing the Legislature windfall this year. To the extent the Legislature is how to allocate the $13.7 billion in available wants to provide funding on top of the guarantee, one-time funds. This allotment is large enough for it has many options—such as providing a larger the state to reverse all existing payment deferrals one-time payment without committing to long-term (at a cost of $12.5 billion). We think this approach increases. would have several advantages. Restoring the Dedicating Some 2021-22 Funding to regular payment schedule would improve cash One-Time Activities Would Build a Budget flow for schools and community colleges, reducing Cushion. Regardless of what the Legislature the need for internal or external borrowing. Paying decides about supplemental payments, the state down the deferrals also would remove pressure on would have Proposition 98 funds available for future Proposition 98 funding, giving the Legislature additional commitments in 2021-22. Although the more options to address economic downturns or state could allocate all of the 2021-22 funding for fund other priorities moving forward. In addition, ongoing programs, setting aside some portion the state would re-establish the link between for one-time activities would provide a measure ongoing program costs and ongoing funding. Since of protection against volatility in the minimum the deferrals are set to begin in February 2021, guarantee. To the extent the guarantee drops in the the Legislature would need to take early budget future, the expiration of one-time initiatives allows action if it wanted to rescind them in 2020-21. the state to accommodate the lower guarantee (Alternatively, the Legislature could pay down the without taking action to reduce funding, such as by deferrals starting in 2021-22.) If the Legislature cutting ongoing programs or deferring payments. does take early action, we would suggest a When the state sets aside little one-time funding, two-pronged approach that pays down some by contrast, budget balancing becomes more deferrals immediately and the remainder contingent difficult. The 2019-20 budget plan, for example, on state tax collections meeting expectations. had a one-time cushion of only $121 million. This Rebound in Funding Warrants a small cushion is one reason the state had to rely Reassessment of the Supplemental Payments. heavily on other actions (mainly deferrals) when it According to the Governor’s May Revision, adopted the 2020-21 budget. the supplemental payments were intended to One-Time Allocations Could Address a Range accelerate growth in funding relative to the of Issues. Some reports suggest certain students anticipated reductions in 2019-20 and 2020-21. have experienced significant learning loss since Under our outlook, however, these reductions the closure of schools in March 2020. We think the no longer occur. Rather than being $12.4 billion Legislature might want to explore how one-time below the level needed to keep pace with the funds could help districts provide additional economy over those two years, the guarantee support for these students. Prior to providing any is $600 million above this level. Moreover, our funds, however, we encourage the Legislature main forecast suggests that in a relatively stable to learn more about how districts spent their economic environment, growth in the guarantee previous allotment of federal funding and whether would be enough to cover the statutory COLA other policy changes might be needed. (The as well as other augmentations. Based on these 2020-21 budget plan included more than $6 billion developments, we think the Legislature should in one-time federal funding for schools, the majority reassess the supplemental payments after of which must be spent by December 30, 2020.) reviewing all of its budget priorities. In contrast Regarding district budgets, the Legislature could to many other education funding decisions, make additional pension payments to pay down the supplemental payments involve long-term future cost increases. If the Legislature were to take 16 LEGISLATIVE ANALYST’S OFFICE analysis full gutter 2021-22 BUDGET this approach, we encourage it to structure these Legislature could make additional deposits in the payments so they reduce costs on a long-term Proposition 98 Reserve or provide districts funding basis beginning in 2022-23, when contribution to build local reserves. If the Legislature were to rates are scheduled to increase. The Legislature pursue the local approach, it might need to modify also could set aside additional funding to protect the reserve cap. against economic downturns. For example, the www.lao.ca.gov 17 analysis full gutter 2021-22 BUDGET LAO PUBLICATIONS This report was prepared by Kenneth Kapphahn, and reviewed by Edgar Cabral and Anthony Simbol. 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. 18 LEGISLATIVE ANALYST’S OFFICE