The 2025‑26 Budget: Fiscal Outlook for Schools and Community Colleges

2025-26 BUDGET The 2025-26 Budget: Fiscal Outlook for Schools and Community Colleges GABRIEL PETEK | LEGISLATIVE ANALYST NOVEMBER 2024 www.lao.ca.gov 1 2025-26 BUDGET 2 LEGISLATIVE ANALYST’S OFFICE 2025-26 BUDGET Executive Summary Moderate Increase in School Funding Projected for 2025-26. Each year, the state calculates a “minimum guarantee” for school and community college funding based upon a set of formulas established by Proposition 98 (1988). Under our outlook, the guarantee in 2025-26 is $1.5 billion (1.3 percent) above the 2024-25 enacted budget level. In addition, $3.7 billion in funding is freed-up from the expiration of various one-time costs and other formula-driven adjustments. After accounting for the freed-up funding and the cost of providing a 2.46 percent statutory cost-of-living adjustment for school and community college programs, we estimate that $2.8 billion would be available for new commitments (see figure below). The Legislature could set aside a portion of this amount to eliminate the payment deferrals it adopted in the June 2024 budget plan, which would help build budget resiliency. For the remaining funds, dedicating a portion for one-time spending would create a buffer to help protect ongoing programs in case the guarantee is lower than expected in the future. Ongoing Funds Available in 2025-26 Changes From 2024-25 Enacted Budget (In Billions) 2025-26 Funding for New Minimum Guarantee Commitments $116.8 Billion $2.8 2024-25 Enacted Budget Baseline $115.3 Billion Adjustments -$3.7 Statutory COLA (2.46 Percent) Growth in Guarantee $2.4 ($1.5 Billion) COLA = cost-of-living adjustment. Funding Increase in 2024-25 Deposited Into Proposition 98 Reserve. Separate from our estimates for 2025-26, we estimate the Proposition 98 guarantee in 2024-25 is up $3 billion (2.6 percent) relative to the enacted budget level. Constitutional formulas would require the state to deposit nearly all of this additional funding into a statewide reserve account for schools and community colleges (the Proposition 98 Reserve). This deposit would bring the balance of the reserve to $3.7 billion. www.lao.ca.gov 3 2025-26 BUDGET INTRODUCTION Report Provides Our Fiscal Outlook for how our estimates of the guarantee in 2023-24 and Schools and Community Colleges. State 2024-25 differ from the state’s previous estimates. budgeting for schools and the California Community Third, we estimate the guarantee over the 2025-26 Colleges is governed largely by Proposition 98 through 2028-29 period under our economic (1988). The measure establishes a minimum annual forecast. Finally, we compare the funding available funding requirement for K-14 education commonly under the guarantee with the cost of existing known as the minimum guarantee. In this report, education programs and identify some issues for we provide our estimates of the guarantee and the Legislature to consider in the coming year. analyze the implications for school and community (The 2025-26 Budget: California’s Fiscal Outlook college budgeting. First, we review the formulas contains our outlook for the overall state budget.) that determine the guarantee. Next, we explain BACKGROUND Minimum Guarantee Depends Upon Various the previous year, Test 1 links school funding Inputs and Formulas. The California Constitution to a minimum share of General Fund revenue. sets forth three main tests for calculating the The Constitution sets forth rules for comparing the Proposition 98 guarantee. Each test takes into tests, with one of the tests becoming operative account certain inputs, including General Fund and used for calculating the guarantee that year. revenue, per capita personal income, and student Although the state can provide more funding attendance (Figure 1). Whereas Test 2 and than required, it usually funds at or near the Test 3 build upon the amount of funding provided guarantee. With a two-thirds vote of each house of the Legislature, the state can suspend the guarantee and provide Figure 1 less funding than the formulas require that year. The state funds Three Proposition 98 Tests the guarantee through state General Fund and local property Test 1 Test 2 Test 3 tax revenue. Share of General Change in Per Change in General “Maintenance Factor” Fund Revenue Capita Personal Fund Revenue Income (PCPI) Accelerates Growth in the Guarantee. In addition to the General PCPI Fund three main tests, the Constitution About ADA ADA requires the state to track an 40% obligation known as maintenance Prior-Year Prior-Year factor. The state creates Funding Funding maintenance factor when Test 3 is operative or the Legislature suspends the guarantee. The Guarantee based on share Guarantee based on prior- Guarantee based on prior- maintenance factor obligation 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 equals the difference between the education in 1986-87. in K-12 attendance and in K-12 attendance and actual level of funding provided California PCPI. state General Fund revenue. and the higher Test 1 or Test 2 ADA = average daily attendance. level. Moving forward, the state adjusts the obligation each year 4 LEGISLATIVE ANALYST’S OFFICE 2025-26 BUDGET for changes in student attendance and per capita (LCFF). A school district’s allotment depends on personal income. In subsequent years when its size (as measured by average daily attendance) General Fund revenue is growing faster than per and the share of its students who are low income capita personal income, the Constitution requires or English learners. The Legislature allocates most the state to make maintenance factor payments. community college funding through the Student The size of these payments increases in tandem Centered Funding Formula (SCFF). A college with higher year-over-year revenue growth. district’s allotment depends on its enrollment, “Spike Protection” Slows Growth in the share of low-income students, and performance on Guarantee. Whereas maintenance factor payments certain outcome measures. accelerate growth in the Proposition 98 guarantee, School and Community College Programs a separate formula known as spike protection Typically Receive COLA. The state calculates a prevents the guarantee from growing at an statutory cost-of-living adjustment (COLA) each unsustainable rate. This formula applies when the year using a price index published by the federal guarantee is increasing much faster than per capita government. This index tracks changes in the personal income and student attendance. The cost of goods and services purchased by state formula works by excluding some Proposition 98 and local governments across the country. Costs funding from the calculation of the guarantee in the for employee wages and benefits are the largest subsequent year. Technically, it reduces the Test 2 factor in the index. Other factors include costs for and Test 3 funding levels from what they otherwise fuel, utilities, supplies, equipment, and facilities. would be in the year following the increase. These The state finalizes the statutory COLA rate based lower levels are then used in the comparison with upon the data available in May prior to the start of Test 1 (which is unaffected). The purpose of spike the fiscal year. State law automatically increases protection is to protect the state budget from LCFF for the COLA unless the guarantee—as needing to sustain increases in the guarantee that estimated in the enacted budget—is insufficient are the result of temporary revenue spikes. to cover the associated costs. In these cases, the At Key Points, the State Recalculates the Department of Finance may reduce the COLA rate Guarantee. The state makes an initial estimate of to fit within the available Proposition 98 funding. the guarantee when it enacts the annual budget, For community college programs, the state typically but this estimate typically changes as the state provides the same COLA that it provides for updates the relevant Proposition 98 inputs. school programs. The state recalculates the guarantee at the end of Proposition 98 Reserve Deposits and the year based upon revised estimates of these Withdrawals Required Under Certain inputs, then makes a second recalculation at the Conditions. Proposition 2 (2014) created a state end of the following year. This schedule means that reserve specifically for schools and community for any given budget, the state has new estimates colleges—the Public School System Stabilization of the Proposition 98 guarantee for the prior year, Account (Proposition 98 Reserve). The Constitution current year, and upcoming year. For the prior year, requires the state to deposit Proposition 98 funding the state finalizes its calculation through a process into this reserve when the state receives high known as “certification.” Certification involves levels of capital gains revenue and the minimum the publication of the underlying Proposition 98 guarantee is growing quickly relative to inflation. inputs and a period for public comment and review. It also requires the state to withdraw funding from The most recently certified year is 2022-23. the reserve when the guarantee is growing more Legislature Decides How to Allocate slowly than inflation. When the state’s overall fiscal Proposition 98 Funding. Once the state has condition is relatively weak, the Legislature can calculated the guarantee, the Legislature decides suspend or reduce required deposits or make how to allocate the available funding among school additional discretionary withdrawals. Unlike other and community college programs. Since 2013-14, state reserve accounts, the Proposition 98 Reserve the Legislature has allocated most funding for is earmarked exclusively for school and community schools through the Local Control Funding Formula college programs. www.lao.ca.gov 5 2025-26 BUDGET Proposition 98 Reserve Linked With Cap on limit their reserves to 10 percent of their annual School Districts’ Local Reserves. State law caps expenditures. Smaller districts are exempt. The law school district reserves after the Proposition 98 also exempts reserves that are legally restricted Reserve reaches a certain threshold. Specifically, to specific activities and reserves designated for the cap applies if the funds in the Proposition 98 specific purposes by a district’s governing board. Reserve in the previous year exceed 3 percent of In addition, a district can receive an exemption the Proposition 98 funding allocated to schools that from its county office of education for up to two year. When the cap is operative, medium and large consecutive years. The cap has been operative in districts (those with more than 2,500 students) must previous years but is inoperative as of 2024-25. 2023-24 AND 2024-25 UPDATES State’s Job Market and Consumer Spending State Suspended the Proposition 98 Remain Lackluster… California’s economy Guarantee in 2023-24. The June 2024 budget plan has been in a slowdown for nearly two years, suspended the guarantee in 2023-24 and approved characterized by a soft labor market and weak $98.5 billion in funding for schools and community consumer spending. Although this slowdown has colleges. Although our estimate of General Fund been milder than a recession, recent economic revenue is up compared with the previous estimate, data reflect below-average performance in several changes in revenue do not directly affect funding indicators (Figure 2). Outside of government and when the guarantee is suspended. Moreover, health care, the state has added no jobs over the additional revenue would not have led to the past 18 months. Similarly, the number of higher funding even if the state had not invoked Californians who are unemployed is 25 percent suspension. (In the absence of suspension, Test 2 higher than during the strong labor markets of 2019 would have been operative and the guarantee and 2022. Consumer spending—as measured by would have been linked with growth in per capita inflation-adjusted retail sales and taxable sales— personal income rather than General Fund revenue.) has continued to decline throughout 2024. Proposition 98 Guarantee Revised Up …But Gains for High-Income Workers Are in 2024-25. Our estimate of the guarantee in Driving State Revenues Above Projections. 2024-25 is up $3 billion (2.6 percent) relative to Despite this economic weakness, total pay for the June 2024 estimate (Figure 3 on page 8). California workers has been growing quickly. This increase reflects our higher estimates of During the first quarter of 2024, for example, total General Fund and local property tax revenue. Test 1 pay increased at an annualized rate of 17 percent— is operative, meaning the guarantee increases one of the strongest quarters on record. State nearly 40 cents for each dollar of additional General income tax receipts have followed this trend, Fund revenue. In addition, the required maintenance with withholding collections up nearly 10 percent factor payment increases by $761 million due this year relative to 2023 levels. Most of this to faster year-over-year growth in General Fund increase appears linked with special forms of pay revenue. Under our estimates, the state would end for high-income workers, such as bonuses and 2024-25 with a $3.3 billion maintenance factor stock compensation. These increases, in turn, are obligation remaining. Regarding local property tax linked with the recent run up in the stock market. revenue, our estimates are up $789 million relative Stock compensation has become an increasingly to the June 2024 estimates. This increase reflects important form of pay among California’s recent data showing an uptick in home sales, high-income workers, especially those at major which generate additional property tax revenue as technology companies. This form of compensation properties are reassessed at market value. When is tied to the company’s stock price, so it rises Test 1 is operative, changes in property tax revenue when stock prices rise. have a dollar-for-dollar effect on the guarantee. 6 LEGISLATIVE ANALYST’S OFFICE 2025-26 BUDGET Figure 2 Most Economic Metrics Running Below Average Each dot represents the annual growth rate in the specified economic category in each quarter between 1982 Q1 and 2024 Q2. The purple dots show the first two quarters of 2024. The orange dot shows the historical average. (Income and sales data adjusted for inflation.) Total Pay to Workers -15 -10 -5 5 10 15% Business Owner Income -30 -20 -10 10 20 30% Payroll Jobs -15 -10 -5 5 10 15% Unemployed Workers -90 -60 -30 30 60 90% Taxable Sales -21 -14 -7 7 14 21% www.lao.ca.gov 7 2025-26 BUDGET Figure 3 Updating Prior- and Current-Year Estimates of the Guarantee (In Millions) 2023-24 2024-25 June November June November Budget Plan LAO Estimates Change Budget Plan LAO Estimates Change Minimum Guarantee General Fund $67,095 $67,006 -$89 $82,612b $84,796b $2,183 Local property tax 31,389 31,478 89 32,670 33,460 789 Totals $98,484a $98,484 — $115,283 $118,255 $2,973 General Fund tax revenue $185,490 $187,865 $2,375 $200,107 $203,919 $3,812 Maintenance factor payment — — — 4,072 4,833 761 a The June 2024 budget suspended the guarantee in 2023-24 and set forth this amount as the intended level. b Includes maintenance factor payment. State Required to Make Larger Reserve Program Cost Estimates Revised Up Deposit in 2024-25. Under our outlook, the Slightly in 2023-24 and 2024-25. For 2023-24, amount of state revenue attributable to capital the latest available data show that spending on gains is several billion dollars above the previous LCFF and other formula-driven programs is up estimate. These higher capital gains require $100 million compared with June 2024 estimates. the state to deposit $3.7 billion into the reserve For 2024-25, we estimate that spending is up (Figure 4). The June 2024 budget made a $311 million compared with June 2024 estimates. discretionary deposit into the Proposition 98 Of this increase, $193 million is attributable to Reserve of nearly $1.1 billion. (No deposit was the LCFF. Although the main components of the required by formula.) Provisional language in the LCFF generally are tracking previous estimates, the budget automatically counts the previous deposit costs for a few of the “add-ons”—primarily state toward the higher requirement. This higher deposit reimbursements for school transportation—are absorbs nearly all of the increase in the guarantee running ahead of projections. The other $118 million in 2024-25 that would materialize under our outlook in additional spending is attributable to adjustments estimates. The deposit also makes the local involving SCFF, special education, and support for reserve cap for school districts operative in the low-performing school districts. following year. Figure 4 Prior- and Current-Year Updates Include Larger Reserve Deposit in 2024-25 (In Millions) 2023-24 2024-25 June November June November Budget Plan LAO Estimates Change Budget Plan LAO Estimates Change Minimum Guarantee $98,484a $98,484 — $115,283 $118,255 $2,973 Allocations Local Control Funding Formulab $81,308 $81,360 $52 $80,923 $81,117 $193 Other K-14 programs 25,590 25,637 47 33,305 33,423 118 Reserve deposit/withdrawal (+/-) -8,413 -8,413 — 1,054 3,708 2,654 Totals $98,484 $98,584 $100 $115,283 $118,248 $2,966 Spending Above/Below — $100 $100 — -$7 -$7 Guarantee (+/-) a The June 2024 budget suspended the guarantee in 2023-24 and set forth this amount as the intended level. b Includes school districts, charter schools, and county offices of education. 8 LEGISLATIVE ANALYST’S OFFICE 2025-26 BUDGET Estimate of the Guarantee in 2024-25 Is Estimate of the Required Reserve Deposit Highly Sensitive to Revenue Changes. To the Is Highly Sensitive to Changes in Capital extent that General Fund revenue differs from our Gains. Whereas the guarantee is highly sensitive estimates in 2024-25, the guarantee would increase to changes in General Fund revenue, the required or decrease nearly 95 cents for each dollar of Proposition 98 Reserve deposit is highly sensitive to higher or lower General Fund revenue. This unusual changes in revenue from capital gains. Specifically, dynamic arises because Test 1 is operative and the required deposit would increase or decrease the state is making maintenance factor payments. nearly 95 cents for each dollar of higher or lower Specifically, the state would need to dedicate nearly capital gains revenue. This requirement means that 40 cents of each additional dollar to meeting the increases or decreases in the guarantee might not regular Test 1 requirement and nearly 55 cents of translate into more or less funding for school and each additional dollar to paying maintenance factor. community college programs. One complication is This sensitivity means that any changes in revenue that estimates of total state revenues and capital in 2024-25 fall almost entirely on the school and gains revenue do not necessarily move in tandem. community college portion of the state budget For example, updated data in May could show that and have relatively little impact on non-education total revenues are tracking our outlook estimates programs. (This sensitivity analysis holds every but capital gains account for a larger portion of input constant except state revenues in 2024-25. those revenues. Under this scenario, the state Changes in property tax revenue and certain other would be required to make a larger reserve deposit inputs also could affect the guarantee.) even if the guarantee has not increased by the same amount. MULTIYEAR OUTLOOK In this section, we estimate the minimum rate of growth, partially offset by an adjustment for guarantee for 2025-26 and the following three years policies in the June 2024 budget. Specifically, the under our economic and revenue forecast. We also budget suspended the ability of most businesses examine the Proposition 98 Reserve and several to claim certain tax deductions and credits in factors affecting costs for school and community the 2024, 2025, and 2026 tax years. Eligible college programs. businesses, however, can continue to accrue credits and deductions they are unable to claim Economic and Revenue Picture during this period. Our forecast accounts for lower Forecast Assumes Weak Revenue Growth in corporate tax revenues beginning in the 2027 tax 2025-26 and Moderate Growth in Subsequent year as businesses begin to use their saved-up Years. Our forecast anticipates General Fund credits and deductions. revenue growth of 1.2 percent in 2025-26. Federal Decisions About Interest Rates Are This growth is well below the historical average of a Notable Source of Uncertainty. Over the past about 6 percent annually over the past 15 years. two years, the Federal Reserve has adopted a This estimate reflects the risk that the existing series of actions to bring down the rate of inflation. weakness in the state economy could persist into Most notably, it has increased interest rates several the upcoming year, as well as continued warning times and reduced the amount of money available signs that the national economy faces an elevated for lending and investment. These actions have risk of a slowdown moving forward. In subsequent been a major cause of the current weakness in years, we assume General Fund revenue growth the state economy. As inflation has eased, the accelerates to 3.5 percent in 2026-27 and about Federal Reserve has begun to unwind these 5.5 percent per year in 2027-28 and 2028-29. These actions. If inflation stabilizes at a lower level and the assumptions reflect a gradual return to the historical Federal Reserve continues to reduce interest rates, www.lao.ca.gov 9 2025-26 BUDGET the California economy could improve and state tax revenue both contribute to growth in the revenues could outperform our forecast over the guarantee. The increase also reflects an ongoing next several years. Conversely, an uptick in inflation adjustment of nearly $800 million for the expansion and increase in interest rates could magnify existing of transitional kindergarten. (In 2022-23, the state weakness and cause revenues to underperform. began implementing a plan to make all four-year-old Stock Market Is Another Important Source children eligible for transitional kindergarten over a of Uncertainty. Much of the revenue improvement four-year period. As part of this plan, the Legislature in our forecast builds upon gains for high-income and Governor agreed to adjust the guarantee workers that are driven by strong stock market upward for the additional students enrolling in the performance. A stock market rally, however, can program each year. The state is making the final reverse quickly. Moreover, some indicators suggest adjustment in 2025-26.) the stock market has reached a level it may be …But Declines Relative to Revised Estimate unable to sustain. For example, current stock prices of 2024-25. Although the guarantee in 2025-26 is relative to past corporate earnings (a common $1.5 billion above the previously enacted budget measure of how “expensive” stocks are) have level, it is $1.5 billion (1.2 percent) below our reached levels rivaled only by the transitory booms revised estimate of the guarantee in 2024-25. of 1999 and 2021. Furthermore, a single company This year-over-year decrease is due to the spike (Nvidia) accounts for about one-third of the total protection formula in Proposition 98. This formula gains in the S&P 500 stock index over the last year. effectively treats a portion of the guarantee in Regarding state revenues, stock pay alone at four 2024-25 as a one-timWeo srpkikleo aandd# e 2xc4l0ud4e7s1 that major technology companies accounted for almost amount from the calculation of the guarantee 10 percent of the state’s total income tax withholding in the first Figure 5 half 2024. A reversal in the stock market—or even a drop limited to Proposition 98 Guarantee in 2025-26 these companies—could reduce Would Exceed Previous Budget Level state revenues significantly. On the (In Billions) other hand, developments over the coming year could solidify gains in the stock market and generate $120 additional revenue. For example, 118 if recent optimism over artificial $118.3 $1.5 Billion Increase intelligence proves warranted, 116 $116.8 stock prices for technology $115.3 "Spike" in 114 companies could continue to grow. Guarantee 112 The Minimum Guarantee Guarantee in 2025-26 Grows 110 Modestly Relative to Previously 108 Enacted Budget Level… Under our forecast, the minimum 106 guarantee grows to $116.8 billion in 104 2025-26, an increase of $1.5 billion (1.3 percent) compared with the 102 level in the 2024-25 enacted budget 100 (Figure 5). Test 1 is operative in Enacted Budget Revised Estimate 2025-26 2025-26, and increases in General Estimate 2024-25 Fund revenue and local property 10 LEGISLATIVE ANALYST’S OFFICE 2025-26 BUDGET in the following year. Absent this adjustment, a for each dollar of higher or lower General Fund different Proposition 98 test (Test 3) would have revenue. Based on recent data, the state seems been operative in 2025-26 and the guarantee would unlikely to make any maintenance factor payments have been $4.1 billion higher than the estimate in in 2025-26. Specifically, the data indicate unusually our outlook. strong growth in per capita personal income Guarantee Is Moderately Sensitive to General (8.4 percent), and maintenance factor payments are Fund Changes in 2025-26. General Fund revenue not required unless General Fund revenue were to tends to be the most volatile input in the calculation outpace this growth. of the Proposition 98 guarantee. For any given Moderate Growth in the Guarantee After year, the relationship between the guarantee 2025-26. Figure 6 shows our estimates of the and General Fund revenue generally depends on guarantee under our forecast through 2028-29. which Proposition 98 test is operative and whether The annual increases in the guarantee are moderate another test could become operative with higher after 2025-26, with growth averaging $5.8 billion or lower revenue. In 2025-26, Test 1 is likely to (4.7 percent) annually over the following three years. remain operative even if General Fund revenue or This rate of growth closely tracks our estimate of other inputs vary significantly from our forecast. In the increase in General Fund revenue. By the end Test 1 years, the guarantee changes about 40 cents of the period, the guarantee would be $17.4 billion Figure 6 Proposition 98 Outlook (Dollars in Millions) 2024-25 2025-26 2026-27 2027-28 2028-29 Minimum Guarantee General Fund $84,796 $81,747 $85,161 $89,735 $94,148 Local property tax 33,460 35,052 36,123 38,062 40,073 Totals $118,255 $116,799 $121,284 $127,797 $134,221 Change From Prior Year General Fund $17,690 -$3,049 $3,414 $4,574 $4,413 Percent change 26.4% -3.6% 4.2% 5.4% 4.9% Local property tax $1,982 $1,592 $1,071 $1,939 $2,011 Percent change 6.3% 4.8% 3.1% 5.4% 5.3% Total guarantee $19,672 -$1,457 $4,485 $6,513 $6,424 Percent change 20.0% -1.2% 3.8% 5.4% 5.0% General Fund Tax Revenuea $203,919 $206,457 $213,686 $224,939 $237,777 Growth Rates K-12 average daily attendance 0.2% 0.5% -1.2%b -0.9%b -1.1% Per capita personal income (Test 2) 3.6 8.4 5.6 5.4 5.5 Per capita General Fund (Test 3)c 8.9 1.7 3.8 5.5 5.9 Maintenance Factor Amount created/paid (+/-) -$4,833 — $2,044 — — Amount outstandingd 3,331 $3,626 5,873 $6,188 $6,452 Proposition 98 Reserve Deposit (+) or withdrawal (-) $3,708 — -$2,044 -$1,664 — Cumulative balance 3,708 $3,708 1,664 — — Operative Test 1 1 3 2 1 a Excludes non-tax revenues and transfers, which do not affect the calculation of the minimum guarantee. b This decline is deemed to be zero for the purpose of calculating the guarantee. As set forth in the State Constitution, an attendance decline does not reduce the guarantee unless attendance has declined in the two previous years. c As set forth in the State Constitution, reflects change in per capita General Fund plus 0.5 percent. d Outstanding maintenance factor is adjusted annually for changes in average daily attendance and per capita personal income. www.lao.ca.gov 11 2025-26 BUDGET above the 2025-26 level. Additional spending than our outlook assumes after 2025-26, the from the state General Fund would cover about state likely would be required to begin making 70 percent of this increase, whereas growth in maintenance factor payments. Whereas the three local property tax revenue would cover the other main Proposition 98 tests direct an average of 30 percent. about 40 percent of new revenue toward the Maintenance Factor Obligation Grows minimum guarantee, maintenance factor payments Under Our Outlook Assumptions. Under our tend to increase this percentage—in some cases outlook assumptions, Test 3 would be operative in significantly. Under this faster revenue scenario, 2026-27 and the state would add $2 billion to its schools and community colleges would benefit maintenance factor obligation. The state would not fiscally from receiving a large percentage of create or pay any maintenance factor in subsequent any revenue increases beyond the levels in our years, but the existing obligation would grow each forecast. This requirement would leave a smaller year. By the end of the period, the total outstanding share of revenues available to benefit the rest of amount would be $6.5 billion. The main reason the state budget—which is facing notable deficits the state does not pay any maintenance factor after 2025-26. is our relatively high assumption about growth Estimates of the Guarantee Become More in per capita personal income after 2025-26 Uncertain Over Time. Our forecast builds upon (aveGrargainpgh 5ic.5 S piegrcne nOt fafnnually). The Constitution the revenue estimates we think are most likely, requires maintenance factor payments when per but actual revenues are likely to be more volatile. Secretary capita General Fund revenues are outpacing per For example, our forecast assumes steady revenue Deputy capita personal income, but General Fund revenue acceleration over the next several years, but Chief Dep. grows at a slower rate under our outlook. revenues are likely to fluctuate even if they follow Analyst If Revenues Grow More Quickly After the general trajectory of our outlook. Figure 7 Large.ait ARTWORK #240471 2025-26, Maintenance Factor Payments Could shows how far the minimum guarantee could differ Direct Large Portion to Schools and Community from our forecast based upon swings in General Colleges. If revenues were to grow more quickly Fund revenue. For this analysis, we examined the Figure 7 Estimates of the Proposition 98 Guarantee Become More Uncertain Over Time (In Billions) $160 The shaded region shows how much the minimum guarantee might differ from our main forecast due to 150 changes in General Fund revenue. Outcomes beyond the shaded area are possible, but the guarantee most likely will fall in the shaded area. 140 130 120 110 100 90 2023-24 2024-25 2025-26 2026-27 2027-28 2028-29 12 LEGISLATIVE ANALYST’S OFFICE 2025-26 BUDGET historical relationship between previous revenue the two remaining quarters. These projections estimates and actual tax collections, and then account for the lower rate of inflation observed calculated the minimum guarantee under the since the beginning of the year. The federal different scenarios. The uncertainty in our estimates government will publish data for the final two increases significantly over the outlook period. quarters at the end of January and the end of April, The reasonable range for the guarantee in 2028-29, respectively. At 2.46 percent, our estimate of the for example, is almost twice as large as the range COLA rate is slightly below the historical average of in 2025-26. about 3 percent over the past 20 years. Covering this COLA for existing school and community Proposition 98 Reserve college programs would cost $2.4 billion. Withdrawals Would Be Required After Higher COLA Rates Assumed After 2025-26. 2025-26… Under our outlook, the state would Under our forecast, the COLA would be somewhat not be required to make Proposition 98 Reserve higher after 2025-26. Specifically, our estimate deposits or withdrawals in 2025-26. In 2026-27, of the statutory rate is 3.1 percent in 2026-27, however, the state would be required to withdraw 3.8 percent in 2027-28, and 4 percent in 2028-29. most of the balance. The main reason for this The cost of covering the COLA in each of these withdrawal is that Test 3 is operative, with the years would be $3.2 billion, $4 billion, and guarantee growing slowly relative to per capita $4.3 billion, respectively. personal income (the main inflation factor in the School Attendance Anticipated to Increase reserve calculation). This withdrawal also would Temporarily, Then Decline. Between 2019-20 reduce the balance below the threshold triggering and 2021-22, the number of K-12 students the local reserve cap, meaning the cap would attending school on a daily basis decreased by become inoperative the following year. The state nearly 550,000 (9.3 percent) (Figure 8 on the next would withdraw the remaining balance in 2027-28. page). The primary cause of this decline was a …But Withdrawals and Deposits Are surge in absenteeism. Elevated migration out of Especially Sensitive to Forecast Assumptions. the state and a long-term decline in births also Reserve deposits and withdrawals could swing contributed by reducing the size of the school-age dramatically based upon deviations from our population. Between 2021-22 and 2023-24, forecast assumptions. This instability is partly by statewide attendance increased by approximately design—one purpose of the reserve is to address 100,000 students (corresponding to growth of some of the volatility in the guarantee that is about 1 percent per year in 2022-23 and 2023-24). essentially impossible to anticipate in a multiyear This increase is mainly explained by a moderate forecast. Even small changes in certain inputs can reduction in absenteeism and additional attendance have notable effects. For example, if per capita generated by four-year-old children who recently personal income were to grow at rate that is became eligible for transitional kindergarten. Our 1.5 percent slower than the levels assumed in our outlook assumes further attendance increases of outlook for the next several years, the state would about 12,000 (0.2 percent) in 2024-25 and 26,000 withdraw only a few hundred million dollars from (0.5 percent) in 2025-26 as the state finishes the reserve. Conversely, faster growth in per capita the expansion of transitional kindergarten. After personal income could require the state to draw 2025-26, however, we assume attendance declines down the entire balance in a single year. by roughly 60,000 students (1 percent) each year for the following three years. The largest factor Program Costs behind this assumption is a reduction in the size of Moderate COLA Projected in 2025-26. the school age population due to lower births. We estimate the statutory COLA for 2025-26 LCFF Costs Are Decreasing as Pre-Pandemic is 2.46 percent. Our COLA estimate reflects Attendance Levels Phase Out. Following the preliminary federal data for six of the eight quarters start of the COVID-19 pandemic, the state adopted that affect the calculation and our projections for several policies to insulate school districts from the www.lao.ca.gov 13 Graphic Sign Off Secretary Deputy Chief Dep. Analyst Large.ait ARTWORK #240471 2025-26 BUDGET Figure 8 Statewide Attendance Projected to Decline After 2025-26 Average Daily Attendance (In Millions) 6.0 Transitional kindergarten expansion Baseline attendance 5.6 5.2 4.8 4.4 No Data 4.0 2017-18 2018-19 2019-20 2020-21 2021-22 2022-23 2023-24 2024-25 2025-26 2026-27 2027-28 2028-29 Projection fiscal effects of declining attendance. For 2020-21 Figure 9 and 2021-22, the state used certain pre-pandemic data to determine the attendance credited to each One-Time Costs and Savings in district. In 2022-23, it implemented a new policy 2024-25 Enacted Budget of funding districts based on their attendance (In Millions) in the current year, previous year, or average of the three previous years (whichever is highest). One-Time Costs Prior to this policy, the state had funded districts K-12 costs shifted from 2023-24 $3,570 Discretionary reserve deposit 1,054 according to their attendance in the current or CCC costs shifted from 2023-24 446 previous year only. Over the past two years, K-12 one-time activities 66 districts have been experiencing the fiscal effects of CCC one-time activities 21 declining attendance as their higher, pre-pandemic Subtotal ($5,157) attendance levels phase out of the three-year One-Time Savings State Preschool unallocated funds -$302 average calculation. For 2024-25, the June budget K-12 one-time funds supporting LCFF -257 assumed LCFF-related savings of about $1.2 billion CCC payment deferral -244 as the phaseout continues. Our outlook assumes K-12 payment deferral -244 a similar amount of LCFF savings in 2024-25 and a CCC one-time funds supporting SCFF -22 Other K-12 actions -6 further $200 million in savings in 2025-26. Subtotal (-$1,075) Significant Amount of One-Time Costs Expire Net Costs/Savings (+/-) $4,083 in 2025-26. The June 2024 budget used $5.2 billion CCC = California Community Colleges; LCFF = Local Control Funding in ongoing Proposition 98 funds—funds attributable Formula; and SCFF = Student Centered Funding Formula. to 2024-25—to pay for one-time costs (Figure 9). Most notably, the budget used ongoing funds to (1) cover some payments the state shifted from the previous year and (2) make a discretionary deposit into the Proposition 98 Reserve. Entering 2025-26, 14 LEGISLATIVE ANALYST’S OFFICE 2025-26 BUDGET these costs expire and the underlying funds The largest example involved a temporary reduction become available for other school and community to the California State Preschool Program. Entering college purposes. On the other hand, the budget 2025-26, these savings expire and the state must also relied upon nearly $1.1 billion in one-time replace them with ongoing funds. Accounting for savings to pay for ongoing programs. both the expiring costs and the expiring savings, the net amount of freed-up funding is $4.1 billion. KEY CONSIDERATIONS In this part of the report, we (1) compare the Specifically, we account for (1) baseline funding available under the minimum guarantee adjustments, including the expiration of $4.1 billion with the cost of existing school and community in one-time costs and about $400 million in college programs and (2) identify a few issues formula-driven cost increases; (2) the cost of for the Legislature to consider in its upcoming providing a 2.46 percent statutory COLA for the Graphic Sign Off budget deliberations. school and community college programs that Secretary typically receive a COLA; and (3) growth in the The Budget Picture in Deputy Proposition 98 guarantee. After making these 202 C 5 hi - e 2 f D 6 e a p. n d Beyond adjustments, we estimate the state would have SAtnaatleys Wt ould Have $2.8 Billion Available for $2.8 billion available in ongoing funds in 2025-26. New Commitments in 2025-26.L Faigrguere.a 1it0 A shRoTwWs ORK T#h2e4 L0e4g7is1lature could allocate these funds for any our estimate of the changes in funding and costs combination of one-time or ongoing activities that relative to the 2024-25 enacted budget level. support schools and community colleges. Figure 10 Ongoing Funds Available in 2025-26 Changes From 2024-25 Enacted Budget (In Billions) 2025-26 Funding for New Minimum Guarantee Commitments $116.8 Billion $2.8 2024-25 Enacted Budget Baseline $115.3 Billion Adjustments -$3.7 Statutory COLA (2.46 Percent) Growth in Guarantee $2.4 ($1.5 Billion) COLA = cost-of-living adjustment. www.lao.ca.gov 15 2025-26 BUDGET Funding Available for New Commitments the 25th percentile when measured against the Grows Under Main Forecast. Figure 11 shows potential revenue outcomes that could occur how the amount of funding available for new over the outlook period. Specifically, it assumes commitments could change over the rest of the General Fund revenue grows 4.5 percent in outlook period. Specifically, it shows the difference 2024-25; declines 3 percent in 2025-26; then grows between the Proposition 98 guarantee and the about 3 percent annually in 2026-27, 2027-28, costs for existing school and community college and 2028-29. (By contrast, our main forecast programs (adjusted for the statutory COLA and assumes General Fund revenue grows 8.5 percent changes in attendance). Conceptually, the amounts in 2024-25, 1.2 percent in 2025-26, 3.6 percent in in the figure are analogous to the surplus and deficit 2026-27, and 5.5 percent in 2027-28 and 2028-29.) amounts we calculate for the state budget overall The shortfalls in the sluggish scenario are in the and display in Figure 5 of The 2025-26 Budget: range of $2 billion to $4 billion each year. The California’s Fiscal Outlook. Under our main forecast, difference between the two scenarios indicates the guarantee grows more quickly than costs that despite the favorable picture under our main for existing programs and the state can afford to forecast, school and community college programs expand programs or make other new commitments. are not immune to the effects of downturns that the Under Weaker Scenario, State Would Face state could face in the future. Shortfalls and Difficulty Maintaining Programs. Planning for the Upcoming Year Whereas our main forecast indicates the state would be able to expand programs, the picture Recent Experience Illustrates the Value of could change quickly in a weaker economy. Building Budget Resiliency. Following a surge As the figure shows, the funding available under in the Proposition 98 guarantee in 2021-22, the Workload# 240s4ta7t1e faced two consecutive budgets in which the Proposition 98 would be unable to support the cost guarantee declined from its previous peak. Despite of existing programs if state revenue were growing drops of a few billion dollars each year, the state sluggishly. This weaker scenario corresponds to managed to avoid reductions to ongoing school and community college programs. One major Figure 11 factor was the state’s ability to State Has Funding for New Commitments Under draw upon $9.5 billion that it had Main Forecast, Shortfalls if Revenue Grows Slowly previously deposited into the (In Billions) Proposition 98 Reserve. Another major factor was the Legislature’s decision in June 2022 to set aside $10 $3.5 billion in ongoing funds 8 for one-time expenditures. This approach to the budget created 6 Main Forecast Guarantee a cushion—when the guarantee 4 exceeds costs dropped the following year, of existing 2 programs the expiration of this one-time spending allowed the state to accommodate the lower guarantee -2 Guarantee is without reducing ongoing below costs of programs. Given the risks and -4 existing Sluggish Revenue programs uncertainties the state faces in -6 the coming years, the Legislature 2025-26 2026-27 2027-28 2028-29 could consider using a significant portion of the $2.8 billion in available funding to build budget resiliency. 16 LEGISLATIVE ANALYST’S OFFICE 2025-26 BUDGET Eliminating Deferrals Would Have Multiple Several Considerations for Ongoing Benefits. As a starting point for building resiliency, Increases. If the Legislature decides to use some the Legislature could use $487 million of the of the available funding for ongoing increases, available Proposition 98 funding to eliminate the it has various trade-offs to consider. Ongoing payment deferrals it created in the June 2024 augmentations could help schools and community budget. Eliminating the deferrals would restore the colleges enhance local programs and address the regular payment schedule and remove pressure on cost pressures they face, but they also commit future Proposition 98 funding, giving the Legislature the state to a higher level of ongoing spending more options to address economic downturns within Proposition 98. The Legislature also faces or fund other priorities in subsequent years. trade-offs regarding the distribution of any ongoing Moreover, any ongoing funds used for this purpose increases. For example, allocating additional funds would become available for other purposes in the through the LCFF or SCFF could help districts make following year. progress on state priorities while allowing districts One-Time Spending Could Help Build a flexibility regarding the specific uses of those funds. Budget Cushion. Assuming the state eliminates Regarding LCFF, the Legislature could provide the deferrals, approximately $2.3 billion would across-the-board increases beyond COLA, or it remain available for other school and community could use funding increases to modify the formula. college purposes. The Legislature could consider a Allocating additional funds through categorical variety of one-time uses for these funds that would programs or restricted grants would provide more help build a budget cushion. Regarding schools, for certainty about how districts will use their funds, example, the state previously reduced funding for but could make the school and community college the Learning Recovery Emergency Block Grant by funding system more fragmented if it involves $1.1 billion and grants for electric school buses by creating new programs. If the Legislature does $1 billion. It also adopted language indicating intent want to provide ongoing augmentations, the spring to restore these funds. If these activities remain budget hearings provide an opportunity to study a priority, the upcoming year is an opportunity the costs and trade-offs carefully and ensure the to make these restorations. Another approach increases align with core legislative priorities. could focus on newer priorities. For example, the Legislature could consider setting aside some of this funding to cover the cost of implementing legislation it adopts in the upcoming session. www.lao.ca.gov 17 2025-26 BUDGET 18 LEGISLATIVE ANALYST’S OFFICE 2025-26 BUDGET www.lao.ca.gov 19 2025-26 BUDGET LAO PUBLICATIONS This report was prepared by Kenneth Kapphahn, and reviewed by Edgar Cabral and Ross Brown. 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. 20 LEGISLATIVE ANALYST’S OFFICE