The 2026-27 Budget: Proposition 98 Guarantee and K-12 Spending Plan

analysis full 2026-27 BUDGET The 2026-27 Budget: Proposition 98 Guarantee and K-12 Spending Plan GABRIEL PETEK | LEGISLATIVE ANALYST | FEBRUARY 2026 SUMMARY School Funding Requirement Grows, but Underlying Revenue Estimates Are Risky. The state calculates an annual “minimum guarantee” for school and community college funding based upon the formulas established by Proposition 98 (1988). Compared with the June 2025 enacted budget, the Governor’s budget estimates the guarantee is up $3.9 billion (3.2 percent) in 2024-25, $6.9 billion (6 percent) in 2025-26, and $10.9 billion (9.5 percent) in 2026-27. These estimates depend on revenue projections that do not account for the current elevated stock market risks. A major downturn could reduce revenues by tens of billions of dollars—reducing the guarantee by about 40 cents for each $1 of lower revenue. Recommend an Alternative to the Governor’s Proposed Funding Delay. The Governor proposes delaying a $5.6 billion payment associated with the higher estimate of the 2025-26 guarantee. This delay shifts costs to the future when the state must “settle up” and meet this obligation. We recommend an alternative that would set aside funding to cover the full cost of the guarantee while holding some or all of the additional funding in the Proposition 98 Reserve. This alternative would address the Governor’s concern about inadvertently exceeding the guarantee and avoid worsening future budget deficits. It would also require additional solutions for the non-Proposition 98 side of the budget this year. Governor’s School Spending Plan Has Some Prudent Features. After accounting for higher guarantee estimates, delayed payment, and other adjustments, nearly $9.7 billion is available for new school spending. The Governor’s budget allocates $3.7 billion for ongoing programs and $5.9 billion for one-time activities. It uses $4 billion in ongoing funds to pay for the one-time activities. This approach is prudent because it creates a cushion to protect ongoing programs if the guarantee declines in the future. Separate from the new spending proposals, the Governor’s budget adds $4.1 billion to the Proposition 98 Reserve. Most of this amount is required by constitutional formulas, but a small portion reflects a discretionary deposit. Recommend Adopting Several of the Larger Proposals. The largest ongoing proposal provides $2.3 billion for a 2.41 percent cost-of-living adjustment (COLA). We recommend funding the final statutory COLA rate unless revenue estimates drop significantly by May. The budget also provides $1 billion in ongoing funds for community schools, a proposal we plan to analyze in a forthcoming report. Regarding one-time proposals, the Governor proposes $2.8 billion for a discretionary block grant, $1.9 billion to eliminate previous payment deferrals, and $757 million to restore the Learning Recovery Emergency Block Grant. These proposals would help sustain local programs and fund previous commitments, and we recommend adopting them. Legislature’s Core Budget Decisions Revolve Around Risk and Resiliency. As the Legislature reviews the Governor’s budget and makes adjustments, we recommend that it plan for scenarios where the guarantee decreases. In practical terms, this approach means being cautious about new spending commitments, building reserves and other tools to protect existing school programs, and identifying proposals that it would be willing to delay, reduce, or reject if the guarantee were to drop. The Legislature cannot predict the timing or magnitude of the next downturn, but it can use the upcoming hearings to identify actions that would stabilize the budget, shore up programs that benefit students, and preserve its core priorities. (For brevity, this report refers to school districts, charter schools, and county offices of education collectively as “districts.” The appendix contains a summary of our recommendations.) www.lao.ca.gov 1 analysis full INTRODUCTION This brief examines the Governor’s school sections address issues affecting schools and spending plan. The first section analyzes the community colleges, the third section focuses funding requirement established by Proposition 98 solely on proposals affecting schools. We analyze and explains how changes in revenue estimates community college spending proposals in our could affect this requirement. The second section forthcoming publication The 2026-27 Budget: analyzes the Governor’s proposal to delay a California Community Colleges. On the “EdBudget” payment associated with the higher estimate section of our website, we post numerous tables of this requirement. The third section analyzes with additional budget information. We also plan to the Governor’s plan for allocating the available release additional briefs in the coming weeks that funds, focusing on its overall structure and will examine many of the proposals in detail. major proposals. Whereas the first and second MINIMUM GUARANTEE Proposition 98 established a minimum funding house of the Legislature, the state can suspend requirement for schools and community colleges the guarantee and provide less funding than the known as the minimum guarantee. In this section, formulas require in a given year. The state funds the we (1) provide background on the guarantee, guarantee through a combination of state General (2) describe the administration’s estimates of the Fund and local property tax revenue. guarantee, and (3) explain how the guarantee could Maintenance Factor Accelerates Growth in change in the coming months as the state revises the Guarantee. Besides the three main tests, the its revenue estimates. Constitution requires the state to track an obligation Background Proposition 98 Guarantee Figure 1 Depends on Various Inputs Three Proposition 98 Tests and Formulas. The California Constitution sets forth three main “tests” (formulas) for calculating Test 1 Test 2 Test 3 the Proposition 98 guarantee. Share of General Change in Per Change in General Fund Revenue Capita Personal Fund Revenue Each test takes into account Income (PCPI) certain inputs, including General Fund revenue, per capita personal PCPI Ge F n u e n r d al income, and student attendance About ADA ADA (Figure 1). Whereas Test 1 links 40% school funding to a minimum Prior-Year Prior-Year share of General Fund revenue, Funding Funding Test 2 and Test 3 build upon the funding provided in the previous year. The Constitution contains Guarantee based on share Guarantee based on prior- Guarantee based on prior- of state General Fund year funding level adjusted year funding level adjusted rules for comparing the tests, revenue going to K-14 for year-over-year changes for year-over-year changes with one becoming operative and education in 1986-87. in K-12 attendance and in K-12 attendance and California PCPI. state General Fund revenue. determining the guarantee for that year. With a two-thirds vote of each ADA = average daily attendance. 2 LEGISLATIVE ANALYST’S OFFICE analysis full 2026-27 BUDGET known as maintenance factor. The state creates quickly relative to inflation. It requires withdrawals this obligation when Test 3 is operative or the when the guarantee grows more slowly than Legislature suspends the guarantee. The obligation inflation. The state can use these withdrawals for equals the difference between the actual funding any school or community college purpose. The provided and the higher Test 1 or Test 2 level. state updates its estimates of any required deposits Moving forward, the state adjusts the obligation or withdrawals whenever it recalculates the for changes in student attendance and per capita guarantee. Additionally, a state law caps the local personal income. The Constitution requires the reserves held by medium and large school districts state to make maintenance factor payments when when the Proposition 98 Reserve balance exceeds General Fund revenue grows faster than per capita 3 percent of the funding allocated to schools in the personal income. previous year. The Guarantee Is a Moving Target. The Governor’s Budget state estimates the guarantee when it enacts the budget, but this calculation typically changes as Estimates of the Guarantee Revised Up the state updates its revenue estimates. The state in 2024-25 and 2025-26. Compared with the June 2025 budget estimates, the administration recalculates the guarantee at the end of each estimates the guarantee is up $3.9 billion year and again at the end of the following year. (3.2 percent) in 2024-25 and $6.9 billion (6 percent) This schedule means each budget includes new estimates for the previous, current, and upcoming in 2025-26 (Figure 2). Test 1 remains operative in both years, with the increase mainly reflecting years. The state finalizes its calculation of the higher General Fund revenue estimates. The prior-year guarantee through a statutory process administration also revises its local property tax called certification. This process involves publishing estimates upward by $319 million in 2024-25 and the underlying inputs and allowing the public to $126 million in 2025-26. These increases reflect review and comment on the calculations. The most recent data showing higher distributions from recently certified year is 2023-24. The state will redevelopment successor agencies and slightly begin certifying the 2024-25 guarantee in May and faster growth in assessed property values. When conclude this process in August. Test 1 is operative, changes in property tax revenue Proposition 98 Reserve Helps Stabilize have dollar-for-dollar effects on the guarantee. Funding. The Constitution establishes a reserve for school and community college funding—the State Pays Off Most of the Maintenance Public School System Stabilization Account Factor Obligation. The administration’s calculation of the 2024-25 guarantee includes a $7.8 billion (Proposition 98 Reserve). The Constitution requires maintenance factor payment, an increase of the state to deposit Proposition 98 funds into this $2.3 billion from the June 2025 estimate. After reserve when it receives significant tax revenue making this payment, the state’s remaining from capital gains and the guarantee is growing Figure 2 Guarantee Revised Up in Prior and Current Year (In Millions) 2024-25 2025-26 June January June January 2025 2026 Percent 2025 2026 Percent Estimate Estimate Change Change Estimate Estimate Change Change General Fund $87,628 $91,197 $3,568 4.1% $80,738 $87,473 $6,735 8.3% Local property taxes 32,317 32,636 319 1.0 33,821 33,947 126 0.4 Total Guarantee $119,946 $123,833 $3,887 3.2% $114,558 $121,420 $6,861 6.0% General Fund tax revenue $209,813 $213,420 $3,607 1.7% $204,027 $222,181 $18,154 8.9% www.lao.ca.gov 3 analysis full obligation would be $523 million. For 2025-26, the State Makes Notable Deposits Into the Constitution does not require any maintenance Proposition 98 Reserve. The June 2025 budget factor payments because General Fund revenues withdrew the entire balance from the Proposition 98 are growing relatively slowly year over year. Reserve. Under the Governor’s budget, the Downward Adjustment Related to Transitional state would make four adjustments that increase Kindergarten (TK) Estimates. In 2022-23, the the reserve balance to $4.1 billion (Figure 4). state began implementing a multiyear plan to The largest adjustment is a $3.8 billion mandatory make all four-year old children eligible for TK. deposit in 2024-25, driven by significantly higher The plan requires the state to adjust the guarantee capital gains revenue since June. Another notable upward for these additional students. The adjustment is the Governor’s proposal to make Governor’s budget revises the previous estimate a $240 million discretionary deposit in 2025-26. of this expansion downward by 5,900 students The reserve balance would exceed the threshold (5.8 percent) in 2024-25 and by that triggers the local district reserve cap 13,600 students (8.9 percent) in 2025-26. These new estimates Figure 3 reduce the guarantee by $80 million 2026-27 Guarantee Grows Significantly Relative to in 2024-25 and $190 million in Previous Budget Level 2025-26. On a cumulative basis, (In Millions) the Governor’s budget estimates that 139,100 additional students are 2025-26 2026-27 attending TK programs in 2025-26 June January Enacted Governor’s Percent (the final year of the plan). The Budget Budget Change Change Proposition 98 guarantee, in turn, is General Fund $80,738 $89,877 $9,139 11.3% $1.9 billion more than it would have Local property taxes 33,821 35,604 1,783 5.3 been without the plan. Total Guarantee $114,558 $125,480 $10,922 9.5% Estimates of the 2026-27 General Fund tax revenue $204,027 $228,467 $24,440 12.0% Guarantee Up Significantly From the Previous Budget Level. The Governor’s budget estimates Figure 4 the guarantee at $125.5 billion Proposition 98 Reserve Balance in 2026-27, an increase of Would Grow to $4.1 Billion $10.9 billion (9.5 percent) relative to the 2025-26 enacted budget level (In Millions) (Figure 3). Test 1 is operative, and the increase in the General Fund $240 -$407 $424 share of the guarantee is about $3,845 40 percent of the projected growth in General Fund tax revenue. Increases in local property tax $4.1 billion cumulative revenue also contribute to the balance higher guarantee. This property tax increase reflects projected growth in assessed property values (estimated at 5.4 percent) and Mandatory Mandatory Discretionary Mandatory several smaller adjustments. The 2024-25 2026-27 2025-26 Governor’s budget does not make Deposit any further adjustments related to Withdrawal TK, but the previous adjustments remain in place. 4 LEGISLATIVE ANALYST’S OFFICE analysis full 2026-27 BUDGET (approximately $3 billion). Although the cap Guarantee Is Moderately Sensitive to nominally limits a district’s discretionary reserves Revenue Changes in 2025-26 and 2026-27. to 10 percent of its budgeted expenditures, various General Fund revenue is typically the most exemptions and exclusions typically allow higher significant input affecting the guarantee. For any reserve levels. given year, the relationship between revenues and the guarantee depends on which Proposition 98 Assessment test is operative and whether another test could The Stock Market Poses a Notable Risk to become operative with different inputs. In 2025-26 General Fund Revenues. State tax collections and 2026-27, Test 1 is likely to remain operative have been strong over the past year, but these even if revenues or other inputs vary significantly gains primarily reflect investor enthusiasm for from the Governor’s budget estimates. Revenue Artificial Intelligence and robust stock market fluctuations in those years would change the growth. The S&P 500, for example, has risen guarantee by approximately 40 cents for each about 40 percent over the last two years. Several $1 change in General Fund revenue. In 2024-25, the signs, however, suggest that the stock market has maintenance factor payment makes the guarantee become overvalued. For example, the ratio of stock highly sensitive to revenue changes. The potential prices to corporate earnings (a measure of how fluctuations in 2024-25, however, are much smaller expensive stocks are) is near historically high levels than in the other years. (Figure 5). Investors are borrowing large sums to Prepare for the Possibility the Guarantee Is buy stocks, and households are more invested Billions of Dollars Lower. Given the significant in the stock market than at any time in at least risks to state revenue estimates, we recommend 70 years. Historically, these signs have preceded the Legislature begin preparing for scenarios where stock market downturns. The Governor’s budget the guarantee falls short of the Governor’s budget acknowledges these risks but assumes that state estimates. For example, our November General revenues will continue to grow. If the stock market Fund revenue estimates for 2026-27 were about declines significantly, revenues most likely would $20 billion lower than the administration’s estimates drop by tens of billions of dollars. for that year. A revenue decline of this magnitude would reduce the Figure 5 Proposition 98 guarantee by about $8 billion. In such a scenario, the Stock Prices Near Historic state could likely maintain existing Highs Relative to Corporate Earnings programs, but would have to reject Shiller Price-Earnings Ratio for S&P 500 (Inflation-Adjusted Ten-Year Average) many of the Governor’s proposals. Although revenue estimates will 50 change in the coming months, we recommend the Legislature 40 place more emphasis on downside risk than upside potential during 30 the upcoming budget hearings. 20 In practical terms, this approach means being cautious about new 10 commitments; building reserves and other buffers to protect 1975 1980 1985 1990 1995 2000 2005 2010 2015 2020 2025 existing school programs; and identifying proposals that the Legislature would be willing to delay, reduce, or reject. www.lao.ca.gov 5 analysis full Proposition 98 Reserve Is a Key Tool for 2026-27, making it a modest but important step Protecting Programs. The state has multiple toward budget resiliency. Later in this report, we tools that can make school and community college recommend an even larger discretionary deposit as programs more resilient against risk and volatility. an alternative to the Governor’s settle-up proposal. The Proposition 98 reserve is particularly powerful Local Property Tax Estimates Seem because it (1) can be accessed relatively quickly, Reasonable. The administration’s property (2) can support any school or community college tax estimates are only $93 million lower than activities, and (3) avoids disrupting district cash our November estimates over the 2024-25 flow (unlike payment deferrals). Whether through through 2026-27 period (a difference of less than mandatory or discretionary deposits, building this 0.1 percent). The state will receive updated property reserve helps protect programs from unexpected tax data in February and April, but significant revenue drops. The $4.1 billion reserve balance changes to these estimates seem unlikely. under the Governor’s budget is equivalent to 3.3 percent of the estimated guarantee in SETTLE UP In this section, we examine the Governor’s A year after the first revision, the state adopts a proposal to delay a $5.6 billion payment that would second revision as part of the next budget. If the be required under the administration’s estimate of second revision exceeds the first, the state makes the guarantee. The first section reviews how the another settle-up payment. Figure 6 summarizes state typically makes these payments. The second the usual schedule for these revisions and settle-up section explains the Governor’s proposal and its payments. From an accounting perspective, connection to the overall state budget. The third settle-up payments are always scored to the year in section provides our assessment, and the fourth which the guarantee increased, rather than to the section describes our recommended alternative. year the state disburses the payment to schools. …But the State Has Made Several Background Exceptions. In several instances, the state has State Required to Settle Up After the recognized an increase in the guarantee without Proposition 98 Guarantee Rises. The state providing additional funding. For example, in July makes an initial estimate of the guarantee when it 2009, the state identified a $212 million obligation adopts the budget. Over the following two years, related to meeting the 2006-07 guarantee. Trailer revenue estimates and other inputs change, legislation scheduled the payment for 2014-15 (later sometimes significantly. When these revisions changed to 2015-16). In October 2010, the state increase the guarantee, the state must provide recognized a $1.8 billion increase to its previous additional funding through settle-up payments. estimate of the 2009-10 guarantee. It made an The Legislature can allocate these payments for initial payment of $300 million but did not schedule any school or community college purposes. The any future payments. It paid the remaining amount Constitution does not specifically address the over the 2015-16 through 2018-19 period. Most timing of these payments. recently, the June 2025 budget recognized an State Usually Pays Settle Up as Soon as It increase in the 2024-25 guarantee but set school Recognizes a Higher Guarantee… The state does funding $1.9 billion below the revised estimate. not officially update its estimate of the guarantee Trailer legislation required the administration to until it adopts the following year’s budget. If that propose a plan to provide this funding as part of the budget shows a higher estimate, the state typically Governor’s January budget. includes the corresponding settle-up payment. 6 LEGISLATIVE ANALYST’S OFFICE analysis full 2026-27 BUDGET State Law Has a Contingency for Unpaid full-time-equivalent enrollment. The law requires the Settle-Up Obligations. A state law adopted State Controller to disburse this grant automatically in 2018-19 establishes an alternative payment according to a schedule determined by the Director mechanism if any settle-up obligation remains of the Department of Finance, potentially over after the state certifies the guarantee. (The state multiple years. This law has never been operative— begins the certification process after adopting its since 2018-19, the state has always paid settle up final estimate of the guarantee.) Specifically, the before completing certification. law converts the remaining obligation into a block State Law Prohibits Downward Spending grant. The state allocates 89 percent of this grant Adjustments After the Year Ends. Settle-up to schools based on average daily attendance payments occur after the guarantee increases, and 11 percent to community colleges based on but in other years, the guarantee falls short of projections. In these cases, the state usually reduces school Figure 6 spending to match the lower Typical Schedule for Updating guarantee. In 2019-20, however, Proposition 98 Estimates and Paying Settle Up the state adopted a new law prohibiting spending reductions after the fiscal year ends. This law Budget-Year Estimates (Before the Year Begins) allows the state to reduce spending during its first recalculation of - Legislature adopts June budget with initial estimates of the guarantee. - Budget appropriates funding to meet the estimated guarantee. the guarantee, but prevents reductions during the second recalculation at the end of the next fiscal year. If school spending Current-Year Revisions (as the Year Ends) exceeds the guarantee at that - Legislature adopts revised estimate of the guarantee in June. time, the higher amount becomes - Settle up paid if guarantee rises. - Spending reduced if guarantee drops. the base for future Proposition 98 Spending revised up or down calculations. Before this law, the state typically made prior-year Prior-Year Revisions (One Year After the Year Ends) spending reductions through state accounting adjustments, - Legislature adopts final estimate of the guarantee in June. - Settle up paid if guarantee rises. such as counting some of that - Certification process begins with public review and comment period. year’s spending toward the Upward spending adjustments only following year’s guarantee. These adjustments sometimes reduced Certification (Two Years After the Year Ends) the guarantee going forward, but they did not require districts to - State certifies final Proposition 98 calculations. - Legal challenge period (90 days). return prior payments. - Director of the Department of Finance provides a schedule for paying any settle-up obligation that the state did not previously address. Governor’s Budget No further spending adjustments Creates $5.6 Billion Settle-Up Obligation for 2025-26. The Governor’s budget estimates that the 2025-26 guarantee has Calculations and Appropriations Are Final increased to $121.5 billion but provides only $115.9 billion for schools and community colleges (slightly above the June 2025 www.lao.ca.gov 7 analysis full enacted budget level). This difference results in a Assessment $5.6 billion settle-up obligation. The administration Three Distinct Budget Challenges Are indicates that the purpose of the proposal is “to Relevant to the Governor’s Proposal. First, mitigate the risk of potentially appropriating more the budget faces short-term forecasting risk. resources to the Guarantee than are ultimately Specifically, the state could adopt a spending level available in the final calculation for 2025-26.” The that appears affordable based on current revenue budget does not specify when the state would estimates, but becomes unaffordable if revenue falls make this payment. If the Legislature adopts the short of expectations. Regarding Proposition 98, proposal, it would face three choices next year, the state might increase school spending based assuming the obligation is still owed: (1) appropriate on its higher estimate of the guarantee, only additional funding for schools and community for the guarantee to decline the following year. colleges in the 2027-28 budget; (2) take no action, This scenario poses a risk to the state budget, meaning the contingency law would apply and which likely cannot afford to spend beyond the the Director of the Department of Finance would guarantee. The second challenge concerns future determine the payment schedule; or (3) adopt an deficits. Chronic deficits like the ones projected alternative plan before certification concludes in by the administration and our office increase the August 2027. likelihood that the state will (1) be unable to sustain Uses the Savings to Help Balance This its current priorities, (2) lack funding to address new Year’s Budget. For the state budget, the settle-up priorities in the future, and/or (3) face a fiscal crisis proposal is similar to other forms of borrowing and if revenues decline significantly. The third challenge spending delays—it provides temporary savings in involves the risk to school and community college the current year but increases costs in the future. programs from future declines in the guarantee. The The Governor’s budget allocates these savings for state would likely have to reduce these programs the non-Proposition 98 side of the budget. Without if the guarantee declines significantly, which this proposal, the budget would require $5.6 billion could negatively affect the education students in other solutions this year. receive. The rest of this section analyzes how the Pays Previous Settle-Up Obligation. The Governor’s proposal affects these three challenges. Governor’s budget provides $1.9 billion to cover The State’s Short-Term Forecasting Risk Is the settle-up obligation from the June 2025 budget Considerable. The state’s reliance on tax revenue (related to 2024-25). Additionally, the Governor’s associated with the stock market poses an acute budget estimates that the 2024-25 guarantee is risk to its revenue forecast. Several signs suggest $3.9 billion above the June estimate and provides the stock market is overvalued, and a significant additional funding to meet the higher requirement. drop most likely would reduce state revenues Projects Large Budget Deficits Moving by tens of billions of dollars. The state, however, Forward. The Governor’s budget projects annual cannot predict the timing of such a decline. The deficits exceeding $20 billion over the next three potential forecasting errors are larger in 2026-27 years, including an operating deficit of more than than in 2025-26 because the 2026-27 estimates $26 billion in 2027-28. (These deficits reflect the must make assumptions further into the future, gap between the cost of currently authorized state and the state does not yet have any tax collection programs and forecasted revenues each year.) data for the year. The risks for 2025-26, however, These projections assume state revenues grow at are still significant. The state will not have complete a modest pace. If the stock market declines or an tax collection data for 2025-26 before adopting the economic downturn occurs, the deficits would be June budget. Moreover, complex accrual policies much larger. Moreover, these estimates exclude the could assign future revenue gains or losses to future cost of providing the $5.6 billion payment. 2025-26 after the year ends. Making that payment in next year’s budget, for Proposal Would Lessen Forecast-Related example, would increase the deficit to about Risk in 2025-26. Our office and the administration $32 billion (holding other factors constant). will release updated revenue forecasts in May that 8 LEGISLATIVE ANALYST’S OFFICE analysis full 2026-27 BUDGET incorporate additional months of tax collection least affordable. The uncertainty about when the data. The additional data will narrow some of the state will provide the $5.6 billion and how it will uncertainty around revenue estimates for 2025-26 cover the associated costs makes it a weak form of relative to the level in our November outlook and protection for ongoing school programs. the Governor’s budget. We analyzed previous Prohibition on Prior-Year Spending forecasts and found that, for current-year revenue Reductions Contributes to Actions Making estimates, the May forecast is typically within about School Funding More Unpredictable. The law 4 percent of the year’s final revenue collections. prohibiting spending reductions after the year (The range of uncertainty for the budget year is ends was meant to provide greater certainty in more than twice as large.) This analysis suggests calculating the guarantee and allocating school that the state could expect 2025-26 revenues to funding. Recent budgets, however, suggest it has be as much as $9 billion higher or lower than the had the opposite effect. Rather than establishing updated estimates it will have in May. If revenues a stable base for Proposition 98 calculations, fall short of projections by $9 billion, the guarantee it has led the state to adopt a range of actions would decrease by about $3.5 billion relative to to avoid exceeding the prior-year guarantee. the May estimate. Under the Governor’s proposal, Most notably, this law was part of the rationale by comparison, the guarantee could decrease as for the complicated funding maneuver the state much as $5.6 billion, and the state could respond adopted to address the unexpected drop in the by making a smaller settle-up payment. In other 2022-23 guarantee. It also prompted a complex words, the Governor’s proposal likely provides a law that excludes certain school spending from larger buffer than necessary if the state’s goal is Proposition 98 calculations when the state to avoid inadvertently exceeding the guarantee overestimates the guarantee due to tax-filing in 2025-26. extensions. The June 2025 budget alluded to this Proposal Worsens the Challenge Posed by law in its explanation for the $1.9 billion settle-up Future Budget Deficits. Whereas the proposal delay in 2024-25, and the Governor’s budget makes reduces short-term forecasting risk, it will likely a similar reference to explain the proposed delay worsen future budget deficits. If the revenue in 2025-26. For schools, these actions create new estimates meet the Governor’s projections, the uncertainty about when and how the state will state will owe schools $5.6 billion in payments allocate Proposition 98 funding. for which no funding is currently set aside. The Recommendations proposal effectively shifts that cost from this year to future budgets—helping address the current budget Alternative Approach Makes Difficult problem on a one-time basis, but adding to the Decisions Now but Reduces Future Budget large budget deficits the state is projecting over the Challenges. We recommend an alternative to next several years. the Governor’s proposal that would continue to mitigate short-term forecasting risk while also Proposal Has Limited Value in Protecting reducing future state costs and better protecting Ongoing School Programs. The Governor’s school and community college programs from proposal could provide some one-time protection future downturns. This approach entails additional for ongoing school programs in a future downturn. solutions affecting the non-Proposition 98 side For example, if the guarantee declines while the of the budget this year. Some details of this state is paying the settle-up obligation, the state alternative will depend on the state’s updated could use the payments to help cover Local Control revenue estimates in May. The Legislature could Funding Formula (LCFF) costs on a temporary adopt the alternative under a range of potential basis. The Governor’s proposal, however, does revenue scenarios, but for illustrative purposes, not specify when it will make these payments. we describe its effects using the Governor’s budget More importantly, the payments would be most as the baseline. beneficial when the state experiences a significant revenue decline—exactly when they would be www.lao.ca.gov 9 analysis full 2026-27 BUDGET Fully Fund the Estimate of the Guarantee. consistent with an approach we outlined in our We recommend the Legislature allocate enough November 2025 report, The 2026-27 Budget: funding to cover the full cost of the guarantee Fiscal Outlook for Schools and Community based on the revenue estimates it adopts. Relative Colleges. This approach would help protect to the Governor’s budget, the state would need district cash flow by reducing the state’s reliance to set aside an additional $5.6 billion. Adopting on deferrals to manage future downturns. A third this approach would recognize the full cost of the option is to provide additional funding for district state’s school funding obligations this year and pension costs. The state could structure this avoid creating new settle-up obligations payment to reduce pension costs over time or Deposit Some of the Additional Funding to provide short-term relief if costs rise above Into the Proposition 98 Reserve. Whereas we a specified threshold. This approach would recommend setting aside additional funding to build resiliency by reducing future pressure on meet the guarantee, we do not recommend a district budgets. corresponding increase in school and community Adopt Solutions That Address the State’s college spending this year. Instead, we recommend Underlying Budget Problem. Setting aside (1) making a larger deposit into the Proposition 98 enough funding to cover the guarantee means Reserve, and (2) adopting trailer legislation that adopting a commensurate level of budget solutions automatically reduces the deposit if the 2025-26 for the non-Proposition 98 side of the budget this guarantee declines relative to May estimates. year. (Using the Governor’s budget as a baseline, The savings from any reductions in the deposit the state would need $5.6 billion in additional would help the state balance the budget. Like solutions.) As we explained in The 2026-27 the Governor’s proposal, this approach would Budget: Overview of the Governor’s Budget, allow the state to avoid inadvertently exceeding we recommend the Legislature adopt a plan to the guarantee if revenues fall short of projections, shrink multiyear deficits that includes spending thereby mitigating the state’s short-term forecasting reductions, revenue increases, or a combination risk. We recommend that the Legislature make of both. (General Fund tax increases would a total deposit of at least $3.5 billion in 2025-26. increase the state’s constitutional requirements This deposit would provide a buffer to address the further, eroding some of the benefit to the budget’s likely range of reductions to the 2025-26 guarantee bottom line.) These additional solutions would relative to the state’s May estimate. The Governor’s entail difficult decisions amidst an already tight budget already contains $664 million in budget. Nevertheless, taking this proactive Proposition 98 Reserve deposits for 2025-26, so approach would avoid an even more difficult budget implementing this recommendation would involve situation next year and begin to address the state’s an additional deposit of nearly $2.9 billion. structural deficit. Use Remaining Funds to Build Additional Consider Repealing Prohibition on Prior-Year Resiliency for School Programs. If the state Spending Reductions. Repealing the law on makes an additional $2.9 billion deposit in 2025-26, prior-year spending reductions would mitigate it would have $2.7 billion remaining for other some of the risk motivating the Governor’s one-time school and community college priorities settle-up proposal. It would also reduce pressure (relative to the Governor’s budget). We recommend to use funding maneuvers, spending exclusions, using this funding to build additional resiliency for settle-up delays, or similar actions that complicate school programs. One option is to deposit all the state budgeting and make school funding less remaining funds into the Proposition 98 Reserve, predictable. If the Legislature wanted to implement bringing the total balance to $9.7 billion. At this the recommendation in a way that protected level, the reserve likely would be large enough to local district budgets, it could replace the law protect school and community college programs with a less strict alternative. Specifically, it could from the initial effects of a significant downturn. allow reductions through state-level accounting Another option is to provide advance payments to adjustments while still prohibiting reductions that districts toward their 2027-28 funding allotments, require districts to return previous funding. 10 LEGISLATIVE ANALYST’S OFFICE analysis full 2026-27 BUDGET SCHOOL SPENDING PLAN In this section, we examine the Governor’s Adjusting for inflation, the 2026-27 funding level plan for allocating Proposition 98 funds to schools. is about $300 per student below the previous First, we describe the Governor’s overall approach peak (2024-25). and explain the most notable spending proposals. Major Ongoing Proposals Next, we assess the merits of this approach. Finally, we provide our recommendations for $2.1 Billion for Statutory COLA. The state the Legislature. calculates the COLA rate using a federal price index that tracks goods and services purchased by GOVERNOR’S BUDGET state and local governments during the preceding year. For 2026-27, the administration estimates Overall Structure the statutory rate is 2.41 percent. The Governor’s Contains Nearly $9.7 Billion in New School budget provides $2.1 billion to cover the associated Spending Proposals. Of the new spending, the cost—$1.9 billion for LCFF and $230 million for Governor proposes to allocate several other programs. more than $5.9 billion for one-time activities and $3.7 billion for ongoing Figure 7 augmentations (Figure 7). From an Governor’s Budget Has $9.7 Billion in School accounting perspective, nearly Spending Proposals all of this spending ($8.1 billion) is (In Millions) attributable to the increase in the 2026-27 guarantee. Most of the Ongoing remaining $1.6 billion relates to Local Control Funding Formula COLA (2.41 percent) $1,893 2024-25, reflecting the increase Community schools 1,000 Special Education 509 in the guarantee and the settle-up COLA for select categorical programs (2.41 percent)a 230 payment being made that year. Expanded Learning Opportunities Program 62 Separately from these proposals, Necessary Small Schools 31 the Governor’s budget also COE funding to support districts and charter schools 13 Charter School Facility Grant Program 7 provides $1.2 billion in ongoing FCMAT salary adjustment 1 Proposition 98 funds to offset the California School Information Services 1 expiration of various one-time funds Science performance tasks 1b that paid for school programs in K-12 High Speed Network 1 Subtotal ($3,749) the 2025-26 budget. (The figure One Time excludes this backfill because it is Discretionary block grant $2,796 a required adjustment rather than a Deferral paydown 1,875 new proposal.) Learning Recovery Emergency Block Grant 757 Teacher Residency Grant Program 250 Funding Per Student Near Dual enrollment 100 Previous Inflation-Adjusted Peak. Kitchen infrastructure and training 100 Under the Governor’s budget, total Reading difficulties screening 40 Proposition 98 funding for schools Wildfire-related support for schools 23 Subtotal ($5,941) would be $20,512 per student in Total Proposals $9,690 2026-27, an increase of $1,887 a Applies to Special Education, State Preschool, Child Nutrition, Equity Multiplier, K-12 Mandates (10.1 percent) over the 2025-26 Block Grant, Charter School Facility Grant Program, Foster Youth Services Coordinating Program, budget level. This funding level Adults in Correctional Facilities, American Indian Education Centers, Child and Adult Care Food Program, and American Indian Early Childhood Education. is an all-time high in unadjusted b Reflects $890,000 ongoing, beginning in 2025-26. dollars (Figure 8 on the next page). COLA = cost-of-living adjustment; COE = county office of education; and FCMAT = Fiscal Crisis Management Assistance Team. www.lao.ca.gov 11 analysis full Major One-Time Proposals Figure 8 $2.8 Billion for Discretionary Block Grant. The Governor Proposition 98 Funding Per Student Is Volatile but Growing proposes $2.8 billion for the Through 2026-27 Under Governor's Budget Student Support and Professional Development Discretionary $22,000 Block Grant. This funding would 20,000 18,000 supplement the $1.8 billion provided 16,000 for a similar grant in the June 2025 14,000 Inflation Adjusted budget. Districts would receive 12,000 10,000 funding based on their average daily Actual 8,000 attendance in 2025-26—$512 per 6,000 student under current attendance 4,000 estimates. The grant would not have 2,000 specific spending requirements, 2007-08 09-10 11-12 13-14 15-16 17-18 19-20 21-22 23-24 25-26 but trailer legislation suggests several potential uses, including teacher professional development, $1 Billion for Community Schools Grants. teacher recruitment and retention, The Governor’s budget includes $1 billion in career pathways, dual enrollment programs, and ongoing funding for schools to implement the “addressing rising costs.” Districts could spend their community schools model. The administration funds at any time before June 30, 2030. indicates that this funding is intended to provide $1.9 Billion to Eliminate Payment Deferral. The ongoing support to the roughly 2,500 schools that June 2025 budget deferred $1.9 billion from 2025-26 have received one-time funding to implement the to 2026-27 by moving a portion of the payment model and to expand the model to additional school schools would typically receive in June 2026 sites. The accompanying trailer legislation also to July 2026. The Governor’s budget provides indicates that moving forward, the state will provide $1.9 billion to eliminate the deferral and restore the the statutory COLA for this program. regular payment schedule beginning in 2026-27. $509 Million for Special Education. Most $757 Million for the Learning Recovery state special education funding is provided through Emergency Block Grant (LREBG). The state a base rate formula that is allocated to Special provided $7.9 billion for the LREBG in the 2022-23 Education Local Plan Areas (SELPAs)—typically budget to mitigate the learning loss and social regional consortia of local education agencies that disruption students experienced during the coordinate special education funding and services. pandemic. The subsequent budget reduced the The formula distributes funding based on total grant by $1.1 billion to address a revenue shortfall. student attendance rather than direct measures It also established a plan to restore the grant in three of special education costs. The Governor’s equal installments across 2025-26, 2026-27, and budget provides $509 million to increase the 2027-28. The June 2025 budget provided the first special education base rate to $999 per student. installment of $379 million. The Governor’s budget For most SELPAs, this would be a 6.3 percent proposes $757 million—two more installments—to increase beyond the statutory COLA. With this restore the grant a year earlier than planned. Like the augmentation, all SELPAs would receive the same original grant, districts would receive funding based rate, equalizing per-pupil funding across the state. mainly on their counts of English learners and low-income students. The proposal also maintains the deadline requiring districts to spend their funds by June 30, 2028. 12 LEGISLATIVE ANALYST’S OFFICE analysis full 2026-27 BUDGET ASSESSMENT individual circumstances and local priorities. It also helps districts manage cost increases and Overall Structure develop cohesive local programs. The budget Spending Plan Builds Upon Estimates of the dedicates the remaining one-third for proposals Guarantee That Seem Risky. The Governor’s that require districts to undertake specific activities spending proposals are predicated on estimates (primarily the community schools grant and LREBG of state revenues and the guarantee that are augmentation). This targeted spending helps ensure substantially higher than the June 2025 budget districts use their funding for activities the state level. The state faces a significant risk that some considers its highest priorities. This approach— of these increases will not be sustained, eroding proposals in both areas but with greater emphasis its capacity for new school spending. As we on flexible funding—seems reasonable. It could explain in The 2026-27 Budget: Overview of the allow districts to address their cost pressures and a Governor’s Budget, the state could reduce its risks few core state priorities without being overwhelmed by adopting revenue estimates that account for a by additional spending requirements. potential stock market drop. The State would have Nearly All of the Targeted Proposals Build to pare back some of the Governor’s proposals on Existing Programs. The Governor’s budget under this approach, but it would reduce the risk does not introduce any significant new programs. that revenues fall far short of budget estimates. Instead, nearly all the proposals extend or expand A spending plan that uses the Governor’s revenue existing programs. This budgeting approach estimates can still mitigate risk in other ways, but it encourages districts to prioritize existing activities. requires careful budgeting—not making too many For the upcoming hearings, the Legislature could new commitments, building up reserves, and not focus its review of these proposals on a few core committing all of the new funding next year to issues: (1) whether the underlying problem remains ongoing program increases. unaddressed, (2) whether the existing program is Contains a Notable One-Time Cushion. meeting its objectives, and (3) whether additional The Governor’s budget allocates $4 billion in funding would allow districts to address the ongoing 2026-27 funds for one-time spending. problem more effectively. The underlying funding will be freed up in 2027-28 Major Ongoing Proposals when this one-time spending ends. This budgeting approach creates a cushion that protects ongoing Funding a COLA Helps Districts Maintain programs. For example, if the guarantee were to Programs. Districts face cost increases in many decrease by as much as $4 billion in 2027-28, parts of their budgets. Most districts spend the state could absorb the drop without reducing roughly 80 percent of their operating budgets on programs or deferring payments. This cushion is personnel costs, including salaries, health benefits, large by historical standards, and seems especially and pensions. Districts have faced pressure in all prudent this year given the significant risks to state of these areas over the past few years, including revenues. The state took a similar approach when pressure to increase salaries to keep up with it adopted the 2022-23 budget, which included a inflation. Districts also face higher costs in a few $3.5 billion cushion. When the guarantee declined other areas, including notable increases for utilities sharply in the following year, the cushion helped the and insurance. Funding the statutory COLA is state avoid reductions to ongoing programs. a straightforward way to help districts address these costs, balance their budgets, and sustain Contains a Reasonable Mix of Flexible local programs. Funding and Targeted Proposals. The Governor’s budget dedicates about two-thirds of the new COLA Estimate Is More Uncertain Than spending to proposals that provide districts with Usual. The federal government typically publishes flexible funding—mainly the LCFF COLA and the eight quarters of data used to calculate the discretionary block grant. Flexible funding allows COLA on a standard schedule. Due to the fall 2025 districts to implement programs tailored to their government shutdown, the last few quarters of data www.lao.ca.gov 13 analysis full have been delayed. Specifically, the sixth quarter Providing additional base special education funding (normally published in October) was not available would help address these cost increases and free in time for the Governor’s budget, and the seventh up local funding for other purposes. In addition, quarter (normally published in January) will not be the proposal would achieve a long-term state available until February 20. These delays make goal of equalizing special education base rates. the COLA estimate more uncertain and could The state used special education increases from lead to larger changes in the coming months. 2020-21 through 2022-23 to address historical For each 0.5 percent increase or decrease in the inequities in base rates. Currently, all SELPAs but statutory rate, the associated costs for school one receive the same per-student base rate. Under programs would change by about $450 million. the Governor’s proposal, all SELPAs would receive Based on the current federal schedule, the state the same rate. will receive the final quarter and finalize the rate Budget Overestimates the Cost of Special on April 30. Education Proposal. The Governor’s budget Community Schools Proposal Raises Several likely overestimates the higher costs associated Issues to Consider. The state has provided with funding higher special education base rates. $4.1 billion in one-time Proposition 98 funding Based on the statewide student attendance to support the implementation and expansion estimates in the Governor’s budget, we estimate of the community schools model. This funding that increasing base rates to $999 per student has provided multiyear grants to approximately would cost $325 million—$184 million less than the 2,500 schools across four cohorts of grantees, administration’s estimate. a statewide and regional technical assistance Major One-Time Proposals system, and grants to county offices of education to coordinate services for community schools Districts Could Use Discretionary Grants for within their counties. These funds were provided Various Costs and Programs. We spoke with with the expectation that school districts would be local leaders and explored how districts might use responsible for sustaining their community schools one-time discretionary funding. Some districts model after the grant funding expired. In assessing likely would use the funding to help implement the proposal, the Legislature may want to consider the state’s new curriculum for teaching literacy the rationale for creating a new ongoing program and mathematics, including costs for teacher for current grantees. It may also want to weigh training and instructional materials. Additionally, the trade-offs of providing dedicated, ongoing many districts would likely extend programs they funding for community schools against other previously funded with one-time federal grants. alternatives, such as a comparable LCFF increase. (The federal government provided more than We will analyze the proposal in greater detail in a $20 billion in one-time grants during the pandemic, forthcoming publication. but these funds expired in September 2024.) These programs include coaching for teachers, Special Education Increase Would Help counseling and tutoring for students, attendance Address District Cost Pressures. School improvement initiatives, and Multi-Tiered Systems districts cover special education costs through of Support (a framework for providing supports a combination of federal categorical, state to students that vary based on their academic categorical, and local unrestricted funding (largely and behavioral needs). A few districts likely would LCFF). Over the past two decades, special address infrastructure-related priorities, such as education costs have increased faster than refreshing technology and upgrading facilities federal and state categorical funding, requiring for transitional kindergarten. We also think many districts to rely more on local funds. Based on our districts would use some of their grants to offset analysis of historical spending data, we estimate revenue reductions from declining enrollment. the share of special education costs covered by While this approach could delay necessary budget local funds has increased from roughly 50 percent adjustments, it might be reasonable if it allows to roughly 60 percent over the past decade. 14 LEGISLATIVE ANALYST’S OFFICE analysis full 2026-27 BUDGET districts to implement expenditure reductions Restoring the LREBG Ahead of Schedule Has gradually. Districts might also consider using their Merit. The original impetus for the grant—helping grants to cover fiscal liabilities, including unfunded students recover from learning loss—remains a retiree health care obligations and one-time and significant concern. State test scores show that ongoing liability insurance costs. student achievement has been improving but Eliminating Deferrals Is Prudent. Conceptually, remains below pre-pandemic levels. Adopting the deferrals are similar to borrowing from future Governor’s proposal to accelerate this restoration Proposition 98 funds. The Governor’s proposal to would give districts greater certainty about their eliminate them would align the ongoing costs of final funding levels. This approach seems especially school programs with the ongoing funding needed important if the state maintains the original to support them. This realignment would ease spending deadline. The LREBG requires districts pressure on future budgets, improve cash flow for to undertake a lengthy planning process, including districts, and simplify state and school accounting. (1) conducting a needs assessment, (2) gathering community input, (3) developing measures of Districts Have Spent Most of Their LREBG student engagement and performance, and Funds on Instruction. Based on our analysis of (4) explaining how research or other evidence district fiscal data, we estimate districts spent supports their plans. If the state does not make the about $4.5 billion in LREBG funds through 2024-25 final payment until 2027-28, districts would not have (covering the first three years of the program). More time for a thoughtful planning process. Accelerating than half of this spending involved direct instruction, the restoration also eliminates the need for another such as increased instructional time, additional payment in 2027-28. teachers and aides, and tutoring (Figure 9). Most of the other spending supported student services, such Figure 9 as counseling and transportation. Although the state does not collect Districts Have Spent Most of Their detailed information on district LREBG Funds on Direct Instruction use of the grant, the emphasis Estimated Expenditures Through 2024-25 (in Billions)ª on direct instruction and student services suggests that districts $3.0 are prioritizing initiatives that could address learning loss. 2.5 The spending reported through 2.0 2024-25 represents approximately two-thirds of the initial grant 1.5 amount. The remainder— 1.0 approximately $2.3 billion— remained unspent at the end of 0.5 2024-25. Districts, however, are required to adopt multiyear plans Direct Guidance Health and School All Other Instruction Counseling Behavorial Services Transportation for how they will spend these funds by 2027-28. Examples: Direct instruction: increased instructional time, additional teachers and aides, tutoring. Guidance counseling: personal development, career advice, student recordkeeping. Health and behavorial services: diagnostic testing, mental health services, attendance improvement. School transportation: home-to-school transportation, bus passes. All other: administration, curriculum development, teacher training. a Amounts reflect unaudited actual expenditures for 2022-23 and 2023-24 and preliminary expenditure data for 2024-25. Expenditures for each category have been increased by about 12 percent to account for charter schools that file financial reports in an alternative format and school districts that did not submit preliminary data for 2024-25. LREBG = Learning Recovery Emergency Block Grant. www.lao.ca.gov 15 analysis full RECOMMENDATIONS Adopt Special Education Increase but Reduce Cost Estimate. Given statewide increases Maintain Large One-Time Cushion if Adopting in special education costs, we think increasing Governor’s Revenue Estimates. If the Legislature special education base rates is a reasonable way adopts lower revenue estimates, it would mitigate to address local cost pressures. We recommend some of the risks that the Governor’s budget that the Legislature adopt this proposal, but use seeks to address. Under this approach, prudent a lower cost estimate. (We estimate the cost is budgeting would mean paring back spending $325 million, but the number likely will change in proposals to align with the lower guarantee. Other May when the state has updated attendance and tools for budget resilience (such as reserves and COLA data.) Providing additional special education one-time cushions) would be less necessary. If the funding would reduce the need for districts to rely Legislature uses the higher revenue estimates in on general purpose funding, such as LCFF, to cover the Governor’s budget, however, we recommend a rising costs. one-time cushion at least as large as the Governor’s plan ($4 billion). Having a significant cushion means Adopt the Governor’s Major One-Time the budget has some capacity to accommodate a Proposals. The Governor’s three major one-time lower guarantee without disrupting ongoing school proposals seem reasonable, and we recommend programs. This approach means the budget would adopting them. Specifically, we recommend include a mix of one-time and ongoing spending, adopting the discretionary block grant, which could which the Legislature could use to fund the help districts advance local programs and address Governor’s proposals, its own priorities, or some various costs. Whereas the Governor proposes combination of both. $2.8 billion, other amounts could be reasonable based on revised estimates of the guarantee. Maintain the Same General Mix of Flexible Regardless of the final amount, we recommend Funding and Targeted Proposals. The Governor’s refining the intent language to add fiscal liabilities, plan to allocate most of the new spending to flexible infrastructure, and temporary costs to the grants while reserving a smaller portion for targeted suggested uses—the types of expenditures that proposals is a reasonable way to build the budget. one-time funds are well suited to address. We also Whether the Legislature directs new spending recommend adopting the proposal to eliminate toward the Governor’s priorities or to other the payment deferral, which would ease future priorities, we recommend maintaining a roughly budget pressure. Finally, we recommend adopting similar mix of flexible and targeted proposals. the proposal to restore the remaining funds for Adopt Funding for COLA Based on Final LREBG. This proposal would help districts meet the Statutory Rate. Although we recommend the upcoming expenditure deadline and reduce costs Legislature remain cautious about new ongoing in 2027-28. spending, our November outlook concluded that the state could afford to cover the COLA even under our lower revenue estimates. We recommend prioritizing the COLA over other ongoing spending and funding the final statutory rate unless revenue estimates decline significantly by May. Funding the COLA would help districts address the cost increases they face. 16 LEGISLATIVE ANALYST’S OFFICE analysis full 2026-27 BUDGET APPENDIX: SUMMARY OF ASSESSMENT AND RECOMMENDATIONS THE MINIMUM GUARANTEE » Managing short-term forecasting risk (overcommitting to school spending if Assessment revenues are lower than projected). » Addressing future budget deficits. • Revenue Risks. The stock market poses a (The state budget faces deficits averaging notable risk to General Fund revenues. Several more than $20 billion annually over the next signs suggest the market is overvalued, few years.) and a significant decline likely would reduce state revenues by tens of billions of dollars. » Protecting school programs from future The revenue estimates in the Governor’s declines in the guarantee. budget do not account for this risk. • Short-Term Forecasting Risk. The proposal • Proposition 98 Sensitivity. mitigates short-term forecasting risk because The Proposition 98 guarantee is moderately the guarantee could drop by as much as sensitive to revenue changes and would drop $5.6 billion and the state could respond by about 40 cents for each $1 of lower revenue in reducing the eventual settle-up payment. 2025-26 or 2026-27. Past experience suggests the 2025-26 • Budget Preparation. We recommend that guarantee is unlikely to drop by more than the Legislature prepare for the possibility $3.5 billion relative to May estimates. that the guarantee is billions of dollars lower • Future Deficits. The proposal effectively by (1) being cautious about new spending shifts $5.6 billion in costs from this year to commitments, (2) building reserves and other future budgets—helping address the current tools to protect existing school programs, and budget problem on a one-time basis but (3) using the upcoming hearings to identify adding to the large budget deficits the state proposals that could be delayed, reduced, or faces in the future. rejected if the guarantee drops. • School Programs. The future settle-up • Proposition 98 Reserve. The $4.1 billion payments could help support school deposit under the Governor’s budget is a key programs the next time the guarantee drops, tool for protecting school programs because but they are a weak form of protection. the reserve is flexible and can be accessed The payments would be most beneficial relatively quickly. when the state experiences a significant • Property Tax Estimates. The administration’s revenue decline—exactly when they would be estimates are reasonable. least affordable. • Prior-Year Spending Adjustments. SETTLE UP A state law that prohibits school spending adjustments after the year ends is one of Assessment the motivations for the Governor’s proposal. • Budget Challenges. Three distinct budget Rather than making school funding more challenges are relevant to the Governor’s predictable, the law seems to have prompted proposal to delay a $5.6 billion settle-up the state to adopt settle-up delays and other payment in 2025-26: actions that create new uncertainty about when and how the state will allocate funding. www.lao.ca.gov 17 analysis full Recommendations also less risk. Using the Governor’s estimates heightens the importance of managing risk in • Adopt Alternative Approach. The alternative other ways. addresses the risk of overcommitting school • Mix of One-Time and Ongoing Spending. funding and reduces future budget risks and The Governor’s budget includes challenges. However, it involves some difficult $3.7 billion in ongoing spending and decisions for the non-Proposition 98 side of $5.6 billion in one-time spending. Of the the budget this year. Although the details will one-time amount, $4 billion is paid with vary based on updated revenue estimates ongoing 2026-27 funds. This approach builds in May, the core elements of the alternative a cushion that would protect programs if the include the following: guarantee declines in the future. » Setting aside enough funding to cover the • Flexible and Targeted Spending. full estimate of the guarantee, rather than The Governor’s budget allocates about delaying $5.6 billion in costs to the future. two-thirds of the proposed spending to flexible » Making a Proposition 98 Reserve deposit of grants and one-third to targeted grants with at least $3.5 billion in 2025-26 ($2.9 billion spending requirements. This is a reasonable more than the Governor’s budget mix that could help districts cover their costs proposes), pending additional revenue while addressing a few state priorities. information. The state would reduce this • Relation to Existing Programs. Nearly all the deposit to the extent the guarantee falls targeted proposals expand or extend existing short of its May estimates. programs rather than create new initiatives. » Using the remaining funds to build additional resiliency for school programs, Assessment of Specific Proposals such as by making further reserve deposits, • Cost-of-Living Adjustment (COLA). Funding providing an advance payment, or the statutory COLA would help districts addressing district pension costs. manage cost pressures ranging from salaries » Adopting budget solutions that address and benefits to utilities and insurance. the state’s structural deficit—spending The COLA rate estimate (2.41 percent) is more reductions for non-Proposition 98 programs uncertain than usual due to federal delays, but or revenue increases. final data should be available in late April. • Prior-Year Spending Adjustments. Consider • Community Schools. Core issues to repealing the prohibition on prior-year consider include (1) whether districts should spending reductions to mitigate the risks be responsible for sustaining community posed by drops in the guarantee. The schools with existing funds, (2) the rationale state could continue to prohibit reductions for creating a new ongoing program, that would require districts to return and (3) the trade-off between funding previous payments. for community schools and increases in other programs. SCHOOL SPENDING PLAN • Special Education. The proposed $59 per-student increase (about 6 percent) Assessment of Overall Structure would supplement the COLA and help districts cover costs that have risen faster • Budget Starting Point. The Governor’s than inflation. We estimate the associated budget builds its spending package on cost is $325 million—$184 million less than the estimates of the state revenues that do not Governor’s budget estimates. account for the elevated risk of a stock market • Discretionary Grant. Districts could use downturn. Using lower estimates would mean this $2.8 billion grant for various costs and a lower guarantee and less new spending but 18 LEGISLATIVE ANALYST’S OFFICE analysis full 2026-27 BUDGET programs, including (1) implementing new » Maintain the same general mix of flexible state curriculum, (2) extending programs funding and targeted proposals. previously funded with one-time federal funds, • Specific Proposals: (3) making infrastructure improvements, (4) managing enrollment declines, and » Adopt funding for the statutory COLA (5) covering fiscal obligations and liabilities. rate unless revenue estimates deteriorate • Payment Deferral. Using $1.9 billion to significantly by May. eliminate the June 2025 payment deferrals » Adopt the special education increase but is prudent because it aligns ongoing reduce the cost estimate to $325 million. program costs with the funding necessary to » Adopt the discretionary block grant support them. proposal but modify the list of priorities • Learning Recovery Emergency Block to include fiscal liabilities, infrastructure, Grant. Providing $757 million to accelerate the and temporary costs. Consider increasing restoration of this grant would help districts or decreasing the amount in response to sustain learning recovery efforts and meet an changes in the guarantee. upcoming expenditure deadline. It would also » Adopt the proposal to eliminate reduce future state costs. payment deferrals. » Adopt the proposal to restore the Learning Recommendations Recovery Emergency Block Grant. • Budget Structure: » Consider using revenue estimates that account for stock market risks. Alternatively, maintain a large one-time cushion if building a budget based on the Governor’s revenue estimates. www.lao.ca.gov 19 analysis full 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