The 2022-23 Budget: Fiscal Outlook for Schools and Community Colleges

analysis full gutter 2022-23 BUDGET The 2022-23 Budget: Fiscal Outlook for Schools and Community Colleges SUMMARY Surge in School and Community College Funding Projected in Upcoming Budget Cycle. 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). Based upon revenue projections that are significantly above the June 2021 estimates, we estimate the guarantee in 2022-23 is $11.6 billion (12.4 percent) above the 2021-22 enacted budget level. After accounting for various adjustments—backing out one-time expenditures, funding a 5.35 percent cost-of-living adjustment, and making required reserve deposits—we estimate that $9.5 billion is available for new commitments. In addition, we estimate that $10.2 billion in one-time funding is available due to increases in the guarantee in 2020-21 and 2021-22. In total, we estimate nearly $20 billion is available to allocate in the upcoming budget cycle. To help the Legislature prepare to allocate this funding, we outline several options that would build upon existing programs, expand services in targeted ways, and address future costs and uncertainties. GABRIEL PETEK | LEGISLATIVE ANALYST NOVEMBER 2021 www.lao.ca.gov 1 analysis full gutter 2022-23 BUDGET INTRODUCTION Report Provides Our Fiscal Outlook for differ from the June 2021 estimates. Third, we Schools and Community Colleges. State estimate the guarantee over the 2022-23 through budgeting for schools and the California Community 2025-26 period under our main economic forecast. Colleges is governed largely by Proposition 98. Finally, we identify the amount of funding that would The measure establishes a minimum funding be available for new commitments in the upcoming requirement for K-14 education commonly known year and describe some issues and options for the as the minimum guarantee. This report provides Legislature to consider as it prepares to allocate our estimate of the minimum guarantee for the this funding. (The 2022-23 Budget: California’s upcoming budget cycle. The report has four parts. Fiscal Outlook contains an abbreviated version of First, we explain the formulas that determine the this report, along with the outlook for other major minimum guarantee. Next, we explain how our programs in the state budget.) estimates of the guarantee in 2020-21 and 2021-22 BACKGROUND Minimum Guarantee Depends Upon Various Legislature Decides How to Allocate Inputs and Formulas. The California Constitution Proposition 98 Funding. Whereas Proposition 98 sets forth three main tests for calculating the establishes a minimum funding level, the Legislature Proposition 98 minimum guarantee. Each test takes decides how to allocate this funding among school into account certain inputs, including General Fund and community college programs. Since 2013-14, revenue, per capita personal income, and student the Legislature has allocated most funding for attendance (Figure 1). Whereas Test 2 and Test schools through the Local Control Funding Formula 3 build upon the amount of funding provided the (LCFF). A school district’s allotment depends on its previous year, Test 1 links school funding to a minimum share Figure 1 of General Fund revenue. The Three Proposition 98 Tests Constitution sets forth rules for comparing the tests, with one of the tests becoming operative and Test 1 Test 2 Test 3 used for calculating the minimum Share of General Change in Per Change in General guarantee that year. Although the Fund Revenue Capita Personal Fund Revenue Income (PCPI) state can provide more funding than required, in practice it usually General PCPI Fund funds at or near the guarantee. About ADA ADA With a two-thirds vote of each 40% house of the Legislature, the state Prior-Year Prior-Year can suspend the guarantee and Funding Funding provide less funding than the formulas require that year. The state meets the guarantee through Guarantee based on share Guarantee based on prior- Guarantee based on prior- of state General Fund year funding level adjusted year funding level adjusted a combination of General Fund and revenue going to K-14 for year-over-year changes for year-over-year changes local property tax revenue. education in 1986-87. in K-12 attendance and in K-12 attendance and California PCPI. state General Fund revenue. ADA = average daily attendance. 2 LEGISLATIVE ANALYST’S OFFICE analysis full gutter 2022-23 BUDGET size (as measured by student attendance) and the fit within the guarantee. Though statute is silent on share of its students who are low income or English community college programs, the state generally learners. The Legislature allocates most community aligns the COLA rate for these programs with the college funding through the Student Centered K-12 rate. Funding Formula (SCFF). A college district’s Proposition 98 Reserve Deposits Required allotment depends on its enrollment, share of Under Certain Conditions. Proposition 2 (2014) low-income students, and performance on certain created a state reserve specifically for schools and outcome measures. community colleges—the Public School System At Key Points, State Recalculates Minimum Stabilization Account (Proposition 98 Reserve). Guarantee and Certain Proposition 98 Costs. The Constitution requires the state to make The guarantee typically changes from the level deposits into this reserve when the state receives initially assumed in the budget act as the state above average revenue from capital gains and the updates the relevant Proposition 98 inputs. The minimum guarantee meets certain conditions (see state updates these inputs until May of the following the box on the next page). fiscal year. The state also revises its estimates of Proposition 98 Reserve Linked With Cap on certain school and community college costs after School Districts’ Local Reserves. A state law it adopts the budget. When student attendance enacted in 2014 and modified in 2017 sets a cap changes, for example, the cost of LCFF tends on school district reserves after the Proposition 98 to change in tandem. The state finalizes its Reserve reaches a certain threshold. Specifically, calculations through “certification,” a process the cap applies if the balance in the reserve during involving the publication of the underlying inputs the previous year exceeded 3 percent of the and a period of public review. The most recently Proposition 98 funding allocated for K-12 schools certified year is 2019-20. that year. Once the cap becomes operative, School and Community College Programs medium and large districts (those with more Typically Receive COLA. The cost-of-living than 2,500 students) must limit their reserves to adjustment (COLA) rate is based on a price index 10 percent of their annual expenditures. Smaller published by the federal government. This index districts are exempt. The law also exempts reserves reflects changes in the cost of goods and services that are legally restricted to specific activities and purchased by state and local governments across reserves set aside by a district’s governing board the country. State law provides an automatic COLA for specific purposes. In addition, a district facing for LCFF unless the guarantee—as estimated in “extraordinary fiscal circumstances” can apply for the enacted budget—is insufficient to cover the an exemption from its county office of education for associated costs. In these cases, the law reduces up to two consecutive years. the COLA for LCFF (and other K-12 programs) to 2020-21 AND 2021-22 UPDATES State Revenues Have Been Surging. State tax growth in 2021. Stock prices have doubled from collections have grown rapidly in recent months their pandemic low in the spring of 2020. Several (Figure 2 on page 5). For example, September 2021 major firms have posted historically high earnings. collections from the three largest taxes (personal Consistent with these developments, General income, sales, and corporation taxes) were Fund revenues under our outlook are more than 40 percent higher than September 2020 and $28 billion above the June 2021 estimates across almost 60 percent higher than September 2019. 2020-21 and 2021-22. These increases build upon extraordinary growth Proposition 98 Guarantee Revised Up in several measures of economic activity. Retail Significantly Across 2020-21 and 2021-22. sales, for example, have posted double digit Compared with the estimates included in the www.lao.ca.gov 3 analysis full gutter 2022-23 BUDGET Key Rules Governing the Proposition 98 Reserve Deposits Predicated on Two Basic Conditions. To determine whether a deposit is required, the state estimates the amount of revenue it will receive from taxes on capital gains (a relatively volatile source of General Fund revenue). Deposits are required only when the state expects to receive an above-average amount of capital gains revenue. The state also identifies which of the three tests will determine the minimum guarantee. Deposits are required only when Test 1 is operative. (Test 1 years typically are associated with relatively strong growth in the guarantee.) Required Deposit Amount Depends on Formulas. After the state determines it meets the basic conditions, it performs additional 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 actual guarantee and the hypothetical 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 prior-year adjusted level. • Room Available Under a 10 Percent Cap. The Proposition 98 Reserve has a cap on required deposits equal to 10 percent of the funding allocated to schools and community colleges. Deposits are only required to the extent the balance is below this threshold. Legislature Has Some Control Over Deposit Amounts. Although the constitutional formulas generally control the size of the deposits, the Legislature can make different decisions in certain circumstances. In tight fiscal times, the Legislature can reduce or cancel a deposit if the Governor declares a budget emergency (based on a natural disaster or slowdown in state revenues). In addition, any required reserve deposit is canceled if the Legislature votes to suspend the minimum guarantee. In stronger fiscal times, the Constitution does not prevent the Legislature from making deposits above the required amount. (Since 2014, the state has made several optional deposits into the Budget Stabilization Account—the other reserve account established by Proposition 2.) Withdrawals Also Linked With Formulas. The Constitution requires the state to withdraw previously required deposits 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 2022-23 BUDGET June 2021 budget plan, we estimate the minimum estimates of capital gains, which are down slightly guarantee is up $1.8 billion in 2020-21 and in 2020-21 and up in 2021-22. $8.9 billion in 2021-22 (Figure 3). These upward State Required to Provide $10.2 Billion in revisions are due almost entirely to our higher Additional One-Time Funding. After accounting General Fund revenue estimates. Test 1 remains for increases in the minimum guarantee, lower operative in both years, with the increase in the program costs, and the higher reserve deposit, we General Fund portion of the guarantee equating estimate that spending is nearly $2.1 billion below to nearly 40 percent of the additional revenue. the guarantee in 2020-21 and nearly $8.2 billion Our estimates of local property tax revenue, by below the guarantee in 2021-22. Across the two comparison, are up slightly in 2020-21 and down years, the state would be required to make one-time slightly in 2021-22. (When Test 1 is operative, payments totaling $10.2 billion to “settle up” for changes in local property tax revenue directly affect the difference. The Legislature could allocate the Proposition 98 guarantee. They do not offset these payments for any school or community General Fund spending.) college programs. Program Costs Down Slightly Over the Two Years. For 2020-21, the latest available Figure 2 data show that costs of LCFF and Rapid Rise in Revenue Collections in Recent Months other Proposition 98 programs Rolling 12-Month Total Collections From Income, Sales, and Corporation Taxes are essentially unchanged from June 2021 estimates (Figure 4 on the next page). For 2021-22, (In Billions) we estimate costs are down $101 $200 During the 12-month period ending in September 2021, tax collections grew million. This drop mainly relates to at an annual rate of 30 percent, the our estimate that LCFF costs are 160 fastest rate in at least four decades. likely to grow slightly less quickly than the state previously assumed. 120 Higher Proposition 98 80 Reserve Deposit Over the Two Years. Compared with June 2021 40 estimates, the reserve deposits under our outlook are down $231 million in 2020-21 and up 1999-00 01-02 03-04 05-06 07-08 09-10 11-12 13-14 15-16 17-18 19-20 21-22 $871 million in 2021-22. These changes are due to our revised Figure 3 Updating Prior-and Current-Year Estimates of the Minimum Guarantee (In Millions) 2020-21 2021-22 June November June November Budget Plan LAO Estimates Change Budget Plan LAO Estimates Change Minimum Guarantee General Fund $67,685 $69,449 $1,764 $66,374 $75,399 $9,024 Local property tax 25,745 25,814 69 27,365 27,279 -85 Totals $93,430 $95,263 $1,833 $93,739 $102,678 $8,939 General Fund tax revenue $178,080 $182,722 $4,642 $174,610 $198,365 $23,755 www.lao.ca.gov 5 analysis full gutter 2022-23 BUDGET Figure 4 Additional Spending Required to Meet Guarantee in Prior and Current Year (In Millions) 2020-21 2021-22 June November June November Budget Plan LAO Estimates Change Budget Plan LAO Estimates Change Minimum Guarantee $93,430 $95,263 $1,833 $93,739 $102,678 $8,939 Funding Allocations Local Control Funding Formula $62,342 $62,354 $12 $66,710 $66,584 -$126 Other K-14 programs 29,198 29,191 -7 24,412 24,437 25 Proposition 98 Reserve deposit 1,889 1,658 -231 2,617 3,488 871 Totals $93,430 $93,204 -$226 $93,739 $94,509 $770 Settle-Up Payment — $2,059 $2,059 — $8,169 $8,169 MULTIYEAR OUTLOOK In this section, we estimate the minimum the remaining years of the period, increasing guarantee for 2022-23 and the following three modestly in 2023-24 and accelerating in 2024-25 years under our main economic forecast. We also and 2025-26. examine how the Proposition 98 Reserve would Three Factors Account for Growth in the change and the factors affecting state costs for Guarantee. Under our main forecast, the guarantee school and community college programs. grows to $121.3 billion in 2025-26, an increase of $18.6 billion compared with the revised 2021-22 Economic Assumptions level (Figure 6 on page 8). The average annual Main Forecast Anticipates Moderate Growth. growth is $4.7 billion (4.3 percent). The largest Our main forecast anticipates that the rapid pace of factor contributing to this growth is the increase revenue growth will moderate significantly over the in General Fund revenue. Test 1 is operative coming months. Whereas we forecast revenue will throughout period, with the General Fund portion grow 8 percent in 2021-22, we anticipate growth of the guarantee increasing about 40 cents for will be about 2 percent in 2022-23, remain relatively each dollar of additional revenue. Growth in flat in 2023-24, and return to historical norms local property tax revenue also accounts for a of 5 percent to 6 percent annually thereafter. In significant portion of the increase. Our property developing these estimates, we accounted for the tax estimates primarily reflect growth in assessed unprecedented nature of economic growth over the property values, which ranges from 5.6 percent to past year and assumed that only a portion of that 6 percent annually. Finally, the guarantee increases growth would be sustained. because of the planned expansion of Transitional Kindergarten. As we discuss later in this report, the The Minimum Guarantee Legislature and Governor have agreed to increase the General Fund portion of the guarantee to cover Guarantee Grows Throughout the Outlook the cost of this expansion. Period. The minimum guarantee under our main forecast is $105.3 billion in 2022-23. Relative to Guarantee Is Moderately Sensitive to the 2021-22 enacted budget level, this increase is Changes in Revenue Estimates. General Fund substantial—$11.6 billion (12.4 percent). Compared revenue tends to be the most volatile input in the with our revised estimate of 2021-22, however, the calculation of the Proposition 98 guarantee. For any increase is more modest—$2.6 billion (2.6 percent) given year, the relationship between the guarantee (Figure 5). The guarantee continues to grow over and General Fund revenue generally depends on which Proposition 98 test is operative and whether 6 LEGISLATIVE ANALYST’S OFFICE analysis full gutter 2022-23 BUDGET another test could become operative with higher or (barring a recession) is about half as large as the lower revenue. Test 1 is likely to remain operative range by 2025-26. The figure also shows that in over the period even if revenues differ from our main most scenarios, the guarantee is above our 2021-22 forecast, meaning the guarantee would change estimates by the end of the period. Local property about 40 cents for each dollar of higher or lower tax revenue contributes significantly to this trend, General Fund revenue. because it tends to increase even when General Estimates of the Guarantee Become More Fund revenue is sluggish or declining Uncertain Over Time. We also examined the State and School District Reserves range of potential variation in General Fund revenue estimates relative to our main forecast. For this Proposition 98 Reserve Deposits Required in analysis, we looked at how much revenue forecasts 2022-23 and 2023-24. Under our main forecast, tended to differ from actual revenues over the last the state would make a $3.1 billion deposit into 50 years. We then used this historical relationship the Proposition 98 Reserve in 2022-23 and a to determine the likely range of revenues over the $1.1 billion deposit in 2023-24. Combined with next several years. We also identified the subset of previous deposits, these two deposits would bring this range likely to be associated with a recession. the total balance in the reserve to $9.4 billion (nearly Figure 7 on the next page displays our estimates 9 percent of the estimated guarantee in 2023-24). of the guarantee under the various revenue In the following two years, the state would not ranges. The uncertainty in our estimates increases make any deposits or withdrawals. These estimates significantly over the outlook period. For example, mainly reflect our assumptions about capital gains the reasonable range for the guarantee in 2022-23 revenue. Under our outlook, capital gains revenue is Figure 5 Proposition 98 Outlook Under Main Forecast (Dollars in Millions) 2021-22 2022-23 2023-24 2024-25 2025-26 Minimum Guarantee General Funda $75,399 $76,660 $77,146 $81,644 $87,777 Local property tax 27,279 28,661 30,188 31,838 33,524 Totals $102,678 $105,321 $107,334 $113,482 $121,302 Change From Prior Year General Fund $5,950 $1,261 $486 $4,499 $6,133 Percent change 8.6% 1.7% 0.6% 5.8% 7.5% Local property tax $1,465 $1,382 $1,527 $1,650 $1,686 Percent change 5.7% 5.1% 5.3% 5.5% 5.3% Total guarantee $7,415 $2,643 $2,013 $6,148 $7,819 Percent change 7.8% 2.6% 1.9% 5.7% 6.9% General Fund Tax Revenueb $198,365 $200,575 $200,290 $210,272 $223,301 Growth Rates K-12 average daily attendancea -2.5% 1.1% 1.1% 0.9% 0.3% Per capita personal income (Test 2) 5.7 5.1 4.1 3.2 3.3 Per capita General Fund (Test 3)c 9.6 1.6 0.0 4.9 6.1 Proposition 98 Reserve Deposit (+) or withdrawal (-) $3,488 $3,123 $1,145 — — Cumulative balance 5,147 8,270 9,415 $9,415 $9,415 a Estimates account for the expansion of Transitional Kindergarten eligibility over the 2022-23 through 2025-26 period. b Excludes non-tax revenues 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. Notes: Test 1 is operative throughout the period. No maintenance factor is created or paid. www.lao.ca.gov 7 analysis full gutter 2022-23 BUDGET strong in 2022-23, but fades to below average levels The latest available data show that as of June 30, by the end of the outlook period. Reserve deposits, 2020, 265 out of 350 medium and large districts however, are sensitive to these assumptions. subject to the cap held reserves exceeding 10 Deposits could increase if capital gains revenue percent of their expenditures. The total amount were stronger over the period, potentially reaching above the cap was $4.6 billion—approximately half the 10 percent limit. Conversely, the state could of the reserves held by these districts. Districts make no deposits if capital gains were weak over affected by the cap could designate their reserves the period. for specific purposes, seek temporary exemptions Proposition 98 Reserve Helps Mitigate from their county offices of education, or spend Volatility in the Guarantee. Reserve deposits and down their reserves. withdrawals provide a cushion for school and community programs Figure 6 when the minimum guarantee changes. If the guarantee were to Growth in the Proposition 98 Guarantee exceed our main forecast because From 2021-22 to 2025-26a of higher General Fund revenues, Main Forecast (Dollars in Billions) the state likely would be required to make a larger deposit. The higher Average Annual Increase Increase Over deposit would limit the amount Four-Year Period Amount Percent available for expanding school and General Fund: community college programs. On Increases due to higher revenues $9,518 $2,380 3.0% the downside, a lower guarantee TK adjustment 2,861 715 — likely would reduce or eliminate Subtotal (General Fund) ($12,379) ($3,095) (3.9%) Local property tax increases $6,245 $1,561 5.3% any required deposits. Moreover, Total Guarantee $18,624 $4,656 4.3% if the guarantee were below the a Relative to 2021-22 revised estimate of the guarantee. previous year’s level (adjusted for TK = Transitional Kindergarten. inflation), the state could make reserve withdrawals. These actions would reduce the size of potential Figure 7 reductions to school and community college programs. The cushioning Proposition 98 Estimates Become effect of the reserve, however, is More Uncertain Over Time relatively modest. If the state were to Minimum Guarantee (In Billions) experience a significant upward or downward swing in the guarantee, The shaded region shows how much the guarantee might the funding available for programs differ from our main forecast. The upper shaded area $140 shows the most likely range of possibilities barring a could still change significantly. recession. The lower shaded area shows how far the Local Reserve Cap Would 130 guarantee could fall should a recession occur. Remain Operative Over the 120 Period. The June 2021 budget plan estimated that the Proposition 110 LAO Main Forecast 98 Reserve balance would exceed 100 3 percent of the Proposition 98 funding allocated for schools in 90 2021-22, triggering the reserve cap in 2022-23. Under our main 80 forecast, the balance remains above 2020-21 2021-22 2022-23 2023-24 2024-25 2025-26 this threshold and the reserve cap is operative throughout the period. 8 LEGISLATIVE ANALYST’S OFFICE analysis full gutter 2022-23 BUDGET Program Costs Several Previous Commitments Increase Costs Over the Period. The June 2021 budget Large Statutory COLA Projected in 2022-23, plan created five commitments that increase costs Followed by COLAs Around the Historical for various school programs over the next several Average. For 2022-23, we estimate the statutory years. Relative to the funding included in the COLA is 5.35 percent. This COLA rate—the highest 2021-22 budget, we estimate these commitments in 15 years—reflects above average growth in will increase costs by $2.3 billion in 2022-23 and prices for many goods and services over the past $8.2 billion by 2025-26 (Figure 8 on the next page). several months. We estimate the cost of providing One of these commitments involves the expansion this COLA for school and community college of Transitional Kindergarten, a program that is programs is $4.4 billion. Moving forward, most currently available to four-year olds born between economic forecasters expect price inflation to September 2 and December 2. Trailer legislation moderate sometime next year. Consistent with begins expanding eligibility for this program in this assumption, our main forecast estimates the 2022-23 and opens the program to all four-year COLA rate at 3.5 percent in 2023-24, 3 percent olds by 2025-26. The Legislature and Governor in 2024-25, and 3 percent in 2025-26. These also have agreed to adjust the minimum guarantee rates are somewhat above the annual average upward by the cost of this expansion (which we of 2.6 percent over the past three decades. estimate at $421 million in 2022-23 and $2.9 billion We estimate the associated costs are roughly in 2025-26). For the other four commitments— $3 billion per year. (Our outlook also reflects a new related to the Expanded Learning Opportunities methodology for estimating the COLA rate, which Program, Transitional Kindergarten staffing, school we think better aligns with our overall economic meal reimbursements, and special education—the assumptions. Whereas we previously relied on state will not adjust the guarantee. consensus estimates from Moody’s Analytics, K-12 Attendance Projected to Drop in this year we developed our own estimates based 2021-22, Rise Over the Following Four Years. on the consensus of economists in the Blue Chip The state did not collect school attendance data in Economic Indicators survey.) 2020-21 due to the pandemic and the temporary Higher COLA Rates and Costs if Inflation switch to remote learning. For 2021-22, our outlook Persists. Although many economists expect assumes average daily attendance will be down inflation to moderate, an alternative possibility is about 170,000 students (3 percent) relative to that higher inflation persists for at least the next the pre-pandemic level of 5,897,000. Over the several years. (Underscoring this possibility, data following four years, our outlook accounts for three released after the development of our main forecast trends affecting attendance. First, we expect an showed higher-than-expected inflation in October.) additional reduction of about 170,000 students Based on our analysis of previous deviations from by 2025-26 due to declines in the school age the economic consensus, a scenario in which population. This drop primarily reflects declining inflation runs closer to 5 percent per year seems births in California—a trend that began more than plausible. If the statutory COLA rate were 5 percent a decade ago and has continued through the annually over the 2023-24 through 2025-26 period, pandemic. Second, we expect the expansion of the annual cost increases would be roughly Transitional Kindergarten to add nearly 230,000 $4.5 billion per year. (The 2022-23 COLA rate is students by 2025-26. Finally, we assume districts’ unlikely to change significantly because it reflects attendance eventually recovers by the equivalent changes in the price index during the previous year. of about 140,000 students relative to the drop in The federal government has already published most 2021-22. Accounting for all these estimates and of the data that will determine the 2022-23 COLA.) assumptions, statewide attendance would be approximately 5,925,000 students in 2025-26— slightly above the pre-pandemic level. www.lao.ca.gov 9 analysis full gutter 2022-23 BUDGET Figure 8 Estimated Cost Increases for Previous Commitments (In Billions) Additional State Costsa Program/Issue New Requirement(s) 2022-23 2025-26 Expanded Learning Districts must offer before/after school programs and summer $1.0b $4.0b Opportunities Program programs to low-income students and English learners in Transitional Kindergarten through grade 6 in 2021-22. Beginning in 2022-23, districts with the highest concentrations of low-income students and English learners (80 percent or above) must serve all interested Transitional Kindergarten through grade 6 students. Transitional Kindergarten Districts must begin expanding eligibility for Transitional Kindergarten 0.4 2.9 eligibility in 2022-23 and enroll all interested four-year olds by 2025-26. School meal Districts must provide two free meals per school day for any student 0.7 0.7 reimbursements requesting a meal beginning in 2022-23. Transitional Kindergarten Districts must maintain a 12:1 ratio of students to adults in 2022-23 — 0.4 staffing ratios and a 10:1 ratio beginning in 2023-24. Special education Beginning in 2022-23, the state must backfill one-time funds provided 0.2c 0.2c in 2021-22 that count toward the federal maintenance of effort requirement. Totals $2.3 $8.2 a Estimate of the additional costs relative to the 2021-22 budget level. b The 2021-22 budget provided $1 billion in ongoing funds and $750 million in one-time funds. Increases are relative to the ongoing amount provided in 2021-22. c Excludes the portion of this requirement that is satisfied by funding growth and the cost-of-living adjustment in 2022-23. The state could allocate the backfill for any special education purpose. KEY CONSIDERATIONS In this part of the report, we highlight a few the underlying funds. An additional $1.8 billion issues for the Legislature to consider as it is available from reductions in costs due to begins planning for the upcoming budget cycle. lower attendance. Regarding cost increases, we Specifically, we (1) analyze the amount of new account for previous commitments, the required funding available for school and community college reserve deposit, and the 5.35 percent COLA. After programs, (2) describe a few notable issues adjusting for these issues and the growth in the affecting district budgets, and (3) comment on the minimum guarantee, we estimate the Legislature options for allocating the available one-time and has $9.5 billion in ongoing funds available in ongoing funding. 2022-23. (Our estimates do not account for potential interactions with the state appropriations Ongoing Funds for New Commitments limit. The box on page 12 explains how the limit Nearly $10 Billion in New Ongoing Funds could affect school funding.) Available in 2022-23. Figure 9 shows our estimate Under Main Forecast, Funding for New of the changes in funding and costs relative to Commitments Dips in 2023-24, Then Grows. the 2021-22 enacted budget level. Regarding The top of Figure 10 on page 13 shows how the downward cost adjustments, the 2021-22 funding and costs change over the period under our budget plan allocated $5.9 billion for one-time main forecast. The lighter shaded area represents activities, including funds to pay down deferrals the amount available for new commitments, and cover the reserve deposit required in 2021-22. assuming no changes to current law or policy. These allocations expire in 2022-23, freeing-up More specifically, it represents the difference 10 LEGISLATIVE ANALYST’S OFFICE analysis full gutter 2022-23 BUDGET between the Proposition 98 guarantee and baseline Under Mild Economic Downturn, State costs, which include the cost of providing the Could Cover Existing Commitments Only. We statutory COLA for existing programs and the examined how funding for schools and community cost increases related to previous commitments. colleges would change under a mild economic Under our main forecast, the amount of funding downturn (bottom of Figure 10). For this analysis, available dips from $9.5 billion in 2022-23 to we assumed that instead of growing throughout the $8.4 billion in 2023-24, then grows over the rest period, General Fund revenues would experience of the period. To the extent the state adopts new a year-over-year decline of $20 billion (10 percent) ongoing commitments in 2022-23, the amount of in 2023-24, then grow slowly over the following funding available in each subsequent year would two years. In this scenario, the state would have be lower by a corresponding amount. We also enough funding cover the statutory COLA and the explored a variant of our main forecast in which the cost of its previous commitments, but would be minimum guarantee is unchanged but the statutory unable to cover significant new commitments. The COLA is 5 percent per year from 2023-24 through state, however, also could make withdrawals from 2025-26. Baseline costs grow more quickly in this the Proposition 98 Reserve in this situation. If the scenario, reducing the amount available for new state had made any new ongoing commitments commitments to about $7 billion in 2023-24 and in 2022-23, these withdrawals would mitigate about $9 billion in 2025-26. the need to make immediate reductions to those commitments in 2023-24. Figure 9 Significant Funding Available for New Commitments in 2022-23 Changes From 2021-22 Enacted Budget (In Billions) Funding for New Growth in 2022-23 Commitments Guarantee Minimum $9.5 $11.6 Guarantee $105.3 Billion Statutory COLA (5.35 percent) Backout $4.4 2021-22 One-Time Enacted Spendinga Budget $93.7 Billion -$5.9 Reserve Deposit $3.1 Previous Attendance Commitmentsc Adjustmentsb $2.3 -$1.8 a Consists primarily of deferral paydowns and the 2021-22 reserve deposit. b Consists primarily of lower LCFF costs due to attendance reductions in the previous year and the expiration of the hold harmless provision in 2022-23. c Includes increases related to the Expanded Learning Opportunities Program, school meal reimbursements, Transitional Kindergarten, and special education. COLA = cost-of-living adjustment and LCFF = Local Control Funding Formula. www.lao.ca.gov 11 analysis full gutter 2022-23 BUDGET District Budget Issues on lower attendance in 2021-22, but only to the extent those reductions continue in 2022-23. Attendance Declines Likely to Affect School Our outlook assumes an attendance-related District LCFF Funding in 2022-23. Several large drop in LCFF of about $1.8 billion (2.5 percent) in school districts have recently reported attendance 2022-23. Attendance-related drops, however, do levels that are well below their pre-pandemic levels. not translate into less overall funding for schools Districts indicate these drops reflect a combination statewide because the state must allocate the of fewer students enrolling and higher rates of same total amount to meet the minimum guarantee. absenteeism for those who do enroll. A state law (Any funds freed-up from lower LCFF costs could mitigates the effects of this decrease in 2021-22 be allocated for other school priorities—including by crediting districts with their pre-pandemic LCFF augmentations.) Many community colleges attendance levels for the purpose of LCFF. In also report enrollment declines relative to their 2022-23, however, the state is scheduled to pre-pandemic levels. Although these reductions return to its longstanding policy and will credit eventually could translate into lower SCFF funding districts with the higher of their attendance in levels, the state has several “hold harmless” 2021-22 or 2022-23. This policy means that provisions to maintain funding in 2022-23. districts could experience funding declines based The State Appropriations Limit and School Funding Constitution Establishes State Appropriations Limit (SAL). Proposition 4 (1979) established an appropriations limit for the state (and most types of local governments). Under the measure, the state must compare its limit to the appropriations subject to the limit each year. Appropriations subject to the limit are determined by taking all proceeds of taxes and subtracting excluded spending, such as spending on capital outlay and certain subventions to local governments. If appropriations subject to the limit exceed the limit (on net) over any two-year period, the state has excess revenues. The Legislature can respond to excess revenues by (1) lowering tax revenues, (2) splitting the excess between taxpayer rebates and one-time payments to school and community college districts, or (3) appropriating more money for purposes excluded from the limit. Under Our Revenue Estimates, SAL Has Significant Budget Implications. Our outlook anticipates the state will have a $31 billion General Fund surplus (outside of the Proposition 98 budget) to allocate in the upcoming budget process. Under our estimates of revenues and spending under current law and policy, the state would need to allocate $14 billion to meet the constitutional requirements under SAL across 2020-21 and 2021-22. Moreover, while there is significant uncertainty in these figures, we estimate the state could have $12 billion in additional SAL requirements to meet in 2022-23. This means that, under our revenue estimates, the Legislature likely would need to use a significant share of the surplus to meet its SAL requirements. Potential Effects on School and Community College Funding. The effects on schools and community colleges depend on how the state responds to the limit. For example, the Legislature could split the excess revenues between taxpayer rebates and additional school and community college spending. In this scenario, schools and community colleges would receive funding (allocated on a per-pupil basis) to supplement the Proposition 98 guarantee. Alternatively, the Legislature could reduce General Fund taxes. Under this scenario, the guarantee would decrease about 40 cents for each dollar of lower revenue. Depending on the nature of those revenue reductions, the decrease in the guarantee could be temporary or ongoing. 12 LEGISLATIVE ANALYST’S OFFICE analysis full gutter 2022-23 BUDGET Pension Costs Increasing for School and other pandemic-related costs. These funds have Community College Districts. Districts make various spending deadlines, but the majority must annual contributions to the California State be spent by September 2024. As of September Teachers’ Retirement System (CalSTRS) for 2021, California schools reported spending teachers, faculty, and administrators, as well as to less than 15 percent of available federal funds. the California Public Employees’ Retirement System Moreover, in March 2021, the state provided an (CalPERS) for their other employees. To mitigate additional $4.6 billion in one-time Proposition 98 increases in district contributions, the state allocated more than Figure 10 $3 billion non-Proposition 98 General Fund for district cost relief Proposition 98 Funding and Costs over the 2019-20 through 2021-22 Under Main Forecast and Downturn Scenario period. As this relief expires, district (In Billions) contributions are expected to grow significantly. For employees covered by CalSTRS, district costs Main Forecast currently are expected to increase about $1 billion (2.2 percent of pay) Uncommitted Funds Available $14.4 in 2022-23. For employees covered by CalPERS, the increase is about Baseline Costsa $600 million (3.2 percent). Although $11.1 CalSTRS recently reported investment returns far above its Minimum long-term target, these returns are $8.4 $13.2 Guaranteea unlikely to reduce required district $9.5 contributions. Under the funding $8.7 plan the Legislature adopted in $5.2 2013-14, the state General Fund $2.1 is responsible for most of the 2022-23 2023-24 2024-25 2025-26 volatility in CalSTRS’ investment returns. In other words, the General Fund receives the benefit when returns are strong and bears the Economic Downturn Beginning in 2023-24 costs when returns are weak. To the extent that projected district contributions to CalSTRS change in the coming months, they are $0.6 likely to be somewhat higher than $9.5 $13.2 $0.6 current estimates (as we explain in $8.7 Minimum a separate post). $2.0 Guaranteea Districts Have Significant $4.0b $2.1 Amounts of Unspent One-Time 2022-23 2023-24 2024-25 2025-26 Funds. Since March 2020, the federal government has provided California more than $23 billion a Increases in the minimum guarantee and baseline costs are relative to the 2021-22 enacted in one-time funding for K-12 budget level. Baseline costs include statutory cost-of-living adjustments, costs of previously schools to address learning approved commitments, attendance changes, and required reserve deposits. b Decrease relative to main forecast is due to elimination of required reserve deposit. loss, reopen schools, and cover www.lao.ca.gov 13 analysis full gutter 2022-23 BUDGET funds for similar purposes. (Community colleges higher inflation scenario. This approach would have also received a large amount of one-time leave as much as $7 billion in funding available for federal and state funding, and a significant portion new ongoing commitments. Setting aside even remains unspent.) more one-time funding would provide protection against a larger array of negative scenarios, though LAO Comments the Legislature would have less funding available Outlook for School and Community College to allocate for new ongoing commitments. After Funding Is Highly Positive. The projected growth deciding upon its overall mix of one-time and in the guarantee under our outlook is extraordinary ongoing spending, the Legislature could then turn by several measures. For the upcoming budget to decisions about funding specific school and cycle, the Legislature has nearly $20 billion community college programs. to allocate for new commitments, including Options for Allocating Additional Funds to $10.2 billion in one-time funds related to 2020-21 Schools. For K-12 schools, the Legislature could and 2021-22 and $9.5 billion in ongoing funds consider allocating additional funding in ways related to 2022-23. This estimate of available that would build upon existing initiatives, improve funding exceeds the amount of new funding in any services in targeted ways, and/or address historical previous outlook report our office has produced. funding disparities. Below, we outline a few The pace at which this funding has emerged also is promising options. remarkable. Our estimate of the 2021-22 guarantee, • Accelerate Expanded Learning for example, is up more than $24 billion (30 percent) Opportunities Program (ELO-P). The compared with the guarantee three years ago. state created ELO-P in the 2021-22 budget These funding increases provide a significant to fund before/after school programs and opportunity for the Legislature to make progress summer programs for students in Transitional on its school and community college priorities. Kindergarten through grade 6. The Legislature In the remainder of this section, we outline and Governor previously agreed to ramp up some considerations and options for allocating ongoing funding over the next four years— this funding. from $1 billion in 2021-22 to about $5 billion Setting Aside Some 2022-23 Funds for by 2025-26. The state could accelerate One-Time Activities Would Mitigate Downside this schedule, which would give districts Risk. One preliminary decision for the Legislature more certainty about their funding levels involves the overall mix of one-time and ongoing and potentially improve local planning for activities to fund using the $9.5 billion available these programs. in 2022-23. (The increases associated with • Equalize LCFF Add-Ons. School districts 2020-21 and 2021-22 are available only for receive $1.4 billion annually from various one-time activities.) If the state were to allocate all add-ons to the LCFF, largely based on the $9.5 billion for new ongoing commitments, it could size of certain programs they were operating face difficulty maintaining those commitments in decades ago. The state could use some of 2023-24 unless economic growth exceeds our the available ongoing funds to equalize these main forecast. Under our main forecast, the amount add-ons—for example, ensuring all districts available for new commitments in 2023-24 dips receive a minimum amount per student, by about $1 billion. Under a scenario where the regardless of their previous allocations. statutory COLA remains at 5 percent, the dip would Equalization would increase general purpose be closer to $2.5 billion. Although the Legislature funding and reduce historical disparities could go about determining its mix of one-time in LCFF. and ongoing funding in various ways based on • Fund Implementation of Special Education its risk tolerance and spending priorities, one Reforms. In recent years, the state has approach would be to set aside at least $2.5 billion commissioned several studies examining for one-time activities to mitigate the risk from the 14 LEGISLATIVE ANALYST’S OFFICE analysis full gutter 2022-23 BUDGET the delivery of special education to students one-time or ongoing funds to support food with disabilities. Their purpose is to make and housing insecure students. The state also recommendations for improvement in a could provide additional funding to further variety of areas ranging from governance and support the mental health needs of community accountability to coordination of services college students. during important transitions. The state could Crosscutting Options for Allocating Additional use one-time or ongoing funds to implement Funds. The Legislature could allocate some of the the most promising recommendations. additional funding to address issues facing both Options for Allocating Additional Funds to schools and community colleges. We provide a few Community Colleges. The Legislature could examples below, focusing on options that could increase funding for the community colleges mitigate future risks, costs, and uncertainties. by providing more unrestricted funding, more • Address Pension Liabilities and Costs. The restricted funding for specified purposes, or more state has a number of options for allocating support directly to students to address living costs. funds that would improve the funding status of Below, we provide potential augmentations for the pension systems and/or provide cost relief each category. for districts. For example, the state could use • Augment Core Funding for SCFF. The SCFF one-time funds to pay down pension liabilities is the primary source of general purpose more quickly, which would also tend to lower funding for community college districts. The district costs over the next several decades. state could augment core funding for SCFF Another approach could focus on smoothing (beyond the statutory COLA) to help districts future growth in pension costs, such as by cover fixed and other general operating costs setting aside funds districts would receive if and increase overall funding per student. Each their annual pension costs were to increase by 1 percent increase in the base funding for more than a certain amount. SCFF would cost about $75 million ongoing. • Improve Climate Resiliency and Emergency • Provide Funding for Facility Maintenance. Preparedness. Our office has released One notable funding need is for renewal of several reports examining the effects of districts’ physical infrastructure. Even after climate change, including sea level rise, receiving a sizeable amount of one-time increasing temperatures, and more frequent funds for facilities maintenance in the and severe wildfires. School and community 2021-22 budget, districts continue to have college districts own and operate more a large deferred maintenance backlog (likely than 10,000 facilities across the state that more than $600 million). The state could could be affected. The state could explore provide additional one-time or ongoing providing grants for districts to assess their funds for deferred or scheduled (on time) vulnerability, conduct emergency response maintenance projects. planning, purchase emergency equipment, and retrofit buildings to improve their resiliency • Provide More Direct Student Support. Over to these trends. the past several years, the state has increased • Make Optional Proposition 98 Reserve funding for community college students Deposit. An additional one-time deposit into through increased financial aid, food pantries, the Proposition 98 Reserve would increase the rapid rehousing programs for homeless protection for ongoing programs in the event of students, and student mental health services. an economic downturn, reducing the likelihood To address high living costs for students, of cuts or deferrals. It also could allow the the state could increase ongoing funding Legislature to set aside funds temporarily for for financial aid (such as by augmenting programs it intends to identify or develop in funding for the Student Success Completion the future. Grant, which supports eligible low-income students attending college full time) or provide www.lao.ca.gov 15 analysis full gutter 2022-23 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. 16 LEGISLATIVE ANALYST’S OFFICE