The 2026-27 Budget: Fiscal Outlook for Schools and Community Colleges

analysis full 2026-27 BUDGET The 2026-27 Budget: Fiscal Outlook for Schools and Community Colleges GABRIEL PETEK | LEGISLATIVE ANALYST | NOVEMBER 2025 SUMMARY Large One-Time Windfall and Modest Ongoing Increase Projected for School and Community College Funding. Each year, the state calculates a “minimum guarantee” for school and community college funding based on the formulas established by Proposition 98 (1988). Under our forecast, increases to the guarantee in 2024-25 and 2025-26, coupled with a preexisting payment obligation, require the state to provide nearly $7.4 billion in one-time funds for schools and community colleges. For 2026-27, we estimate the guarantee is $117.8 billion, an increase of $3.2 billion (2.8 percent) from the previously enacted level. This growth—combined with a required reserve withdrawal—would be just enough to fund a 2.51 percent statutory cost-of-living adjustment (COLA) (see figure below). The state could use the one-time funds to build budget resiliency, which seems especially important given the risks of a stock market downturn. Some promising options include eliminating payment deferrals, providing districts with an advance payment toward their future funding allocations, and accelerating the restoration of a grant the state previously reduced. These actions would help protect ongoing programs if state revenues decline. Ongoing Increase Is Just Enough to Cover COLA in 2026-27 Changes From 2025-26 Enacted Budget (In Billions) Statutory 2026-27 COLA Reserve Minimum (2.51 Percent) Withdrawal Guarantee Uncommitted $117.8 $2.5 -$1.1 Funds Billion $0.2 Backfill One-Time Actions 2025-26 Enacted Budget $1.7 $114.6 Billion Growth in Guarantee ($3.2 Billion) Note: statutory COLA amount includes a $38 million net decrease for baseline adjustments, mainly related to school attendance and community college enrollment. COLA = cost-of-living adjustment. www.lao.ca.gov 1 analysis full 2026-27 BUDGET INTRODUCTION Report Provides Our Fiscal Outlook Next, we analyze recent revenue trends and explain for Schools and Community Colleges. their effect on the guarantee in 2024-25 and State budgeting for schools and the California 2025-26. Third, we estimate the guarantee from Community Colleges is governed largely by 2026-27 through 2029-30 based on our revenue Proposition 98. The measure establishes an annual forecast. Finally, we assess the funding available funding requirement commonly known as the for school and community college programs and minimum guarantee. In this report, we estimate provide some considerations for the Legislature the guarantee and examine its implications for in the upcoming year. (The 2026-27 Budget: school and community college programs. First, we California’s Fiscal Outlook contains our outlook for review the formulas that determine the guarantee. the overall state General Fund budget.) BACKGROUND Proposition 98 Establishes an Education of this section provides additional details on the Budget Within the Overall State Budget. guarantee, program costs, and the reserve. By requiring the state to allocate a specific amount Proposition 98 Guarantee Depends on of funding each year, Proposition 98 creates a Various Inputs and Formulas. The California dedicated budget for schools and community Constitution sets forth three main “tests” (formulas) colleges. The guarantee represents the minimum for calculating the Proposition 98 guarantee. Each revenue the Legislature must make available in this test takes into account certain inputs, including budget. Specific school and community college General Fund revenue, per capita personal programs, in turn, correspond to the annual income, and student attendance (Figure 1). expenditures. The largest school program is the Local Control Funding Formula (LCFF), and the Figure 1 largest community college program Three Proposition 98 Tests is the Student Centered Funding Formula (SCFF). During strong economic times, the guarantee Test 1 Test 2 Test 3 often increases more quickly than Share of General Change in Per Change in General Fund Revenue Capita Personal Fund Revenue the cost of existing programs. Income (PCPI) In such cases, funding is available to expand programs (similar to a PCPI Ge F n u e n r d al surplus). Conversely, in weaker About ADA ADA economic times, the guarantee 40% often falls below the cost of Prior-Year Prior-Year existing programs, and the state Funding Funding must either provide more funding than the guarantee or reduce Guarantee based on share Guarantee based on prior- Guarantee based on prior- spending on programs (similar to a of state General Fund year funding level adjusted year funding level adjusted deficit). The school and community revenue going to K-14 for year-over-year changes for year-over-year changes education in 1986-87. in K-12 attendance and in K-12 attendance and college budget also includes a California PCPI. state General Fund revenue. dedicated reserve account to help stabilize funding over time. The rest ADA = average daily attendance. 2 LEGISLATIVE ANALYST’S OFFICE analysis full 2026-27 BUDGET Whereas Test 1 links school funding to a minimum as the expansion of transitional kindergarten— share of General Fund revenue, Test 2 and Test 3 also have notable effects. For the community build upon the funding provided in the previous colleges, enrollment changes reflect a combination year. The Constitution contains rules for comparing of factors, including demographic and economic the tests, with one becoming operative and trends, community college districts’ enrollment determining the guarantee for that year. With a management strategies, and state decisions two-thirds vote of each house of the Legislature, regarding enrollment growth funding. Separate from the state can suspend the guarantee and provide enrollment changes, the state typically provides less funding than the formulas require in a given a COLA for existing programs. The COLA rate year. The state funds the guarantee through a depends on a federal price index that tracks the combination of state General Fund and local cost of goods and services purchased by state and property tax revenue. local governments nationwide. The state finalizes Proposition 98 Guarantee Is a Moving Target. the COLA rate for the upcoming year using the The state estimates the guarantee when it enacts data available in May. For school programs, state the budget, but this calculation typically changes law automatically provides the COLA unless the as the state updates its revenue estimates and guarantee cannot cover the associated costs. other inputs. The state recalculates the guarantee For community colleges, the state typically provides at the end of each year, then recalculates it again the same COLA as it does for schools. at the end of the following year. This schedule Proposition 98 Reserve Helps Stabilize means each budget includes new estimates for the Funding. The California Constitution establishes previous, current, and upcoming years. When the a reserve specifically for school and community guarantee exceeds the initial estimate, the state college funding—the Public School System makes additional payments (known as “settle up”) Stabilization Account (Proposition 98 Reserve). to meet the higher requirement. The state finalizes The Constitution requires the state to deposit its prior-year calculation through a statutory Proposition 98 funds into this reserve when it process called certification. This process involves receives significant tax revenue from capital gains publishing the underlying Proposition 98 inputs and and the guarantee is growing quickly relative to providing a period for public comment and review. inflation. It requires withdrawals when the guarantee The most recently certified year is 2023-24. is not keeping pace with inflation. The state can School and Community College Programs use these withdrawals for any school or community Are Adjusted for Enrollment Changes and college purpose. The state updates its estimates COLA. The LCFF, SCFF, and many other school of any required deposits or withdrawals whenever and community college programs allocate funding it recalculates the guarantee. Separate from these through per-student formulas. As enrollment constitutional provisions, a state law caps the local changes, the costs for these programs tend to reserves held by medium and large school districts move in tandem. For school programs, changes when the Proposition 98 Reserve balance exceeds in the school-age population are usually the most 3 percent of the funding allocated to schools in the significant factor, though policy decisions—such previous year. 2024-25 AND 2025-26 UPDATES Revenue Trends factor in business expansions and major consumer purchases—remain high. New tariffs on imports Corporation and Sales Tax Receipts Reflect into the U.S. are increasing costs for businesses Weak Economic Conditions. Both the California and consumers. Surveys report that consumers and U.S. economies currently face significant are pessimistic about economic growth and their headwinds. For example, borrowing costs—a key www.lao.ca.gov 3 analysis full 2026-27 BUDGET personal finances. Reflecting these conditions, two reflect higher General Fund revenue estimates. broad measures of California’s economy—payroll Test 1 is operative in both years, meaning the job growth and sales of taxable goods—have been guarantee automatically grows by about 40 cents flat over the past year. Consistent with these trends, for each $1 of higher revenue. In 2024-25, the state receipts from the sales tax and corporation guarantee increases even more because the state tax (adjusted for recent policy changes) have makes a larger “maintenance factor” payment. posted below-average growth in recent months. (Maintenance factor is a constitutional obligation Income Tax Receipts Have Been Strong, created under certain conditions, including when Reflecting Exuberance Around Artificial the state suspends the guarantee. The state Intelligence (AI). Income tax receipts, by contrast, pays this obligation when it experiences strong have been growing at an annualized rate of more year-over-year revenue growth. The payments are than 10 percent for the past several months. part of the guarantee.) After making this payment, This trend reflects investor enthusiasm around the remaining maintenance factor obligation would the advance of AI, which has pushed the stock be $1.7 billion. Our estimates of local property tax market to record highs and boosted compensation revenue are also slightly higher in 2024-25 and among the state’s tech workers. The S&P 500 2025-26 based on updated data. In Test 1 years, has risen 50 percent over the past two years, increases in local property tax revenue directly with most of the gains driven by a few large tech increase the guarantee. companies. These companies have committed Program Cost Estimates Reduced in 2024-25 hundreds of billions of dollars to new datacenters and 2025-26. For 2024-25, updated data from and offered extraordinary pay packages to recruit the California Department of Education show that AI researchers. This spending, coupled with sizable LCFF costs were $466 million lower than the June gains to investors and tech company employees 2025 estimates (Figure 3). We estimate that much via stock options, is boosting state income of this decrease is ongoing, and our LCFF cost tax receipts. estimate for 2025-26 is $295 million below the June estimate. In contrast, our estimates for other school Funding Changes and community college programs are slightly higher Proposition 98 Guarantee Revised Up in than the June estimates in both years. 2024-25 and 2025-26. We estimate the guarantee Larger Reserve Deposit Required in 2024-25. is up $2.2 billion (1.8 percent) in 2024-25 and We estimate that capital gains revenues in 2024-25 $3.8 billion (3.3 percent) in 2025-26 compared are more than $1 billion above the June 2025 with the estimates in the June 2025 budget estimate. These increased capital gains require the (Figure 2). These upward revisions mainly state to deposit an additional $927 million into the Figure 2 Guarantee Revised Up in Prior and Current Year (In Millions) 2024-25 2025-26 June November June November Budget Plan LAO Estimates Change Budget Plan LAO Estimates Change Minimum Guarantee General Funda $87,628 $89,520 $1,892 $80,738 $84,326 $3,588 Local property tax 32,317 32,581 263 33,821 34,029 208 Totals $119,946 $122,101 $2,155 $114,558 $118,355 $3,796 General Fund tax revenue $209,813 $211,822 $2,009 $204,027 $213,705 $9,678 Maintenance factor payment 5,466 6,619 1,154 — — — a Includes maintenance factor payment. 4 LEGISLATIVE ANALYST’S OFFICE analysis full 2026-27 BUDGET Figure 3 Additional Funding Required in 2024-25 and 2025-26 (In Millions) 2024-25 2025-26 June November June November Budget Plan LAO Estimates Change Budget Plan LAO Estimates Change Minimum Guarantee $119,946 $122,101 $2,155 $114,558 $118,355 $3,796 Allocations Local Control Funding Formulaa $81,606 $81,140 -$466 $84,480 $84,186 -$295 Other K-14 programs 35,968 36,041 73 30,533 30,619 86 Reserve deposit/withdrawal (+/-) 455 1,382 927 -455 -270 185 Totals $118,029 $118,562 $533 $114,558 $114,535 -$24 Additional Funding Owed $1,917 $3,539 $1,622 — $3,820 $3,820 (Settle Up) a Includes school districts, charter schools, and county offices of education. Proposition 98 Reserve. For 2025-26, we estimate to support existing programs, eliminate payment the state will make a mandatory withdrawal of deferrals, and/or avoid future deferrals. (If the $270 million from the reserve—$185 million less state does not make this payment in the upcoming than the June estimate. The State Constitution budget, a fallback provision in the certification law requires this withdrawal because the guarantee— would convert the obligation into a per-student though significantly above the previous estimate— grant that would be paid on a schedule determined is below the inflation-adjusted 2024-25 level. by the Department of Finance.) Accounting for these changes, the reserve would State Required to Provide Nearly $7.4 Billion have a balance of $1.1 billion at the end of 2025-26. in One-Time Funding. After accounting for State Has a Preexisting Obligation Related increases in the guarantee, lower program costs, to 2024-25. The June budget approved funding larger reserve deposits, and the preexisting for schools and community colleges at a level obligation from 2024-25, school and community $1.9 billion below the estimated guarantee for college funding is $3.5 billion below our estimate 2024-25. We assume the state will provide a of the guarantee in 2024-25 and $3.8 billion below settle-up payment to meet this obligation in in 2025-26. Across the two years, the state would the upcoming budget. This assumption aligns need to provide nearly $7.4 billion to meet the with state practice since 2018-19, which is to guarantee. The Legislature could allocate this provide any required funding before certifying the one-time funding for any school or community guarantee. Trailer legislation accompanying the college purposes. budget indicates the state will use the $1.9 billion MULTIYEAR OUTLOOK Revenue Assumptions high levels, investors are borrowing more to buy stocks, and households are more invested in Several Signs Suggest the Stock Market May the stock market than they have been in at least Be Overvalued. Several indicators suggest that 70 years (Figure 4 on the next page). Historically, enthusiasm for AI is pushing the stock market to these patterns have signaled that a stock market unsustainable levels. For example, measures of downturn will occur within the next few years. whether stocks are “expensive” are at historically www.lao.ca.gov 5 analysis full 2026-27 BUDGET in 2027-28 and 2028-29 Figure 4 and average growth in 2029-30. (The 2026-27 Signs the Stock Market May Be Due for a Downturn Budget: California’s Fiscal Outlook provides Below, we compare stock market metrics from right now to prior overheated markets that ended in crashes and show that current conditions look a lot like prior overheated stock additional context for our markets. The data is quartely and covers 1952 to present. Growth in borrowing and stock revenue assumptions.) ownership are changes from two years prior. Proposition 98 What Returns Are Investors Accepting to Hold Stocks? Guarantee When likely returns are low, it could mean investors are paying too much for stocks. Guarantee Revised Up From the Previous Overheated Markets Now Normal Times Budget Level. Under our forecast, the minimum 1 2 3 4 5% guarantee grows to $117.8 billion in 2026-27, How Much Has Investor Borrowing to Buy Stocks Grown? an increase of $3.2 billion When borrowing grows quickly, it could mean prices are being propped up by debt. (2.8 percent) from the previously enacted budget level (Figure 6). Test 1 is operative, with growth in General Fund revenue 10 20 30 40 50% and local property tax revenue each contributing How Much Have Households Increased Their Holdings of Stocks? about equally to the When households are highly invested in stocks, it could signal overoptimism. increase. The 2026-27 guarantee is less than our revised estimate of the 2025-26 guarantee, however. This difference 10 20 30 40% mirrors our forecast that state revenues in 2026-27 are up relative to the Forecast Assumes Recent Revenue Gains previously enacted budget Are Temporary. The state’s strong income tax level but down slightly from our revised 2025-26 receipts over the past several months usually would estimate. Regarding local property tax revenue, we imply an ongoing revenue increase. Our forecast, project a 4.8 percent increase in 2026-27, which is however, assumes these gains fade in 2026-27. below the long-term average of about 6 percent. Specifically, our revenue estimate for 2026-27 This slower growth is related to declining home reflects an increase relative to the 2025-26 enacted sales and a slowdown in home price growth over budget level, but a decrease relative to our revised the past few years. 2025-26 estimate (Figure 5). The decrease reflects Guarantee Is Moderately Sensitive to the strong risk that the recent gains are tied to an Revenue Changes in 2026-27. General Fund unsustainable stock market. Our forecast does revenue is typically the most significant input for not specifically project a stock market downturn calculating the guarantee. For any given year, the next year, but it gives this possibility much greater relationship between the guarantee and General weight than previous outlooks. Moving forward, Fund revenue generally depends on which our forecast reflects modest revenue increases Proposition 98 test is operative and whether 6 LEGISLATIVE ANALYST’S OFFICE analysis full 2026-27 BUDGET another test could become operative with higher or lower Figure 5 revenue. In 2026-27, Test 1 is likely LAO Revenue Outlook to remain operative even if General Fund revenue or other inputs vary “Big Three” Revenue (In Billions) significantly from our forecast. In Test 1 years, the guarantee $300 changes by about 40 cents for The shaded area shows how far revenues could deviate from our main forecast. each $1 of higher or lower General 280 Outcomes beyond the shaded area are Fund revenue. (The state also is possible, but revenues most likely will fall in 260 the shaded area. unlikely to pay any maintenance factor unless revenue growth from 240 2025-26 to 2026-27 is substantially higher than our forecast estimates.) LAO Fiscal Outlook 220 Average Growth in the Guarantee After 2026-27. 200 Budget Act Figure 7 on the next page 180 shows the guarantee under our forecast over the next four 160 years. The increases in 2027-28 2023-24 2024-25 2025-26 2026-27 2027-28 2028-29 2029-30 and 2028-29 are just below the long-term average of 5.4 percent. In 2029-30, growth would accelerate to 7.5 percent under our assumptions, driven by faster Figure 6 revenue growth and a required maintenance factor payment. Estimate of Proposition 98 Guarantee This payment would eliminate Exceeds Previous Budget Level virtually all of the remaining (In Billions) maintenance factor obligation. Test 1 remains operative over the period, with increases in General $118.4 $3.2 Billion $117.8 Fund revenue and local property Increase tax revenue each contributing $114.6 to growth in the guarantee. The increases in the General Fund portion of the guarantee closely track our General Fund revenue estimates. Regarding local property tax revenue, we expect that improvements in the housing market will result in annual growth that approaches the historical average (about 6 percent) from Enacted Budget Revised Estimate 2026-27 Estimate 2027-28 through 2029-30. 2025-26 www.lao.ca.gov 7 analysis full 2026-27 BUDGET Figure 7 Proposition 98 Outlook (Dollars in Millions) 2025-26 2026-27 2027-28 2028-29 2029-30 Minimum Guarantee General Fund $84,326 $82,130 $85,785 $90,183 $97,689 Local property tax 34,029 35,671 37,849 39,968 42,257 Totals $118,355 $117,800 $123,634 $130,151 $139,946 Change From Prior Year General Fund -$5,194 -$2,196 $3,655 $4,399 $7,506 Percent change -5.8% -2.6% 4.5% 5.1% 8.3% Local property tax $1,448 $1,642 $2,178 $2,119 $2,289 Percent change 4.4% 4.8% 6.1% 5.6% 5.7% Total guarantee -$3,746 -$554 $5,833 $6,517 $9,795 Percent change -3.1% -0.5% 5.0% 5.3% 7.5% General Fund Tax Revenuea $213,705 $208,298 $217,562 $228,278 $242,912 Growth Rates K-12 average daily attendance 0.9% -1.0%b -0.7%b -1.0% -1.1% Per capita personal income (Test 2) 6.4 4.2 4.8 4.6 4.7 Per capita General Fund (Test 3)c 1.1 -2.3 4.8 5.3 6.7 Maintenance Factor Amount created/paid (+/-) — — — -$171 -$1,907 Amount outstandingd $1,796 $1,871 $1,960 1,860 18 Proposition 98 Reserve Deposit (+) or withdrawal (-) -$270 -$1,112 — $1,863 $3,376 Cumulative balance 1,112 — — 1,863 5,239 Operative Test 1 1 1 1 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 Includes adjustments to the previous year’s maintenance factor for growth in per capita personal income and K-12 attendance as required by the State Constitution. Estimates of the Guarantee Become Less Certain Over Time. Our forecast reflects the Program Costs revenue estimates we consider most likely, but many other revenue scenarios are possible. Moderate COLA Projected for 2026-27. Revenues can also fluctuate notably from year to We estimate the statutory COLA for 2026-27 will year, even if they track our forecast over a longer be 2.51 percent, but our estimate carries more period. Figure 8 shows how much the minimum uncertainty than usual. Our November forecast guarantee could differ from our projections based typically incorporates published data for six of the on variations in General Fund revenue. For this eight quarters affecting the calculation (and our analysis, we examined the historical relationship projections for the remaining quarters). This year, between previous revenue estimates and actual tax the sixth quarter was unavailable due to the lapse collections, then calculated the guarantee under in appropriations for the federal agency providing the different revenue scenarios. The uncertainty the data (the U.S. Bureau of Economic Analysis). in our estimates increases significantly over time. As of this writing, the agency has reopened but For example, the likely range for the guarantee in not yet determined when the data will be available. 2029-30 is nearly twice the range in 2026-27. Assuming the COLA rate remains at 2.51 percent, the associated cost would be $2.5 billion. 8 LEGISLATIVE ANALYST’S OFFICE analysis full 2026-27 BUDGET This decline is likely to be the main Figure 8 factor affecting school attendance over the next several years, Estimates of the Guarantee and we estimate corresponding Become Less Certain Over Time attendance decreases of about (In Billions) 1 percent per year (Figure 9 on the next page). We expect the decline $160 The shaded region shows how much the minimum to yield only minor cost savings in guarantee could differ from our main forecast due 150 to changes in General Fund revenue. Outcomes 2026-27 because the state funds beyond the shaded area are possible, but the 140 guarantee most likely will fall in the shaded area. LCFF based on each district’s attendance in the current year, the 130 previous year, or the average of the 120 LAO Main Forecast three previous years (whichever is 110 highest). As the decline continues, 100 these savings will grow. 90 Community 2023-24 2024-25 2025-26 2026-27 2027-28 2028-29 2029-30 College Enrollment Projected to Continue Increasing. For 2025-26, our projections are based on the Somewhat Higher COLA Rates Projected enrollment assumptions from After 2026-27. Under our forecast, the COLA the adopted budget. For 2026-27, we estimate a rate would increase after 2026-27. Specifically, 2.9 percent increase in funded full-time equivalent our estimate of the statutory rate is 3.7 percent in students, reflecting the net effect of enrollment 2027-28, 4 percent in 2027-28, and 4.2 percent growth and other enrollment adjustments. in 2029-30. These estimates are above the Community college enrollment has increased historical average of about 3 percent per year. in recent years, likely due to several factors The cost of covering the COLA in these years including regional demographic growth, rising would be $3.9 billion, $4.3 billion, and $4.7 billion, unemployment, and the expansion of high school respectively. These projections should be dual enrollment. We expect enrollment will continue interpreted with caution, as the final rates often to increase at a similar rate in 2026-27, then grow differ significantly from the initial estimates. more slowly afterward. Although our outlook treats School Attendance Projected to Increase the cost of enrollment changes as a baseline in 2025-26, Then Decline. We estimate that adjustment, the Legislature has discretion over how school attendance will increase by 0.9 percent in much growth to fund each year. 2025-26. Two main factors explain the increase. June Budget Covered Ongoing Program First, districts can begin implementing attendance Costs With One-Time Funds. The 2025-26 recovery programs—a recent measure that allows adopted budget used $1.7 billion in one-time funds districts more flexibility to offset student absences to pay for ongoing school and community college by providing instruction outside the regular school programs. Most of these one-time funds came from day. We expect these programs to increase (1) increases in the Proposition 98 guarantee in attendance on an ongoing basis. Second, universal previous years and (2) savings related to deferring transitional kindergarten will be fully implemented payments. Entering 2026-27, these one-time funds in 2025-26. (The state began expanding this will expire, leaving a $1.7 billion gap between the program four years ago.) On the other hand, the cost of ongoing programs and the funding set aside state’s school-age population is declining due to a to pay for them. The state will have to allocate some decrease in births that began nearly two decades of the increase in the Proposition 98 guarantee to ago and accelerated between 2017 and 2020. cover this shortfall in the upcoming budget. www.lao.ca.gov 9 analysis full 2026-27 BUDGET Figure 9 School Attendance Projected to Decline Over the Outlook Period Average Daily Attendance (In Millions) 6.0 Projections 5.6 5.2 4.8 4.4 No Data 4.0 2017-18 18-19 19-20 20-21 21-22 22-23 23-24 24-25 25-26 26-27 27-28 28-29 29-30 Baseline Attendance Transitional Kindergarten Expansion Attendence Recovery Programs Proposition 98 Reserve Deposits and Withdrawals After 2026-27 Are Sensitive to Revenue Estimates. For 2027-28, Reserve Withdrawal Required in 2026-27. no deposit would be required under our forecast The Proposition 98 Reserve generally requires because the guarantee is growing more slowly than withdrawals when the guarantee is less than the inflation. As growth in the guarantee accelerates, previous year’s guarantee, adjusted for inflation. the state would be required to make deposits in For 2026-27, we estimate the guarantee is 2028-29 and 2029-30 totaling $5.2 billion. These $5.5 billion below this threshold. This relatively deposits are sensitive to changes in revenue. large gap has several implications. First, the state For example, if revenues grow 1 percent faster than is required to withdraw the entire balance from our forecast assumes in 2027-28, the state would the reserve in 2026-27 ($1.1 billion). Second, the start making deposits that year. state would be unlikely to retain any funding in the reserve even if it makes larger deposits in 2024-25 or 2025-26. Under our forecast, additional required deposits in those years would have to be withdrawn in 2026-27. Finally, the withdrawal is not especially sensitive to changes in revenue. Specifically, General Fund revenues would have to exceed our estimate by roughly $14 billion in 2026-27 before the formulas would cancel the withdrawal. (This threshold holds all other inputs constant.) 10 LEGISLATIVE ANALYST’S OFFICE analysis full 2026-27 BUDGET KEY CONSIDERATIONS Funding Estimates for between the Proposition 98 guarantee and the costs of existing programs (adjusted for the 2026-27 and Beyond statutory COLA and enrollment-related changes). State Would Have Just Enough Funding to The positive bars indicate the guarantee could Cover COLA. Figure 10 shows our estimate of cover existing programs with funds left over for new the funding available for new commitments in commitments—similar to a surplus. This surplus 2026-27. It begins with the spending level the state remains small over the next few years, but increases approved in the 2025-26 budget, then adjusts in the final year when the guarantee grows more for the expiration of one-time savings and the rapidly. This pattern shows how the available cost of covering COLA. These adjustments alone funding depends on state revenues. If revenues would increase spending above the guarantee, grow more slowly than our forecast assumes for the but the state could cover these costs through the next few years, however, the guarantee likely could required reserve withdrawal. After accounting for not even support existing programs. all adjustments, $220 million in Proposition 98 funding would remain available. The state could Planning for the Upcoming Budget use this funding for any school or community Several Considerations for One-Time Funds. college purposes. The $7.4 billion in one-time funds is large by Funding for New Commitments Remains historical standards. Specifically, it exceeds the Limited Until Revenue Accelerates. Figure 11 one-time funding we have projected in all previous next page illustrates how the funding available outlooks, except for November 2020 ($13.7 billion) for new commitments could change over the and November 2021 ($10.2 billion). This funding outlook period. Specifically, it shows the difference offers the Legislature a significant opportunity to Figure 10 Ongoing Increase Is Just Enough to Cover COLA in 2026-27 Changes From 2025-26 Enacted Budget (In Billions) Statutory 2026-27 COLA Reserve Minimum (2.51 Percent) Withdrawal Guarantee Uncommitted $117.8 $2.5 -$1.1 Funds Billion $0.2 Backfill One-Time Actions 2025-26 Enacted Budget $1.7 $114.6 Billion Growth in Guarantee ($3.2 Billion) Note: statutory COLA amount includes a $38 million net decrease for baseline adjustments, mainly related to school attendance and community college enrollment. COLA = cost-of-living adjustment. www.lao.ca.gov 11 analysis full 2026-27 BUDGET in 2022-23 and 2023-24, it used Figure 11 several tools to sustain ongoing Limited Funding for New Commitments school and community college programs. Most notably, it Over Most of the Forecast Period withdrew $9.5 billion from the (In Billions) Proposition 98 Reserve. The state also had a $3.5 billion “cushion” $6 because it did not spend all of the previous increases in the guarantee 5 on ongoing programs. In contrast, our forecast suggests the state will 4 Amount by which end 2026-27 with no funding in the the guarantee 3 reserve and no ongoing cushion. exceeds the cost of existing programs It also enters the upcoming year 2 having already deferred $2.3 billion in school and community college 1 payments. These aspects of the budget—and the state’s dependence on the stock market— 2026-27 2027-28 2028-29 2029-30 make the upcoming year especially precarious. A decline in the value advance its priorities. During budget deliberations, of the tech companies leading the the Legislature will likely want to consider (1) how stock market could rapidly reduce state revenues much to allocate for budget resiliency versus new and the Proposition 98 guarantee. In the rest of this one-time programs, (2) whether additional one-time section, we provide some options to build budget funding could complement any existing initiatives or resiliency and help protect ongoing school and programs, and (3) how these funds could improve community college programs. student outcomes or local budgets beyond the Consider Eliminating Payment Deferrals upcoming year. ($2.3 Billion). School districts and community State Is Not Well Positioned for New Ongoing colleges ordinarily receive their funding in 12 Commitments. Whereas our forecast projects monthly installments. The June budget deferred substantial one-time funding, it also suggests the last payment to schools and the last two the state has little capacity to sustain additional payments to community colleges to obtain one-time ongoing commitments. Most notably, it indicates savings. As a starting point for building resilience, that the guarantee in 2026-27 would be unable the Legislature could use $2.3 billion in one-time to cover the COLA without a reserve withdrawal. funding to eliminate these deferrals and restore the A decline in revenues or a higher COLA rate could regular payment schedule. This approach would make the COLA unaffordable. Our forecast shows remove pressure on future Proposition 98 budgets, the guarantee increasing slightly faster than the giving the Legislature more options during the next inflation-adjusted cost of existing programs in economic downturn. 2027-28, but the margin is small. If the state were Consider Providing Districts an Advance to commit to significant new ongoing spending, it Payment ($1.9 Billion). After eliminating the could find the increase hard to sustain over the next deferrals, the Legislature could further improve few years. budget resiliency with a new fiscal tool: giving Options for Building Budget Resiliency districts a 13th payment at the end of 2026-27 that would count toward their LCFF and SCFF Compared With Previous Years, the State allocations in 2027-28. Moving forward, districts Has Fewer Tools to Address Funding Declines. would receive this same amount a month earlier When the state faced significant revenue drops 12 LEGISLATIVE ANALYST’S OFFICE analysis full 2026-27 BUDGET than usual each year. During the next economic The state, however, typically budgets by allocating downturn, the state could obtain savings by about 89 percent of the guarantee to schools reverting to the regular payment schedule. The and about 11 percent to community colleges. advance payment would function like the opposite These percentages are colloquially known as the of a traditional payment deferral. Whereas a deferral split. The state has an uncodified list of programs provides up-front state savings but creates future that it excludes from this calculation. (The state costs and weakens district cash flow, the advance subtracts the cost of these programs from the payment is an up-front state cost that allows future guarantee before applying the percentages to the savings and improves district cash flow. The fiscal remaining amount.) If the state allocates funding in benefit for school and community college programs 2026-27 using the split and the same exclusions would be similar to having a larger balance in the as the June 2025 budget, the fiscal outcomes Proposition 98 Reserve—without the risk of facing for schools and community colleges would differ premature reserve withdrawals or activating the significantly. Specifically, the state would need local reserve cap. The Legislature could consider to spend $721 million more on school programs any amount for this purpose, but one option is to and $501 million less on community college use the $1.9 billion settle-up payment the state programs compared with the amounts required owes from the June 2025 budget. This approach to maintain existing programs and cover the is consistent with legislative intent for this payment COLA. (These amounts add up to the $220 million because it would reduce the likelihood of future in available funding we identified earlier.) As a deferrals. (The advance payment would require point of comparison for the community colleges, districts to update their cash flow projections, but it $501 million exceeds our projected cost for COLA would not affect the Proposition 98 guarantee.) and all enrollment-related increases in the SCFF Consider Early Restoration of Learning in 2026-27. Recovery Emergency Block Grant ($757 Million). Differences in Split Calculation Related The state created this grant in the 2022-23 budget to Three Factors. The most significant factor to mitigate the learning loss and social disruption explaining the gap between schools and students experienced during the pandemic. The community colleges is enrollment. We estimate initial allocation was $7.9 billion, but the state later that enrollment-related adjustments will increase reduced the grant by $1.1 billion to address a drop community college costs by more than $200 million in the guarantee. The June 2025 budget provided in 2026-27, reducing the funding available for $379 million as the first installment in a three-year other activities. School attendance, by contrast, is plan to restore the original amount. Continuing expected to decline in 2026-27. Another significant with this plan would require another $379 million factor involves a recent change to the split in the upcoming budget, but the Legislature could methodology related to transitional kindergarten. instead provide $757 million to restore the full For 2026-27, the new method provides about amount a year early. This approach would reduce $200 million less for community colleges than the costs in 2027-28, when the state will likely have previous method. The third factor concerns the less one-time funding available. It could also program cost estimates in the adopted budget. accelerate the learning recovery efforts supported Our estimate of SCFF costs for 2025-26 is tracking by the grant. about $90 million higher than the June estimate, and this higher spending level continues into The School and 2026-27. School district costs, by contrast, are Community College Split tracking slightly below the June estimates. Without Sharp Differences Between Schools and these three factors, the split calculation would Community Colleges Based on the “Split.” have produced similar outcomes for schools Throughout this report, we have estimated the and community colleges in 2026-27 (meaning funding available each year by comparing the each segment would have received a roughly Proposition 98 guarantee to the total cost of proportional share of the available funding). all school and community college programs. www.lao.ca.gov 13 analysis full 2026-27 BUDGET Legislature Can Build a Budget Aligned which spending proposals to fund, and determines With Its Priorities. The California Constitution the portion of the guarantee to allocate to activities gives the Legislature broad discretion over the that build budget resiliency. Regarding the split, allocation of Proposition 98 funding. Most notably, the Legislature could use the previous year’s the Legislature decides how to distribute funding methodology, further modify it, or adopt another between schools and community colleges, chooses allocation mechanism altogether. 14 LEGISLATIVE ANALYST’S OFFICE analysis full 2026-27 BUDGET www.lao.ca.gov 15 analysis full 2026-27 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. 16 LEGISLATIVE ANALYST’S OFFICE