The 2023-24 Budget: Proposition 98 Overview and K-12 Spending Plan

2023-24 BUDGET The 2023-24 Budget: Proposition 98 Overview and K-12 Spending Plan GABRIEL PETEK | LEGISLATIVE ANALYST | FEBRUARY 2023 SUMMARY 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). Compared with the level in the 2022-23 enacted budget, the Governor’s budget estimates the guarantee is down $3.4 billion in 2022-23 and $1.5 billion in 2023-24. We think the guarantee is likely to decline further—under our best estimates of General Fund revenue, the guarantee would be roughly $2 billion below the Governor’s budget level in each year. Higher local property tax revenue, however, could offset some of this drop. Despite the lower estimates of the guarantee, the Governor’s budget has about $5.2 billion available for new K-12 spending. This funding is due to lower baseline costs for the Local Control Funding Formula (LCFF) and the expiration of various one-time grants funded in the June 2022 budget. The largest K-12 proposal in the budget is an 8.13 percent statutory cost-of-living adjustment (COLA), but the Governor also proposes several smaller initiatives. Since these proposals together would exceed the available funding, the Governor proposes to (1) use $1.4 billion in one-time funds to pay for ongoing LCFF costs and (2) reduce one of the discretionary block grants the state approved last year by $1.2 billion. We recommend the Legislature commit to less ongoing spending so that the K-12 budget does not rely upon one-time funds. Our brief outlines several options to consider, including (1) funding a lower COLA, (2) avoiding new ongoing proposals, and (3) reducing certain existing programs. Modifying the budget in this way would better position the state to address a lower guarantee emerging in May or future years. INTRODUCTION MINIMUM GUARANTEE In this brief, we analyze the Governor’s Proposition 98 (1988) established a minimum Proposition 98 budget package. The first section funding requirement for schools and community analyzes the administration’s estimate of the colleges commonly known as the minimum minimum funding requirement established by guarantee. In this section, we (1) provide Proposition 98 and explains how this requirement background on the guarantee, (2) analyze the could change in the coming months. The second administration’s estimates of the guarantee, and section describes the Governor’s plan for (3) explain how the guarantee could change in the allocating the available funding and provides our coming months. assessment of the plan. This brief focuses on the Background on the Guarantee Proposition 98 proposals affecting K-12 schools— we analyze the proposals affecting community Minimum Guarantee Depends on Various colleges in our forthcoming brief The 2023-24 Inputs and Formulas. The California Constitution Budget: California Community Colleges. On the sets forth three main tests for calculating the “EdBudget” portion of our website, we post Proposition 98 minimum guarantee. Each test numerous tables with additional information about takes into account certain inputs, including the Governor’s budget. Over the next few weeks, General Fund revenue, per capita personal we plan to release additional briefs analyzing income, and student attendance (Figure 1, on specific proposals in detail. the next page). Test 1 links school funding to a minimum share of General Fund revenue, whereas www.lao.ca.gov 1 2023-24 BUDGET Test 2 and Test 3 build upon the amount of funding Technically, spike protection works by reducing provided the previous year. The Constitution the Test 2 and Test 3 funding levels from what they sets forth rules for comparing the tests, with otherwise would be in the year following the spike. one of the tests becoming operative and used These lower levels are then used in the comparison for calculating the minimum guarantee that year. with Test 1 (which is unaffected). In practice, the Although the state can provide more funding than spike protection adjustment allows the guarantee to required, it usually funds at or near the guarantee. remain elevated, but only to the extent the revenue With a two-thirds vote of each house of the spike is sustained the following year. Legislature, the state can suspend the guarantee At Key Points, the State Recalculates the and provide less funding than the formulas require Minimum Guarantee. The guarantee typically that year. The guarantee consists of state General changes from the level initially assumed in the Fund and local property tax revenue. enacted budget as the state updates the relevant “Spike Protection” Slows Growth in the Proposition 98 inputs. The state continues to Guarantee Following Revenue Surges. update Proposition 98 inputs until the following In addition to the three tests, the Constitution May after the close of each fiscal year. If these contains a provision to prevent the minimum updates show that the revised minimum guarantee guarantee from growing too quickly when General exceeds the initial estimate, the state must make a Fund revenue is especially strong. Specifically, one-time payment to “settle up” for the difference. when the minimum guarantee is growing much If the guarantee drops, the state can reduce more quickly than per capita personal income and spending to the lower guarantee. After making student attendance, this provision excludes some these revisions, the state finalizes its calculation of Proposition 98 funding from the calculation of the the guarantee through an annual process called guarantee in the subsequent year. This provision “certification.” Certification involves the publication is sometimes known as spike protection because of the underlying Proposition 98 inputs and a it is intended to protect the state budget from period of public review. The most recently certified needing to sustain increases in the guarantee year is 2020-21. that are the result of temporary spikes in revenue. Proposition 98 Reserve Has Rules for Deposits and Figure 1 Withdrawals. Proposition 2 (2014) created a state reserve specifically Three Proposition 98 Tests for schools and community colleges—the Public School Test 1 Test 2 Test 3 System Stabilization Account Share of General Change in Per Change in General (Proposition 98 Reserve). The Fund Revenue Capita Personal Fund Revenue Constitution generally requires the Income (PCPI) state to deposit Proposition 98 PCPI Ge F n u e n r d al funding into this reserve when the state receives high levels of About ADA ADA 40% capital gains revenue and the minimum guarantee is growing Prior-Year Prior-Year Funding Funding relatively quickly (see box). The Constitution also requires the state to withdraw funding Guarantee based on share Guarantee based on prior- Guarantee based on prior- from the reserve under certain of state General Fund year funding level adjusted year funding level adjusted revenue going to K-14 for year-over-year changes for year-over-year changes conditions—generally when the education in 1986-87. in K-12 attendance and in K-12 attendance and guarantee is growing slowly relative California PCPI. state General Fund revenue. to inflation and student attendance. ADA = average daily attendance. 2 LEGISLATIVE ANALYST’S OFFICE 2023-24 BUDGET Overview of Proposition 98 Reserve Deposits Predicated on Two Minimum 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. 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 prior-year funding level for changes in student attendance and inflation. The prior-year level consists of the guarantee that year, adjusted for any reserve deposits or withdrawals, spike protection, and any funds provided on top of the guarantee. 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. • 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 only, so in practice, this calculation rarely limits the deposit amount more than the previous calculation.) • Room Under 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 prior-year funding level, as adjusted for student attendance and inflation. (The prior-year funding level and inflation adjustments in this calculation are the same as in the calculation for deposits.) 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. Discretionary Withdrawals Possible if State Experiences a Budget Emergency. If the Governor declares a budget emergency (based upon a natural or manmade disaster or weakness in state revenues), the Legislature may withdraw any amount from the reserve or suspend required deposits. In contrast to the Budget Stabilization Account (the state’s main rainy day fund), the Constitution does not limit discretionary withdrawals from the Proposition 98 Reserve to half the balance or the amount of the emergency. www.lao.ca.gov 3 2023-24 BUDGET If the Governor declares a budget emergency, This decrease primarily reflects lower General Fund the Legislature can make discretionary revenue estimates. In addition, the administration withdrawals. Unlike other state reserve accounts, estimates local property tax revenue will grow more the Proposition 98 Reserve is available only to slowly than it anticipated in June. Test 1 remains supplement the funding schools and community operative in both years. In Test 1 years, the change colleges receive under Proposition 98. in the General Fund portion of the guarantee is Proposition 98 Reserve Linked With Cap on about 40 cents for each $1 of higher or lower School Districts’ Local Reserves. A state law General Fund revenue. Changes in local property enacted in 2014 and modified in 2017 caps school tax revenue, by comparison, have dollar-for-dollar district reserves after the Proposition 98 Reserve effects on the guarantee in these years. (The state reaches a certain threshold. Specifically, the cap also records large spike protection adjustments applies if the funds in the Proposition 98 Reserve in both years, which reduce the Test 2 and Test 3 in the previous year exceeded 3 percent of the levels in 2022-23 and 2023-24. Without the spike Proposition 98 funding allocated to schools that protection adjustment, Test 3 would have been year. When the cap is operative, medium and large operative in 2022-23 and the guarantee would districts (those with more than 2,500 students) must have been about $1 billion above the level in the limit their reserves to 10 percent of their annual Governor’s budget.) expenditures. Smaller districts are exempt. The law Guarantee Grows Slowly in 2023-24 but also exempts reserves that are legally restricted Remains Below Previously Enacted Budget to specific activities and reserves designated for Level. The administration estimates the minimum specific purposes by a district’s governing board. guarantee is $108.8 billion in 2023-24 (Figure 3). In addition, a district can receive an exemption This funding level is $1.8 billion (1.7 percent) above from its county office of education for up to two the revised 2022-23 level but remains $1.5 billion consecutive years. The cap became operative for (1.4 percent) below the 2022-23 level enacted last the first time in 2022-23. June (Figure 4). Test 1 is operative in 2023-24, and nearly all of the increase in the guarantee Administration’s Estimates is attributable to growth in local property tax Minimum Guarantee Revised Up in 2021-22 revenue. (Under the Governor’s estimates of the but Down in 2022-23. Compared with the estimate guarantee, the spike protection provision would included in the June 2022 budget plan, the exclude nearly $6 billion of the guarantee in administration revises its estimate of the minimum 2023-24 from the Test 2 and Test 3 calculations guarantee up $178 million in 2021-22 (Figure 2). This in 2024-25. Spike protection applies in 2023-24 increase primarily reflects updated data showing because the guarantee recently has grown much local property tax revenue exceeded previous more quickly than per capita personal income and estimates. For 2022-23, the administration revises student attendance in recent years.) its estimate of the guarantee down $3.4 billion. Figure 2 Tracking Changes in the Prior- and Current-Year Guarantee (In Millions) 2021-22 2022-23 June 2022 January 2023 June 2022 January 2023 Estimate Estimate Change Estimate Estimate Change Minimum Guarantee General Fund $83,677 $83,630 -$47 $82,312 $79,103 -$3,210 Local property tax 26,560 26,785 225 28,042 27,889 -153 Totals $110,237 $110,415 $178 $110,354 $106,991 -$3,363 General Fund Tax Revenue $220,109 $219,986 -$123 $214,887 $206,469 -$8,418 4 LEGISLATIVE ANALYST’S OFFICE 2023-24 BUDGET Guarantee Adjusted for Transitional Figure 3 Kindergarten Expansion. The June 2021 budget established a plan to expand Proposition 98 Key Inputs and Outcomes Under eligibility for transitional kindergarten over Governor’s Budget a four-year period, beginning in 2022-23. (Dollars in Millions) It also reflected an agreement between the Governor and the Legislature to 2021-22 2022-23 2023-24 “rebench” the Proposition 98 guarantee Minimum Guarantee for this expansion. Consistent with General Fund $83,630 $79,103 $79,613a Local property tax 26,785 27,889 29,204 this agreement, the calculation of Totals $110,415 $106,991 $108,816 the guarantee in 2023-24 includes a Change From Prior Year $690 million increase to reflect costs General Fund $13,426 -$4,528 $510 for the second year of the expansion. Percent change 19.1% -5.4% 0.6% The budget implements this adjustment by Local property tax $916 $1,104 $1,315 increasing the minimum share of General Percent change 3.5% 4.1% 4.7% Total guarantee $14,342 -$3,424 $1,825 Fund revenues allocated to schools under Percent change 14.9% -3.1% 1.7% Test 1 from 38.3 percent in 2022-23 to General Fund Tax Revenueb $219,986 $206,469 $205,989 38.6 percent in 2023-24. This adjustment Growth Rates is responsible for all of the increase in the K-12 average daily attendance -8.9% 3.1% -0.8% General Fund portion of the guarantee Per capita personal income (Test 2) 5.7 7.6 2.8 in 2023-24. (Absent this adjustment, the Per capita General Fund (Test 3)c 19.7 -5.1 0.3 General Fund portion of the guarantee Proposition 98 Reserve would have declined slightly.) Deposit (+) or withdrawal (-) $3,710 $1,096 $365 Cumulative balance 7,012 8,108 8,473 Proposition 98 Reserve Deposits Revised Down. The June 2022 budget Operative Test 1 1 1 estimated the state would be required to a Excludes $941 million supplemental payment associated with Proposition 28 (2022). make Proposition 98 Reserve deposits b Excludes nontax revenues and transfers, which do not affect the calculation of the guarantee. of $4 billion in 2021-22 and $2.2 billion c As set forth in the State Constitution, reflects change in per capita General Fund plus 0.5 percent. in 2022-23. Based upon lower estimates Note: No maintenance factor is created or paid over the period. of capital gains revenue, the Governor’s budget reduces the estimated deposits Figure 4 to $3.7 billion and $1.1 billion in each year, respectively. For 2023-24, the budget Proposition 98 Changes Over the Budget Period estimates that a deposit of $365 million (In Billions) is required. This deposit is required because the budget anticipates the state will receive excess capital gains and the guarantee—though growing sluggishly—is above the 2022-23 level after accounting $110.2 $110.4 $110.4 $3.4 $1.5 $108.8 for spike protection and inflation. Under $107.0 the Governor’s budget, the total balance in the Proposition 98 Reserve by the end of 2023-24 would be $8.5 billion (7.8 percent of the guarantee that year). Since the balance in the reserve would remain above the 3 percent threshold through 2023-24, 2021-22 2022-23 2023-24 the cap on local district reserves would remain operative at least through 2024-25. June 2022 Enacted Budget January 2023 Governor's Budget www.lao.ca.gov 5 2023-24 BUDGET Modest Growth in the Guarantee After the Reductions in General Fund Revenues Budget Year. Under the administration’s estimates, Would Reduce the Guarantee. General Fund the Proposition 98 guarantee would increase by revenue tends to be the most significant input in an average of 3.9 percent per year from 2023-24 the calculation of the Proposition 98 guarantee. through 2026-27. By 2026-27, the guarantee would For any given year, the relationship between the grow to $122.2 billion, an increase of $13.4 billion guarantee and General Fund revenue generally over the 2023-24 level. Of this increase, $9.9 billion depends on which Proposition 98 test is operative (74 percent) is attributable to growth in the General and whether another test could become operative Fund portion of the guarantee and $3.5 billion with higher or lower revenue. Our analysis indicates (26 percent) is attributable to growth in local Test 1 is likely to remain operative for all three years property tax revenue. Test 1 would remain operative of the budget period, even if General Fund revenue each year of the period. The 3.9 percent annual varies significantly from the levels in the Governor’s increase in the guarantee is somewhat below budget. In Test 1 years, the guarantee increases the historical average—growth in the guarantee or decreases about 40 cents for each $1 of higher since the adoption of Proposition 98 in 1988 has or lower revenue. For example, if General Fund averaged 5.5 percent per year. This lower growth revenues were $5 billion below Governor’s budget rate primarily reflects the administration’s estimate estimates in 2022-23 and 2023-24, the reduction that economic growth will be moderate after in the guarantee would be approximately $2 billion multiple years of rapid growth. each year. (The tendency for Test 1 to remain operative over the budget period is due in large LAO Comments part to spike protection, which lowers the other General Fund Revenue in 2022-23 and two tests and makes them less likely to affect the 2023-24 Likely Lower Than Administration’s calculation of the guarantee.) Estimates. Since the adoption of the June 2022 Proposition 98 Reserve Provides Some budget, several areas of the economy have shown Cushion Against Revenue Declines. Changes notable weakness. For example, the housing market in revenue estimates and the minimum guarantee has cooled, consumer spending has slowed, and likely would affect the amount of funding the state is business startup activity has decreased. Much required to deposit in the Proposition 98 Reserve. of this weakness reflects the Federal Reserve’s A relatively modest revenue reduction occurring in effort to fight inflation by raising interest rates. 2022-23 or 2023-24 likely would reduce or eliminate Although the Governor’s budget contains lower the required deposit in the year the reduction revenue estimates than the budget the state occurs. If the revenue reduction were significant— adopted in June, we think revenues are likely to especially in 2023-24—the state might be required drop even further. Among other considerations, to make an automatic withdrawal. These changes several leading indicators of revenue performance— in the Proposition 98 Reserve would help mitigate including retail sales and income tax withholding— the effects of a drop in the guarantee on school and have shown notable weakness over the past few community college programs. months. For 2022-23, we estimate the probability Local Property Tax Estimates Could Be that General Fund revenues fall below the level in Somewhat Higher by May. Estimates of local the Governor’s budget is nearly 80 percent. Our property tax revenue are the other significant best estimate is that revenues would be about factor affecting the guarantee when Test 1 is $5 billion lower, though the decrease easily could operative. Compared with the Governor’s budget, be several billion dollars more or less than this our November property tax estimates were about estimate. For 2023-24, we think revenues are likely $1 billion higher over the three-year period, with to remain roughly flat relative to our lower 2022-23 most of the difference related to 2023-24. Slightly estimate. Compared with the Governor’s budget more than half of this difference involves our estimate for 2023-24, this level of revenues would estimates of supplemental taxes (taxes levied on represent a reduction of approximately $5 billion. properties sold midyear). Supplemental taxes 6 LEGISLATIVE ANALYST’S OFFICE 2023-24 BUDGET account for a small share of overall property tax continue in 2023-24 and 2024-25. For 2023-24, revenue but are particularly volatile and difficult the administration estimates that baseline costs to forecast. Most of our remaining differences for LCFF will decrease by an additional $1.6 billion relate to assumptions about (1) residual revenue relative to the lower 2022-23 level. allocated to schools and community colleges Significant Amount of One-Time Costs from the dissolution of redevelopment agencies, Expire. The June 2022 budget allocated $2.8 billion and (2) estimates of excess property tax revenue. in ongoing Proposition 98 funds for one-time K-12 (Excess tax revenue refers to the portion of local activities. The largest activities consisted of grants property tax revenue that some school and for community schools and pandemic recovery. community college districts receive beyond their Moving into 2023-24, the costs for these activities funding levels set by the state. This revenue is expire and the associated $2.8 billion in funding excluded from the calculation of the Proposition 98 is freed-up for other priorities. (In addition to this guarantee.) Compared with supplemental taxes, amount, the June 2022 budget allocated nearly these two property tax components typically follow $15 billion in one-time spending from funds that more predictable patterns of growth. Based on our were available only on a one-time basis.) latest review, we think property tax revenues are likely to be at least several hundred million dollars Major Proposals higher than the estimates in the Governor’s budget Budget Contains $5.2 Billion in New over the three-year period, and could be up to Proposition 98 Spending. After accounting $1 billion higher. for reductions in the minimum guarantee and baseline cost savings, the Governor’s budget has K-12 SPENDING PLAN approximately $5.2 billion available to allocate for In this section, we analyze the Governor’s new K-12 spending. The Governor’s plan for the proposals affecting the allocation of Proposition 98 K-12 budget has four basic components: (1) new funding to schools. Specifically, we (1) describe ongoing increases for LCFF totaling $5.3 billion, the baseline adjustments that affect available (2) other ongoing spending proposals totaling funding, (2) describe the Governor’s major $746 million, (3) new one-time spending proposals spending proposals, (3) examine potential spending totaling $376 million, and (4) one proposed increases beyond the budget year, (4) assess the reduction to an existing program of $1.2 billion overall architecture of the plan, and (5) offer our (Figure 5, on the next page). From an accounting recommendations to the Legislature. perspective, most of the new ongoing spending is attributable to 2023-24 and most of the one-time Baseline Adjustments changes are attributable to 2021-22. Lower Local Control Funding Formula Dedicates Most Ongoing Funds to Covering (LCFF) Costs Over the Period Due to Statutory Cost-of-Living Adjustment (COLA). Attendance-Related Adjustments. For 2021-22, The state calculates the statutory COLA each data published by the California Department of year using a price index published by the federal Education last year show that costs for LCFF government. This index reflects changes in the were $471 million lower than the state’s previous cost of goods and services purchased by state and estimate. For 2022-23, the administration local governments across the country during the estimates LCFF costs are $1.3 billion below the preceding year. For 2023-24, the administration level it estimated last June. This lower estimate estimates the COLA rate is 8.13 percent. The primarily reflects (1) the lower costs in the prior Governor’s budget includes $5.7 billion to cover the year carrying forward, and (2) an increase in associated increase for LCFF. It also funds the same the estimate of the savings from the phaseout COLA for various categorical programs. The COLA of districts’ pre-pandemic attendance levels rate for 2023-24 would build upon the 13.26 percent within the three-year rolling average calculation increase the state provided in 2022-23, which was the state adopted last year. This phaseout will approximately twice the statutory rate that year. www.lao.ca.gov 7 2023-24 BUDGET Proposes New Ongoing Component of LCFF. The Governor’s budget proposes to reduce The other notable ongoing proposal in the budget this program by $1.2 billion. (Districts received is $300 million for a new component of the LCFF the first half of their expected grant awards known as the “equity multiplier.” This component in November 2022 but the state has not yet would be allocated for school sites with especially apportioned the other half.) high shares of students who qualify for free meals Covers Some Ongoing Costs Using One-Time under the federal nutrition program (90 percent Funds. The Governor’s budget proposes to use or above for elementary and middle schools $1.4 billion in one-time funds to cover LCFF costs and 85 percent or above for high schools). The in 2023-24. These one-time funds are mainly administration indicates these funds are intended attributable to 2021-22. Three main factors are to provide more targeted support than the existing responsible for making these funds available: supplemental and concentration grants allocated (1) the proposed reduction to the Arts, Music, and to districts under LCFF. The budget also proposes Instructional Materials Discretionary Block Grant; refinements to the statewide system of support and (2) the baseline reduction in LCFF costs in 2021-22; school accountability system to complement this and (3) the increase in the 2021-22 minimum funding. These refinements would occur through guarantee. The proposal would not affect the timing trailer legislation and would not involve additional or distribution of LCFF allotments to districts. state funds. Proposes Two Notable Figure 5 One-Time Grants. The larger Governor’s Budget Contains $5.2 Billion in of the two proposals consists of K-12 Proposition 98 Spending Proposals $250 million for districts to hire (In Millions) and train literacy coaches and reading specialists. This proposal Ongoing Local Control Funding Formula (LCFF) would build upon the previous Statutory COLA (8.13 percent) $5,691 allocation of $250 million included Baseline attendance changes -1,575 in the June 2022 budget. The other Transitional kindergarten expansion 690 Transitional kindergarten staffing ratios 165 proposal would provide $100 million Equity multiplier 300 to fund culturally enriching activities Subtotal LCFF ($5,272) (such as visits to theaters and Other Ongoing Spending museums) for students in grade 12 COLA for select categorical programs (8.13 percent)a $669 during the 2023-24 school year. State Preschool for students with disabilities 64 Access to opioid overdose reversal medication 4 Reduces Funding for K-12 High Speed Network 4 One Previously Authorized California College Guidance Initiative 4 Program. The June 2022 budget Preschool assessment tool 1 allocated $3.6 billion in one-time Fiscal Crisis and Management Assistance Team 1 Subtotal Other Ongoing ($746) funds to create the Arts, Music, and Instructional Materials New One-Time Spending Discretionary Block Grant. Funds Literacy coaches and reading specialists $250 Arts and cultural enrichment 100 from this grant are allocated Charter School Facility Grant Program 30 to districts on a per-students CCEE adjustment for unspent prior year funds -4 basis. Districts can use these Testing consortium membership fee 1 funds for a range of costs, Update to digital learning and standards integration guidance 0.1 Subtotal One-Time ($376) including instructional materials, Reductions to Existing Spending professional development, Arts, Music, and Instructional Materials Discretionary Block Grant -$1,174 pandemic-related expenses, and Total K-12 Spending Changes $5,221 various other operational expenses. a Applies to Special Education, State Preschool, Child Nutrition, K-12 mandates block grant, Charter School Facility Grant Program, Foster Youth Program, American Indian education programs, and Adults in Correctional Facilities. COLA = cost-of-living adjustment and CCEE = California Collaborative for Educational Excellence. 8 LEGISLATIVE ANALYST’S OFFICE 2023-24 BUDGET Sets Aside Additional Funding for Arts Beyond the Budget Year Instruction as Required by Proposition 28. Administration Anticipates Much Lower The voters approved Proposition 28 in the COLAs After 2023-24. The administration’s November 2022 election. The measure requires the economic forecast anticipates inflation will state to establish a new program supporting arts moderate significantly later this year. Consistent instruction in schools, beginning in 2023-24 (see the with this assumption, the administration estimates nearby box). The Governor’s budget estimates the the statutory COLA rate for 2024-25 is 3.54 percent. initial amount for the program is $941 million. For For 2025-26 and 2026-27, the administration 2023-24, the measure specifies that this funding anticipates COLA rates of about 3.3 percent and is on top of the minimum guarantee otherwise 3.2 percent, respectively. These COLA rates are calculated for the year. Beginning in 2024-25, slightly above the historical average over the past the funding is folded into the guarantee and the 20 years (2.8 percent). guarantee is adjusted upward by a corresponding amount. For consistency with the displays in the LAO Comments Governor’s budget, we exclude this funding from School Funding Remains Relatively Strong our Proposition 98 spending totals in 2023-24. Despite Tighter Budget Picture. Although the Governor’s budget reflects a decrease in the guarantee relative to the previously 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. 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 main 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 calculates the cost of the program and funds this cost on top of 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. This increase in the guarantee is intended to support the cost of the program moving forward. Legislature Can Reduce Funding if It Suspends the Guarantee. The measure allows the Legislature to reduce funding for arts instruction 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. www.lao.ca.gov 9 2023-24 BUDGET enacted budget, Proposition 98 funding remains Statutory COLA Rate for 2023-24 Likely to strong by historical standards. Between 2019-20 Be Slightly Higher by May. On January 26, the and 2021-22, the minimum guarantee grew by federal government published a new quarter of $31.1 billion (39.2 percent)—the fastest increase data affecting the calculation of the COLA rate. over any two-year period since the passage of Based on the new data and our latest projections, Proposition 98 in 1988. Overall funding for schools we estimate the statutory COLA rate in 2023-24 remains relatively high even though the drop is 8.4 percent. Covering this higher rate would in 2022-23 erodes some of this gain. Figure 6 increase ongoing costs for LCFF and other illustrates this point by showing how funding per K-12 programs by approximately $220 million student under the Governor’s budget compares (relative to the Governor’s budget). The state will be with funding over the previous 25 years. able to finalize its calculation of the statutory rate School Funding Also Fares Relatively Well on April 27 when the federal government releases Compared With the Rest of State Budget. the final quarter of data used to calculate the In contrast to the relatively modest changes 2023-24 COLA. affecting K-12 schools, the Governor’s budget Governor’s Plan to Avoid Discretionary proposes notable reductions affecting many other Reserve Withdrawal Is a Prudent Starting Point. state programs. As we noted in a recent report, Although the state likely meets the conditions to the Governor’s budget addresses a shortfall of declare a budget emergency, the Governor does approximately $18 billion across all programs in the not propose any discretionary withdrawals from the state budget. The Governor’s proposed changes Proposition 98 Reserve. We think this approach is to programs outside of Proposition 98 include a fiscally prudent starting point because (1) funding (1) delaying more than $7 billion in spending to for school programs remains relatively strong under future years, (2) eliminating more than $6 billion in the Governor’s budget, and (2) saving reserves now previously approved augmentations (some of these gives the state a way to address further reductions reductions would be restored if revenue improves), in the guarantee that would occur if revenue and (3) shifting more than $4 billion in General Fund deteriorates. This budgeting approach seems costs to various special funds. In addition, the especially important this year given our outlook for budget provides limited or no COLA for most state lower General Fund revenues and the heightened programs funded outside of Proposition 98. risk of a recession. Saving reserves preserves a key tool the state could decide to use later to avoid program reductions Figure 6 or deferrals in a recession K-12 Funding Remains Strong by Historical Standards scenario. The Governor’s approach Proposition 98 Funding Per Student to the Proposition 98 Reserve also mirrors the approach to the Budget $20,000 Stabilization Account (BSA)— the state’s main rainy day fund. One difference between these Inflation Adjusted (2023-24 Dollars) 15,000 accounts is that the state might be required to make withdrawals from the Proposition 98 Reserve 10,000 if revenues were to decline significantly, whereas the rules Actual governing the BSA do not require 5,000 automatic withdrawals. Proposed Proposition 98 Estimate Budget Would Create a Deficit 1997-98 2001-02 2005-06 2009-10 2013-14 2017-18 2021-22 for Next Year. Using one-time 10 LEGISLATIVE ANALYST’S OFFICE 2023-24 BUDGET funds to cover ongoing costs creates a deficit in the position the state to deal with decreases in the Proposition 98 budget the following year. Under the guarantee, whether emerging in the coming months Governor’s budget, the Proposition 98 guarantee or in subsequent years. In the event of a severe would need to grow at least $1.4 billion in 2024-25 downturn, the state likely would need to make larger to cover the portion of LCFF paid with one-time reductions and rely upon Proposition 98 Reserve funds in 2023-24. If the state were in recession, this withdrawals, but starting without a deficit would deficit would compound an already difficult budget make the problem more manageable. Second, the situation and make program reductions or deferrals state could avoid reductions to the Arts, Music, and more likely or more severe. Even if the guarantee Instructional Materials Discretionary Block Grant. were growing more quickly, the deficit would reduce Maintaining this grant at its currently authorized the funding available to cover COLA and other level likely would be less disruptive for districts that priorities. Recognizing these risks, the Legislature have already developed plans to spend these funds. generally has avoided adopting Proposition 98 In the remainder of this section, we outline a few budgets that contain these deficits except during ways for the state to reduce ongoing expenditures severe downturns. and avoid reliance on one-time funds. Growth in Guarantee Might Not Be Enough Consider Funding Lower COLA Rate. As a to Support Full COLA in 2024-25. Although starting point for developing the budget, we the administration anticipates the Proposition 98 recommend the Legislature avoid funding a COLA guarantee will grow 3.9 percent annually over the above the level in the Governor’s budget—even next four years, some of that increase is reserved if the statutory rate is somewhat higher by May. for specific program expansions—most notably, Holding the COLA at 8.13 percent would avoid the expansion of transitional kindergarten and new creating additional costs that would make the funding for arts instruction under Proposition 28. Proposition 98 budget more difficult to balance. After accounting for these costs and various other We also recommend the Legislature consider adjustments, we estimate the annual growth in further reductions to the COLA rate, particularly the guarantee available to fund COLA or other if (1) the minimum guarantee is significantly lower new commitments would be about 3.2 percent. than the Governor’s budget estimate in 2023-24, or Using the administration’s assumptions about the (2) the Legislature prefers to avoid reducing ongoing guarantee and future COLA rates, we estimate the spending in other ways. For planning purposes, guarantee would be about $500 million short of the each 0.5 percentage point reduction in the COLA amount required to cover the COLA in 2024-25. rate would reduce costs for K-12 programs by In that scenario, the administration would have the approximately $400 million. If the Legislature were authority under existing law to reduce the COLA to to eliminate the $1.4 billion deficit entirely through rate to fit within the available funding. For 2025-26 funding a lower COLA, the associated reduction in and 2026-27, we estimate the guarantee would be the rate would be about 1.7 percentage points (for a just above the level necessary to fund the COLA COLA rate of about 6.4 percent). Even in this lower under the administration’s assumptions. All of COLA scenario, the rate in 2023-24 would remain these calculations are sensitive to small changes in high by historical standards and would build upon assumptions about the economy. the large increase the state provided in 2022-23. Consider Changes to LCFF Equity Multiplier Recommendations Proposal That Would Ease Budget Pressure. Build Budget Without Creating Future In the coming weeks, we plan to release a brief Deficits. We recommend the Legislature develop analyzing the Governor’s LCFF equity multiplier a budget for the coming year that does not rely on proposal and providing our assessment. Assuming one-time funding for ongoing costs. Eliminating the the Legislature decides to adopt the proposal, $1.4 billion deficit in the Governor’s Proposition 98 it could consider modifications that would ease budget would have at least two notable budget pressure. For example, it could delay the advantages. First, this approach would better implementation of the $300 million increase until www.lao.ca.gov 11 2023-24 BUDGET budget conditions are more favorable. (Regardless For example, even a relatively modest change to of its decision about the proposed spending assume 90 percent participation would reduce increase, the Legislature could immediately costs by approximately $400 million. Another implement the other changes associated with option is to reduce district allocations to account the proposal that do not require additional for the funding districts receive through the ongoing spending.) ASES and 21st Century programs, reducing ELOP Consider Certain Reductions for Expanded costs by at least several hundred million dollars. Learning Opportunities Program (ELOP). (Regardless of how the Legislature proceeds, we The state created this program in the 2021-22 recommend the state require districts to report budget to fund educational and enrichment data on program participation. This would help activities for K-12 students outside of normal school the state gauge student interest and inform future hours. The state currently allocates $4 billion funding decisions.) for the program. These funds are in addition Consider Certain Reductions for State to funding districts receive from the two other Preschool. The Legislature could consider longstanding expanded learning programs—the several changes that would reduce costs in State After School Education and Safety (ASES) program Preschool. For example, the Legislature could and 21st Century Community Learning Centers eliminate funding for slots going unused and ensure (21st Century). District ELOP allocations are based that total budgeted amounts are aligned with the on total district attendance in elementary grades costs of provider contracts. The savings could and the share of students who are low-income range from the low tens of millions of dollars to the or English learners. We understand that some low hundreds of millions of dollars, depending on districts are not on track to spend any or all of the specific options the Legislature takes. (These their ELOP funds in part due to slow program savings pertain specifically to the Proposition 98 ramp up, difficulty hiring staff, and the continued portion of State Preschool. Applying these actions use of temporary federal relief funds to cover to the non-Proposition 98 portion would generate expanded learning costs. Additionally, some some non-Proposition 98 General Fund savings initial district feedback indicates that, similar to too.) In the coming weeks, we plan to release current after school participation trends, not all our analysis of the Governor’s State Preschool students may express interest in participating proposals. In this brief, we will describe these in ELOP. The state has a few options that could options in more detail, as well as cover other reduce costs for the program. One option is to aspects of the Governor’s proposals. no longer assume 100 percent participation. 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. 12 LEGISLATIVE ANALYST’S OFFICE