The 2023-24 Budget: Fiscal Outlook for Schools and Community Colleges

2023-24 BUDGET The 2023-24 Budget: Fiscal Outlook for Schools and Community Colleges GABRIEL PETEK | LEGISLATIVE ANALYST | NOVEMBER 2022 SUMMARY State Could Fund Increases for Existing Programs Despite Decline in Proposition 98 Guarantee. 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 recent signs of weakness in the economy, we estimate the guarantee in 2023-24 is $2.2 billion (2 percent) below the 2022-23 enacted budget level. Despite this drop, $7.6 billion would be available to provide increases for school and community college programs. This funding is available due to three key adjustments—backing out one-time costs, reducing expenditures to reflect student attendance changes, and making a required withdrawal from the Proposition 98 Reserve. In 2023-24, the available funding could cover a cost-of-living adjustment (COLA) of up to 8.38 percent, which is slightly below our estimate of the statutory rate (8.73 percent). Over the next several years, growth in the guarantee and required reserve withdrawals would be just enough to cover the statutory COLA (see the figure below). Given this relatively precarious balance, we outline a few ways the Legislature could create a larger cushion to protect against revenue declines in the future. Proposition 98 Reserve Compensates for Small Shortfalls Over the Next Few Years (In Billions) $3 Surplus/Shortfall Before Reserves Reserve Deposit or Withdrawal 2 Surplus/Shortfall After Reserves 1 -1 Surplus: available funding exceeds program costs, adjusted for COLA. -2 Shortfall: available funding is less than program costs, adjusted for COLA. -3 2023-24 2024-25 2025-26 2026-27 COLA = cost-of-living adjustment. www.lao.ca.gov 1 2023-24 BUDGET INTRODUCTION With a two-thirds vote of each house of the Legislature, the state can suspend the guarantee Report Provides Our Fiscal Outlook for and provide less funding than the formulas require Schools and Community Colleges. State that year. The guarantee consists of state General budgeting for schools and the California Community Fund and local property tax revenue. Colleges is governed largely by Proposition 98. The measure establishes a minimum funding Legislature Decides How to Allocate requirement for K-14 education commonly known Proposition 98 Funding. Whereas Proposition 98 as the minimum guarantee. This report provides establishes a minimum funding level, the Legislature our estimate of the minimum guarantee for the decides how to allocate this funding among school upcoming budget cycle. The report has four parts. and community college programs. Since 2013-14, First, we explain the formulas that determine the the Legislature has allocated most funding for guarantee. Next, we explain how our estimates of schools through the Local Control Funding Formula the guarantee in 2021-22 and 2022-23 differ from (LCFF). A school district’s allotment depends on its the June 2022 estimates. Third, we estimate the size (as measured by student attendance) and the guarantee over the 2023-24 through 2026-27 period share of its students who are low income or English under our economic forecast. Finally, we compare learners. The Legislature allocates most community the funding available under the guarantee with the college funding through the Student Centered cost of existing educational programs and identify Funding Formula (SCFF). A college district’s some issues for the Legislature to consider in the allotment depends on its enrollment, share of upcoming budget cycle. (The 2023-24 Budget: low-income students, and performance on certain California’s Fiscal Outlook contains an abbreviated outcome measures. version of this report, along with the outlook for At Key Points, State Recalculates Minimum other major programs in the state budget.) Guarantee and Certain Proposition 98 Costs. The guarantee typically changes from the BACKGROUND level initially assumed in the enacted budget as the state updates the relevant Proposition 98 inputs. Minimum Guarantee Depends Upon Various Inputs and Formulas. The California Constitution Figure 1 sets forth three main tests for calculating the Proposition 98 Three Proposition 98 Tests minimum guarantee. Each test takes into account certain inputs, including General Fund revenue, Test 1 Test 2 Test 3 Share of General Change in Per Change in General per capita personal income, and Fund Revenue Capita Personal Fund Revenue student attendance (Figure 1). Income (PCPI) Whereas Test 2 and Test 3 build General upon the amount of funding PCPI Fund provided the previous year, Test 1 About ADA ADA links school funding to a minimum 40% share of General Fund revenue. Prior-Year Prior-Year Funding Funding The Constitution sets forth rules for comparing the tests, with one of the tests becoming operative and Guarantee based on share Guarantee based on prior- Guarantee based on prior- used for calculating the minimum of state General Fund year funding level adjusted year funding level adjusted guarantee that year. Although revenue going to K-14 for year-over-year changes for year-over-year changes education in 1986-87. in K-12 attendance and in K-12 attendance and the state can provide more California PCPI. state General Fund revenue. funding than required, it usually funds at or near the guarantee. ADA = average daily attendance. 2 LEGISLATIVE ANALYST’S OFFICE 2023-24 BUDGET The state updates these inputs until May of the guarantee is growing relatively quickly (see the following fiscal year. The state also revises its box on the next page). In tighter fiscal times, estimates of certain school and community college the Constitution requires the state to withdraw costs. When student attendance changes, for funding from the reserve. Unlike other state reserve example, the cost of LCFF tends to change in accounts, the Proposition 98 Reserve is available tandem. If the revised guarantee is above the only to supplement the funding schools and revised cost of programs, the state makes a community colleges receive under Proposition 98. one-time payment to “settle up” for the difference. Proposition 98 Reserve Linked With Cap on If program costs exceed the guarantee, the state School Districts’ Local Reserves. A state law can reduce spending if it chooses. After updating enacted in 2014 and modified in 2017 caps school the guarantee and making any final spending district reserves after the Proposition 98 Reserve adjustments, the state finalizes its Proposition 98 reaches a certain threshold. Specifically, the cap calculations through an annual process called applies if the funds in the Proposition 98 Reserve “certification.” Certification involves the publication in the previous year exceeded 3 percent of the of the underlying Proposition 98 inputs and a Proposition 98 funding allocated to schools that period of public review. The most recently certified year. When the cap is operative, medium and large year is 2020-21. districts (those with more than 2,500 students) must School and Community College Programs limit their reserves to 10 percent of their annual Typically Receive COLA. The state calculates a expenditures. Smaller districts are exempt. The law statutory cost-of-living adjustment (COLA) each also exempts reserves that are legally restricted year using a price index published by the federal to specific activities and reserves designated for government. This index reflects changes in the specific purposes by a district’s governing board. cost of goods and services purchased by state and In addition, a district can receive an exemption local governments across the country. Costs for from its county office of education for up to two employee wages and benefits are the largest factor consecutive years. The cap became operative for affecting the index. Other factors include costs for the first time in 2022-23. fuel, utilities, supplies, equipment, and facilities. The state finalizes the statutory COLA rate based 2021-22 AND 2022-23 UPDATES upon the data available in May prior to the start of Weakening Economy Affecting State the fiscal year. State law automatically increases Revenue Estimates. Over the past year, high LCFF by the COLA unless the guarantee—as levels of inflation have led the Federal Reserve to estimated in the enacted budget—is insufficient raise interest rates significantly. Recent rate hikes to cover the associated costs. In these cases, already have led to weakness in certain parts of the state reduces the COLA for LCFF (and other the economy, particularly housing and financial K-12 programs) to fit within the guarantee. Though markets. Many economists expect this weakness to statute is silent on community college programs, continue over the next year and have downgraded the state typically aligns the COLA rate for these their outlook for the economy. State tax collections programs with the K-12 rate. in recent months also have been weaker than the Proposition 98 Reserve Deposits and state estimated in June. Estimated income tax Withdrawals Required Under Certain payments for 2022 so far have been notably weaker Conditions. Proposition 2 (2014) created a state than 2021, likely due in part to falling stock prices. reserve specifically for schools and community Consistent with this economic environment, our colleges—the Public School System Stabilization estimates of the General Fund revenues that affect Account (Proposition 98 Reserve). The Constitution the Proposition 98 guarantee are $15.1 billion requires the state to deposit Proposition 98 funding below the June 2022 estimates across 2021-22 into this reserve when the state receives high and 2022-23. levels of capital gains revenue and the minimum www.lao.ca.gov 3 2023-24 BUDGET Overview of 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 projects capital gains revenue will exceed 8 percent of total General Fund 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 often 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 8 percent of General Fund revenue). Deposits are capped at the difference between the actual guarantee and the hypothetical guarantee without the excess capital gains. • Growth Relative to Prior-Year Base Level. 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. For this calculation, the inflation factor is the higher of the statutory cost-of-living adjustment (COLA) 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. • 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. (The inflation factor for Test 2 is based upon per capita personal income, so in practice, this calculation tends to be less restrictive than the previous calculation.) • 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 required only when the balance is below this level. Withdrawals Required Under Certain Conditions. The Constitution requires the state to withdraw funds from the reserve if the guarantee is below the previous year’s funding level, as adjusted for student attendance and inflation. The amount withdrawn equals the difference between the prior-year adjusted level and the actual guarantee, up to the full balance in the reserve. The Legislature can allocate withdrawals for any school or community college purpose. (The withdrawal may be more or less than the amount required to cover the COLA for school and community college programs because the calculation depends upon changes in the guarantee rather than changes in costs for those programs.) Additional Withdrawals Possible if State Experiences a Budget Emergency. If the Governor declares a budget emergency (based upon a natural disaster or downturn in revenue growth), the Legislature may withdraw additional amounts from the reserve or suspend required deposits. 4 LEGISLATIVE ANALYST’S OFFICE 2023-24 BUDGET Proposition 98 Guarantee Revised Down Program Cost Estimates Down Over the in 2021-22 and 2022-23. Compared with the Two Years. For 2021-22, the latest available data estimates made in June 2022, we estimate the show that costs for LCFF are down $566 million guarantee is down $204 million in 2021-22 and compared with the June 2022 estimates (Figure 3). $5.4 billion in 2022-23 (Figure 2). These declines For 2022-23, we estimate LCFF costs are down are due to our lower General Fund revenue $1.4 billion. Two factors account for most of this estimates. Test 1 remains operative in both years, reduction: (1) the lower costs in 2021-22 carry with the decrease in the General Fund portion of forward, and (2) we make an additional downward the guarantee equating to nearly 40 percent of adjustment of about 1 percent to account for the revenue drop. Our estimates of local property the phaseout of a policy funding school districts tax revenue, by contrast, are up slightly in both according to the attendance they reported prior years. (When Test 1 is operative, changes in to the COVID-19 pandemic. We also assume local property tax revenue directly affect the somewhat fewer newly eligible students enroll in Proposition 98 guarantee. They do not offset transitional kindergarten (based upon enrollment General Fund spending.) trends over the past few years) and reduce our cost estimates accordingly. For all other K-14 programs, our cost estimates are similar to the June estimates. Figure 2 Updating Prior- and Current-Year Estimates of the Minimum Guarantee (In Millions) 2021-22 2022-23 June November June November Budget Plan LAO Estimates Change Budget Plan LAO Estimates Change Minimum Guarantee General Fund $83,677 $83,306 -$371 $82,312 $76,811 -$5,501 Local property tax 26,560 26,727 167 28,042 28,112 70 Totals $110,237 $110,033 -$204 $110,354 $104,923 -$5,431 General Fund tax revenue $220,109 $219,134 -$975 $214,887 $200,767 -$14,120 Figure 3 Revised Spending Is Above the Guarantee in Prior and Current Year (In Millions) 2021-22 2022-23 June November June November Budget Plan LAO Estimates Change Budget Plan LAO Estimates Change Minimum Guarantee $110,237 $110,033 -$204 $110,354 $104,923 -$5,431 Funding Allocations Local Control Funding Formulaa $68,249 $67,682 -$566 $77,476 $76,055 -$1,422 Other K-14 programs 38,000 37,995 -5 30,654 30,656 2 Proposition 98 Reserve deposit 3,988 4,976 988 2,224 14 -2,210 Totals $110,237 $110,653 $416 $110,354 $106,724 -$3,630 Spending Above Guarantee — $620 $620 — $1,801 $1,801 a Includes school districts, charter schools, and county offices of education. www.lao.ca.gov 5 2023-24 BUDGET Proposition 98 Reserve Deposit up in 2021-22 Economic Assumptions but Down in 2022-23. The June budget plan Weak Economic Picture Weighs anticipated the state would make large reserve Down Revenue Estimates Over the Next deposits in 2021-22 and 2022-23 due to strong Two Years. Current economic conditions point revenue from capital gains. For 2021-22, we to an elevated risk of a recession starting next estimate the required deposit has increased from year. This risk weighs down our economic outlook $4 billion to $5 billion. This increase reflects our and accounts for our estimate of flat General estimate that capital gains revenue was higher Fund revenues in 2023-24 and sluggish growth in than the June estimate even though overall state 2024-25. Notably, however, our outlook does not revenue is down slightly for the year. For 2022-23, specifically assume a recession occurs, which we estimate that capital gains revenue will be would result in more significant revenue declines. significantly weaker and barely exceed the Our forecast also anticipates improvement in 8 percent threshold. Due to this lower estimate, subsequent years, with revenue estimates reflecting the required deposit drops from $2.2 billion to normal levels of growth in 2025-26 and 2026-27. $14 million. These two deposits—combined with deposits in previous years—would bring the total The Minimum Guarantee balance in the reserve to $8.3 billion. This reserve Guarantee Grows Slowly in 2023-24 but level represents 7.9 percent of our revised estimate Remains Below Previously Enacted Budget of the guarantee in 2022-23. Level. The minimum guarantee under our forecast School Spending Would Exceed the is $108.2 billion in 2023-24 (Figure 4). Compared Guarantee in Both Years. After accounting with our revised estimate of Proposition 98 for decreases in the minimum guarantee, lower funding in 2022-23, the guarantee is up $1.5 billion program costs, and modified reserve deposits, (1.4 percent). This increase is attributable to school spending would be $620 million above growth in local property tax revenue and partially the guarantee in 2021-22 and $1.8 billion above offset by lower General Fund spending. Despite in 2022-23. If the Legislature chooses to reduce this increase, the guarantee in 2023-24 remains spending, it could do so in ways that would not $2.2 billion below the enacted budget level for disrupt ongoing programs. For example, it could 2022-23 (Figure 5). reduce certain one-time grants the state has not Growth in the Guarantee Accelerates After yet allocated to schools or community colleges. 2023-24. Increases in the guarantee become The 2022-23 budget also funded several grants larger after 2023-24, with year-over-year growth of that will be allocated in installments over the next 4.9 percent in 2024-25, 5.6 percent in 2025-26, and several years. The Legislature could reduce funding 7.9 percent in 2026-27. By 2026-27, the guarantee for future installments and cover those costs from would be $129.3 billion, an increase of $22.6 billion future budgets instead. (21.1 percent) compared with the revised 2022-23 level. Of this increase, more than $16.7 billion is MULTIYEAR OUTLOOK attributable to the General Fund portion of the In this section, we estimate the minimum guarantee and more than $5.8 billion is attributable guarantee for 2023-24 and the following three years to the local property tax portion. Test 1 is operative under our economic forecast. We also examine how throughout the period, with the General Fund the Proposition 98 Reserve would change and the portion of the guarantee increasing about 40 cents factors affecting costs for school and community for each dollar of additional revenue. Our estimates college programs. also account for two other adjustments. First, we assume the state continues to adjust the guarantee for the expansion of transitional kindergarten. 6 LEGISLATIVE ANALYST’S OFFICE 2023-24 BUDGET Figure 4 Proposition 98 Outlook (Dollars in Millions) 2022-23 2023-24 2024-25 2025-26 2026-27 Proposition 98 Funding General Funda $78,613b $78,098 $81,829 $87,258 $95,354 Local property tax 28,112 30,077 31,627 32,573 33,927 Totals $106,724 $108,175 $113,456 $119,831 $129,281 Change From Prior Year General Fund -$5,313 -$515 $3,732 $5,429 $8,096 Percent change -6.3% -0.7% 4.8% 6.6% 9.3% Local property tax $1,385 $1,965 $1,550 $946 $1,354 Percent change 5.2% 7.0% 5.2% 3.0% 4.2% Total funding -$3,929 $1,451 $5,281 $6,375 $9,450 Percent change -3.6% 1.4% 4.9% 5.6% 7.9% General Fund Tax Revenuec $200,767 $200,080 $207,884 $219,187 $239,523 Growth Rates K-12 average daily attendanced 3.1% 1.2% 1.4% 1.8% 0.7% Per capita personal income (Test 2) 7.6 2.0 1.2 1.8 3.4 Per capita General Fund (Test 3)e -8.7 1.4 2.8 3.2 7.4 Proposition 98 Reserve Deposit (+) or withdrawal (-) $14 -$2,351 -$3,110 -$2,830 $510 Cumulative balance 8,292 5,941 2,830 — 510 a Beginning in 2023-24, General Fund estimates include an increase for Proposition 28. b Includes $1.8 billion in funding above the minimum guarantee. c Excludes non-tax revenues and transfers, which do not affect the calculation of the minimum guarantee. d Estimates account for the expansion of transitional kindergarten eligibility. e 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. This adjustment increases required Figure 5 General Fund spending by approximately $2.6 billion by the end of the period. Second, we account for preliminary Proposition 98 Guarantee in 2023-24 Remains election results indicating the voters have Below Previously Enacted Budget Level approved Proposition 28. This proposition (In Billions) increases required General Fund spending by approximately $1 billion per year $112 beginning in 2023-24 (as discussed later Funding Above Guarantee Guarantee in the report). 110 $110.4 $2.2 billion decrease Local Property Tax Estimates Reflect 108 $108.2 Trends in the Housing Market. Growth in 106 $1.8 property tax revenue is linked with growth in the housing market, but this growth 104 $104.9 typically lags the market by a few years. 102 (This lag exists for three main reasons: (1) properties are not reassessed until 100 Enacted Budget Revised LAO Estimate LAO Estimateª sold, (2) new construction projects started 2023-24 2022-23 a Includes adjustment for Proposition 28 (2022). www.lao.ca.gov 7 2023-24 BUDGET in response to rising prices take time to complete, revenue estimates and actual revenue collections, and (3) property tax bills are based on the assessed and then calculated the minimum guarantee under value of a property during the previous year.) Our the different revenue scenarios. (Technically, the forecast anticipates relatively large increases in bottom of the shaded area corresponds to the property tax revenue of 7 percent in 2023-24 and 10th percentile of potential scenarios and the top 5.2 percent in 2024-25. These increases reflect corresponds to the 90th percentile.) The uncertainty the housing boom that began in the summer of in our estimates increases significantly over the 2020 and continued until early 2022. Our forecast outlook period. For example, the range for the anticipates weaker growth of 3 percent in 2025-26 guarantee in 2026-27 is about twice as large as the and 4.2 percent in 2026-27. These slower increases range in 2023-24. account for cooling trends in the housing market State and School Reserves that began in the spring of 2022. Proposition 98 Reserve Withdrawals Begin Guarantee Is Moderately Sensitive to Changes in General Fund Revenue. General Fund in 2023-24. Under our outlook, growth in the guarantee is somewhat slower than increases revenue tends to be the most volatile input in the in student attendance and inflation for the next calculation of the Proposition 98 guarantee. For any several years. This slower growth triggers reserve given year, the relationship between the guarantee withdrawals of $2.4 billion in 2023-24, $3.1 billion and General Fund revenue generally depends on in 2024-25, and $2.8 billion in 2025-26. The state which Proposition 98 test is operative and whether would begin building back the reserve balance another test could become operative with higher or once the guarantee begins to grow more quickly. lower revenue. Under our forecast, Test 1 remains Under our outlook assumptions, the state makes operative throughout the period, meaning the a small deposit in 2026-27. Reserve deposits and guarantee would change about 40 cents for each withdrawals, however, are relatively sensitive to dollar of higher or lower General Fund revenue. assumptions about revenue and inflation. In 2022-23 and 2023-24, Test 1 is likely to remain operative even if General Fund revenue or other inputs vary significantly from our forecast. Estimates of the Guarantee Figure 6 Become More Uncertain Over Estimates of the Proposition 98 Guarantee Time. Our forecast builds upon Become More Uncertain Over Time the revenue estimates we think are (In Billions) most likely, but these estimates in all likelihood will be wrong to $150 some extent. For example, our The shaded region shows how much the minimum guarantee might differ from our main forecast due to forecast assumes a relatively 140 changes in General Fund revenue. Outcomes beyond smooth transition to faster revenue the shaded area are possible, but the guarantee most likely will fall in the shaded area. growth over the next four years. In 130 practice, however, revenue tends 120 LAO Forecast to be volatile from year to year even if it follows a general upward 110 trajectory over time. Figure 6 100 shows how far the minimum guarantee could differ from our 90 forecast based upon swings in 2021-22 2022-23 2023-24 2024-25 2025-26 2026-27 General Fund revenue. For this analysis, we examined the historical relationship between previous 8 LEGISLATIVE ANALYST’S OFFICE 2023-24 BUDGET Proposition 98 Reserve Mitigates Some The federal government will publish data for these Volatility in the Guarantee. The reserve provides final two quarters at the end of January and the end a modest cushion for school and community of April, respectively. programs when the minimum guarantee changes. Statutory COLA Would Remain High Over On the downside, a lower guarantee likely would the Next Several Years. Although most economic lead to larger withdrawals. These withdrawals forecasters expect price inflation to moderate by would reduce the likelihood of reductions to existing the end of 2022-23, evidence suggests there is programs. This cushioning effect is relatively a risk inflation could remain above the historical limited, however, because the reserve would be average for an extended period. Our corresponding exhausted in 2025-26. If the guarantee were below COLA estimates are 5.3 percent in 2024-25, our estimates in 2024-25, for example, the increase 4.5 percent in 2025-26, and 4.2 percent in 2026-27. in withdrawals that year would come at the expense By comparison, the average statutory COLA over of withdrawals the following year. On the upside, if the past 20 years has been 2.8 percent. the guarantee were to exceed our forecast because Partial Recovery in K-12 Attendance of higher General Fund revenues, the required Assumed. Under our outlook, K-12 student withdrawals likely would decrease. attendance grows by an average of 1.6 percent per Local Reserve Cap Remains Operative. year from 2022-23 through 2026-27. This growth, Under our outlook, the school district reserve cap however, follows a steep attendance decline in would remain in effect through 2024-25. In that 2021-22. Data from the California Department year, the balance in the Proposition 98 reserve of Education show that statewide average daily would drop below 3 percent of the Proposition 98 attendance totaled 5.35 million students in funding allocated to schools. The cap, in turn, 2021-22—a drop of about 550,000 students would become inoperative in 2025-26. Although (9.3 percent) compared with the levels reported statewide data are not yet available, our in 2019-20 prior to the start of the COVID-19 understanding is that school district reserves pandemic. (The state did not collect attendance currently are at relatively high levels despite the cap. data in 2020-21.) Approximately three-quarters County offices of education and other local experts of this drop seems attributable to a surge in indicate that most districts with reserves above the absenteeism. Whereas school attendance rates cap took board action to designate their reserves averaged about 95 percent of enrollment prior to for specific future purposes (as the law allows), the pandemic, they dropped to around 90 percent rather than spending them down immediately. in 2021-22. We think much of this drop reflects the emergence of the Omicron variant of COVID-19 Program Costs in the middle of the 2021-22 school year. Our Very Large Statutory COLA Estimated for outlook assumes districts recover about half this 2023-24. For 2023-24, we estimate the statutory drop in 2022-23, with incremental improvements COLA is 8.73 percent. This COLA rate—the highest in subsequent years. The remaining quarter of the since 1979-80—reflects the significant price attendance drop appears attributable to students inflation recorded in most parts of the economy who left public schools entirely, including students over the past year. Costs for energy and other who left the state, enrolled in private school or “nondurable goods” are the fastest growing homeschool, or dropped out. Our outlook does not component of the index. Available data show that in assume any of these students return to California the third quarter of 2022, this component increased public schools. by 25 percent compared with the same quarter in Transitional Kindergarten Expansion Also 2021. By comparison, the other components of the Affects Statewide Attendance Over the Next price index grew by an average of 6.9 percent over Few Years. Another factor affecting statewide that period. In making our estimate of the statutory attendance is the expansion of transitional COLA, we relied upon published federal data for kindergarten. State law began expanding eligibility six of the eight quarters that determine the COLA, for this program in 2022-23. All four-year olds will and our own projections for the final two quarters. be eligible by 2025-26. Under our outlook, students www.lao.ca.gov 9 2023-24 BUDGET newly eligible for this program account for slightly through 2024-25 period. Our outlook accounts less than half of our estimated attendance growth for these changes with a $1.6 billion (2.2 percent) over the period. downward adjustment to LCFF costs in 2023-24. LCFF Costs Decrease as Pre-Pandemic This adjustment builds upon our lower revised Attendance Funding Phases Out. For the purpose estimate of LCFF costs in 2022-23. (For charter of allocating LCFF funding in 2021-22, the state schools, the state is allocating funding according credited school districts and most charter schools to current-year attendance only, beginning with at least as much attendance as they reported in 2022-23.) in 2019-20. This policy insulated most schools Outlook Assumes New Funding for Arts from the fiscal effects of attendance declines. Education. Preliminary results from the November Beginning in 2022-23, the state will fund school 8 election indicate that the voters have approved districts according to their actual attendance in Proposition 28. This proposition creates a new the current year, prior year, or average of the three ongoing program to fund arts education beginning prior years (whichever is highest). In practice, this in 2023-24 (described in the nearby box). new policy means districts’ higher pre-pandemic The measure also increases the minimum guarantee attendance levels will phase-out over the 2022-23 to cover the additional costs. Throughout this Proposition 28 (2022) Establishes New Program to Fund Arts Education. Proposition 28 establishes a program to provide additional funding for arts instruction and related activities in schools, beginning in 2023-24. The annual amount for the program equals 1 percent of the Proposition 98 funding allocated to schools in the previous year. For 2023-24, we estimate the program will receive an allocation of $941 million. Under our estimates of growth in K-12 funding, this amount would grow by approximately 4 percent per year over the next several years. Provides Rules for Allocating and Using Funds. The measure allocates 70 percent of its funding to school districts, charter schools, and county offices of education through a formula based on prior-year enrollment of students in preschool, transitional kindergarten, kindergarten, and grade 1 through grade 12. The measure allocates the remaining 30 percent based upon the share of low-income students enrolled in those entities in the prior year. School principals are responsible for developing expenditure plans describing how they will use their share of the funds, subject to two requirements. First, the measure requires schools with at least 500 students to use their funds primarily to hire new arts staff. Second, schools must use their funds to supplement any existing funding they already provide for their arts education programs. Adjusts the Proposition 98 Guarantee Upward. In addition to creating a new program funded within Proposition 98, the measure adjusts the minimum guarantee upward. This adjustment occurs in two steps. In 2023-24, the state adds the cost of the program to the minimum guarantee otherwise calculated for the year. The state then converts this amount to a percentage of General Fund revenue. Beginning in 2024-25, the state adds this percentage to the minimum percentage of General Fund revenue allocated to schools under Test 1. Under our outlook, the $941 million cost of the program in 2023-24 would result in an ongoing increase to the guarantee of 0.47 percent of General Fund revenue. Legislature Can Reduce Funding if it Suspends the Guarantee. The measure allows the Legislature to reduce funding for arts education if it suspends the minimum guarantee. In this case, the percentage reduction for arts education cannot exceed the percentage reduction in overall funding for school and community college programs. 10 LEGISLATIVE ANALYST’S OFFICE 2023-24 BUDGET report, we account for Proposition 28 in our Although the minimum guarantee drops $2.2 billion, estimates of school spending and our estimates of a few key adjustments free-up significant the minimum guarantee. amounts of funding. Most notably, the 2022-23 budget allocated a significant amount of ongoing KEY CONSIDERATIONS Proposition 98 funding for one-time activities. These activities expire in 2023-24, freeing-up the In this part of the report, we highlight a few underlying funds. We also score savings from issues for the Legislature to consider as it prepares attendance-related changes to LCFF and account for the upcoming budget cycle. Specifically, for the required reserve withdrawal. After making we (1) compare the funding available under the these adjustments, $7.6 billion in funding is minimum guarantee with the cost of existing school available. Regarding cost increases, we estimate and community college programs, (2) provide that covering the 8.73 percent statutory COLA context for the budget decisions the state will would cost $7.9 billion. Consistent with current law, make in 2023-24, and (3) identify a few issues the we assume the state reduces the COLA rate to Legislature may want to think about when planning 8.38 percent—lowering the cost by approximately for the upcoming budget cycle. $300 million—to fit within the $7.6 billion available. The Budget Picture in Reserve Withdrawals Cover Gap Between 2023-24 and Beyond Guarantee and Program Costs for the Next Few Years. Figure 8 on the next page shows how State Could Cover Existing Programs and the funding available for school and community Most of the Statutory COLA in 2023-24. Figure 7 college programs changes over the period under shows our estimate of the changes in funding and our forecast. The blue bars represent the amount costs relative to the 2022-23 enacted budget level. Figure 7 State Could Cover Most of the Statutory COLA in 2023-24 Changes From 2022-23 Enacted Budget (In Billions) Statutory COLA Reserve Backout One-Time (8.73 Percent) Withdrawal Drop in 2022-23 Allocationsª $0.3 Guarantee Enacted Budget $110.4 Billion -$5.7 $7.6 $2.4 -$2.2 2023-24 Minimum Guarantee Adjusted COLA $108.2 Billionc (8.38 Percent) Attendance Adjustmentsb -$2.7 Proposition 28c $0.9 a Consists primarily of the reserve deposit amount estimated in June and the portions of the K-12 Learning Recovery Emergency Block Grant, K-12 community schools grant, and community college maintenance and equipment funds attributed to 2022-23. b Consists primarily of lower costs for the Local Control Funding Formula resulting from the phaseout of pre-pandemic attendance funding. Also reflects several smaller adjustments for other programs. c Proposition 28 (2022) establishes a program funding arts education in schools. As required by the measure, the estimate of the guarantee in 2023-24 includes a $941 million increase to offset the cost of the program. COLA = cost-of-living adjustment. www.lao.ca.gov 11 2023-24 BUDGET Figure 8 Proposition 98 Reserve Compensates for Small Shortfalls Over the Next Few Years (In Billions) $3 Surplus/Shortfall Before Reserves Reserve Deposit or Withdrawal 2 Surplus/Shortfall After Reserves 1 -1 Surplus: available funding exceeds program costs, adjusted for COLA. -2 Shortfall: available funding is less than program costs, adjusted for COLA. -3 2023-24 2024-25 2025-26 2026-27 COLA = cost-of-living adjustment. by which the Proposition 98 guarantee is above state experiences a recession during the forecast or below the cost of covering existing programs period. In making these estimates, we also assume as adjusted by the statutory COLA. Negative bars the state makes no new ongoing commitments. indicate a “shortfall” (the guarantee is insufficient The Education Budget in Context to cover these costs) and positive bars indicate a “surplus” (the guarantee is more than sufficient). Tighter Outlook Follows Two Years of The gray bars account for required withdrawals Extraordinary Growth. Although our outlook and deposits from the Proposition 98 Reserve. estimates a drop in the guarantee in 2022-23 and The orange bars represent the surplus or shortfall slow growth in 2023-24, these changes build upon after accounting for the reserve. As the figure two previous years of historic growth. Between shows, a small shortfall exists each year through 2019-20 and 2021-22, the minimum guarantee grew 2025-26, but reserve withdrawals provide $31.3 billion (39.5 percent)—the fastest increase additional funding that reduces the shortfall in over any two-year period since the passage of 2023-24 and more than offset the shortfalls in Proposition 98 in 1988. The drop in 2022-23 erodes 2024-25 and 2025-26. only a small portion of this gain. By historical standards, the school funding picture remains Budget Picture Stabilizes by the End strong. Figure 9 illustrates this point by comparing of the Period, Assuming No New Ongoing our estimate of K-12 funding per student under Commitments. Under our forecast, the gap our outlook with funding levels over the previous between the minimum guarantee and program 25 years. After accounting for the effects of inflation costs shrinks over the period. In 2026-27, the and changes in student attendance, school funding guarantee is above the cost of existing programs would dip in 2022-23 and 2023-24 but remain and the state begins making reserve deposits relatively high over the remainder of the period. rather than withdrawals. The picture could improve sooner if the economy grows more quickly than Multiyear Block Grants Provide Further our forecast or the statutory COLA rate is smaller. Support to Districts. The June 2022 budget Alternatively, it might improve after 2026-27 if the plan funded two large block grants to address the 12 LEGISLATIVE ANALYST’S OFFICE 2023-24 BUDGET effects of the COVID-19 pandemic on schools and Rest of the State Budget Faces Large community colleges. These grants are intended Problem. The rest of the state budget— to support district activities over the next several consisting of the programs not funded through years. For schools, the state provided $7.9 billion Proposition 98—is in a difficult position under our for the Learning Recovery Emergency Block Grant outlook. Specifically, the rest of the budget faces (averaging about $1,500 per student). Schools a $25 billion problem in 2023-24. This shortfall can use their funds broadly to support academic represents the difference between available learning recovery, staff and student social and resources and the cost of currently authorized emotional well-being, and other costs attributable programs and services. The problem is due to the pandemic. For community colleges, the state primarily to reductions in General Fund revenue, provided $650 million (about $730 per student) to partially offset by (1) lower required spending to fund student support, reengagement strategies, meet the Proposition 98 guarantee and (2) lower professional development, technology, equipment, required deposits into the state’s general-purpose and other specified activities. Although both block reserve. Moreover, the rest of the budget faces an grants are provided on a one-time basis, they ongoing deficit over the next several years. Even represent an additional source of funding districts with relatively strong revenue growth in 2025-26 can use to supplement other funding over the next and 2026-27, the resources available in those several years. years are less than the estimated cost of current Previous Budget Actions Significantly programs and services. Given these issues, the Improve the Budget Picture in 2023-24. state would have difficulty funding school and Our estimate of the funding available in 2023-24 community college programs beyond the amounts highlights the importance of preparing for economic required to meet the guarantee. downturns during stronger fiscal times. The budget adopted by the Legislature in June contained two major components that improved budget Figure 9 resiliency. Specifically, the budget K-12 Funding Dips When Adjusted for (1) set aside some ongoing funds Inflation but Remains Relatively High for one-time activities and (2) made the Proposition 98 Reserve deposits Funding Per Student required by Proposition 2. If the state had not set aside any ongoing $25,000 funds and lacked the Proposition 98 Reserve, the budget picture in 20,000 2023-24 would look much different. Inflation Adjusted Under that alternative scenario, (2026-27 Dollars) we estimate that the available 15,000 Proposition 98 funding would have been at least $8.3 billion—rather than about $300 million—below the 10,000 level necessary to cover existing Actual programs and the statutory COLA. 5,000 Facing such a scenario, the state might have needed to eliminate the 2023-24 COLA or fund a much smaller COLA and take other actions 99-00 02-03 05-06 08-09 11-12 14-15 17-18 20-21 23-24 2026-27 to reduce spending. www.lao.ca.gov 13 2023-24 BUDGET State Appropriations Limit Is Not a weakness but not a recession. For 2023-24, this Significant Issue This Year… Proposition 4 (1979) uncertainty means the Proposition 98 guarantee places constraints on how the state can spend tax could be billions of dollars above or below our revenues that exceed a certain limit. Specifically, current estimates. Although the state will have a if the state collects revenue in excess of the limit, better sense of revenues and the guarantee by June the Constitution allows the Legislature to respond when it adopts the budget, the economic picture by lowering tax revenues, increasing spending on beyond 2023-24 remains murky. activities excluded from the limit, or splitting the Building a Larger Budget Cushion Would excess revenues equally between taxpayer refunds Mitigate Future Downside Risk. Our outlook and one-time payments to schools and community makes spending estimates for school and colleges. Due primarily to our lower General Fund community college programs based upon current revenues, we estimate the state is below the limit in laws and policies. Two important assumptions are 2022-23 and 2023-24. embedded in this forecasting approach: (1) the …But Would Affect State Budgeting in state maintains existing programs at their current the Future. Assuming General Fund revenues levels except for formula-driven adjustments, and follow the trajectory in our forecast, the state (2) the state applies all available Proposition 98 appropriations limit would begin to affect state funding (including reserve withdrawals) toward budgeting in 2025-26. The main reason is that our covering the statutory COLA. Using this approach estimates of General Fund revenue grow faster to set ongoing spending levels in 2023-24, however, than the limit itself over the next several years. would leave the Proposition 98 budget precariously Our Proposition 98 outlook does not make any balanced over the coming years. For example, explicit adjustment for the appropriations limit, in our estimate of the guarantee in 2024-25 is just part because the state must fund the minimum large enough to cover existing programs and the guarantee even if the limit requires reductions to statutory COLA after accounting for a reserve other programs in the state budget. The state, withdrawal. In approximately half of all the potential however, could respond to future excess revenues economic scenarios that could unfold that year, the in ways that would affect school funding. For guarantee ends up below our estimate. Although example, it could reduce General Fund tax revenue, the Proposition 98 Reserve might cushion a minor which also would lower the guarantee. Alternatively, decrease, a larger drop would pose risks to ongoing it could split excess revenues between refunds and programs. To build up somewhat more protection one-time payments, which would provide schools against such downside risks, the Legislature could and community colleges with additional funding consider some adjustments next year to create on top of the minimum guarantee. Estimates of a larger budget cushion. Specifically, it could the state appropriations limit also are subject to reduce certain ongoing expenditures and increase significant uncertainty beyond the budget year. one-time spending. Below, we outline a few options for reducing ongoing expenditures. Planning for the Upcoming Year Consider Reductions to Expanded Learning Economic Uncertainty Abounds as Opportunities Program (ELOP). The state created Legislature Prepares for Upcoming Budget ELOP in the 2021-22 budget to fund academic and Cycle. The current economic environment poses enrichment activities for K-12 students outside a substantial risk to state revenues. In the past, of normal school hours. As part of the 2022-23 economic conditions similar to the conditions we budget, the state increased ongoing funding have observed over the past several months have for the program from $1 billion to $4 billion. The typically resulted in subsequent revenue declines. program allocates funding to districts based on On the other hand, we do not think a recession next their attendance in the elementary grades and year is inevitable. Even if a recession does occur, its share of low-income students and English learners. exact timing and severity are uncertain. Our outlook Although statewide data are not available, initial takes a middle approach—assuming economic feedback from districts suggests not all low-income 14 LEGISLATIVE ANALYST’S OFFICE 2023-24 BUDGET students and English learners are interested in Consider Funding Smaller COLA. Another the program. We think the state could improve option would involve reducing the COLA rate below the program and reduce costs by allocating the 8.38 percent increase we estimate the state funding based on actual participation instead could fund in 2023-24. One reason the state might of districtwide attendance. The state also could consider this option is that the surge in energy reduce ELOP allocations by accounting for other prices appears to be responsible for a notable state and federal funds districts receive for before portion (likely at least 2 percentage points) of the and after school programs. To achieve additional high COLA rate. Although district energy costs savings on a one-time basis, the state could further are likely up too, these costs typically account for require districts to spend all their ELOP funding a small share of district budgets. The Legislature from 2021-22 and 2022-23 before they receive could consider funding a COLA that is below funding in 2023-24. Any of these actions could the statutory rate but still large enough to allow achieve savings without requiring districts to serve schools and community colleges to address their fewer students. cost pressures and local priorities. We estimate Consider Reductions to Community College that each 1 percent reduction in the COLA rate Programs That Are Under Capacity or Lower equates to approximately $910 million in lower Priority. Over the past few years, the state has ongoing spending. provided some funding that may not be earned by Legislature Could Advance Its Priorities colleges or may be a lower legislative priority. The Next Year Through Oversight. Over the past two 2021-22 budget, for example, provided a $24 million years, the Legislature has allocated Proposition 98 base augmentation to SCFF for enrollment growth. funding to more than 50 new school and community Based on preliminary data, only about $1 million college activities. Some of the largest allocations of this funding will be earned by districts. The have involved learning loss recovery, community Legislature could revert any unearned funds—and schools, the teaching workforce, infrastructure, reduce systemwide base funding by a like amount— and community college financial aid and student once final data is reported by the Chancellor’s support services. The Legislature could use the Office in spring 2023. Similarly, this spring the upcoming budget cycle to conduct oversight Legislature could identify other community college of these activities. In particular, the Legislature programs that may be under capacity, such as the might want to examine: (1) whether these activities California Apprenticeship Initiative or other grant are having their intended effects on students programs the Legislature has authorized in recent and programs, (2) how these activities fit with years. The Legislature also may want to target for broader goals (such as reducing historical funding reductions certain programs that may be a lower disparities among districts, improving student priority given the students served. For example, achievement, and closing achievement gaps), and the 2022-23 budget provided $25 million ongoing (3) any challenges districts face implementing these Proposition 98 General Fund to expand eligibility for activities. By conducting oversight and exploring the California College Promise. This program allows changes in these areas, the Legislature could colleges to waive enrollment fees for returning continue to advance its priorities despite the tighter students enrolled full time who do not have financial budget picture we anticipate next year. need given their higher income level. www.lao.ca.gov 15 2023-24 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, California 95814. 16 LEGISLATIVE ANALYST’S OFFICE