Legislature approves a budget: Schools facing major reductions 

Analysis from CSBA’s Governmental Relations Department

Editor’s note: This revised analysis replaces the version published Feb. 19 with new and updated information. To avoid confusion, the older analysis has been removed from our Web site.

The 17-month state budget enacted last month after–what many consider the ugliest impasse in a long history of standoffs—is designed to cover the remainder of the 2008-09 fiscal year and all of 2009-10. However, the 2009-10 spending plan will likely have to be revised at least once before the end of that year, and much depends on the outcome of a May 19 special election.

“Although we’re glad the stalemate is finally over and the budget includes some new revenues, school governance leaders throughout the state are deeply disappointed in the choices made by Gov. [Arnold] Schwarzenegger and our Legislature to drastically reduce K-12 public education funding,” CSBA Executive Director Scott P. Plotkin said. “It’s time for lawmakers to stop sacrificing the future of our children and start really investing in their educational progress and success.”

State funding issues

The overall budget solution approved by the Legislature and the governor includes $15 billion in cuts, $14.4 billion in temporary revenues and $11 billion in borrowing ($6 billion from Revenue Anticipation Warrants and $5 billion from lottery securitization). Revenues include four major elements:

• 1-cent increase in the sales tax ($5.8 billion over the next 17 months)
• Vehicle License Fee increase to 1.15 percent of the car’s value ($1.7 billion over the next months)
• 0.25 percent increase in the state income tax ($3.7 billion over the next 17 months)
• reduction of the dependent care tax credit ($1.4 billion over the next 17 months)

Revenues are tied directly to a modified spending cap that will appear on the ballot as Proposition 1A in a statewide special election to be held May 19. If the spending cap is approved by voters, then the revenues will stay in effect through the 2012-13 fiscal year. If the spending cap is not approved by voters, then the revenue will stay in effect for only 24 months after enactment.

The following measures will appear on the May 19 ballot, as labeled by California Secretary of State Debra Bowen:

• Proposition 1A: State Budget. Changes California Budget Process. Limits State Spending. Increases “Rainy Day” Budget Stabilization Fund
• Proposition 1B: Education Funding. Payment Plan
• Proposition 1C: Lottery Modernization Act
• Proposition 1D: Protects Children’s Services Funding. Helps Balance State Budget
• Proposition 1E: Mental Health Funding. Temporary Reallocation
• Proposition 1F: Elected Official’s Salaries. Prevents Pay Increases During Budget Deficit Years

A summary of each of these analyses can be found on the Legislative Analyst’s Office Web site at www.lao.ca.gov. Ballot arguments and other information can be found on the secretary of state’s Web site at www.sos.ca.gov

Federal stimulus may restore some funding reductions

A trigger mechanism included in the final budget agreement links some of the state budget cuts and revenues to the amount California receives from the federal stimulus package. The language provides that if the state receives at least $10 billion from the American Recovery and Reinvestment Act’s State Fiscal Stabilization Fund, $947.7 million in cuts and $1.8 billion in tax increases will be reversed.

Half of the 0.25 percent surcharge on personal income tax brackets would not take effect, for example; this would lower the overall revenue increase to the general fund by $1.8 billion—and that would lower the Proposition 98 guarantee to education. None of the nearly $1 billion in restorations would benefit Proposition 98, however. Health and human service programs would be the largest beneficiary, with some funding for Supplemental Security Income/ State Supplementary Payment and Medi-Cal restored; $100 million would be restored for CalGrant increases.

Tax credits

The budget package also included $2.5 billion over five years for corporate tax credits under the guise of economic stimulus. For example, the Single Sales Factor Apportionment will allow most multistate businesses to apportion only their percentage of sales in California as taxable income here, in contrast to the current methodology that allows averages of a business’s proportion of sales, property and payroll taxes. This will reduce taxes for companies that have significant employment and property in California but whose sales are mostly outside of the state. The initial annual revenue loss will be $700 million in 2011, growing to $1.5 billion. Additionally, a credit of 20 percent to 25 percent is available for allowable production costs of motion pictures or TV series produced in California. A total of $500 million in those credits will be available over five years.

2008-09 K-12 cuts

The budget reduces the current-year Proposition 98 appropriation by $5.9 billion through a mix of program reductions, deferrals and redesignation of funds. Of this amount, approximately $2.3 billion will come from program reductions, reducing actual apportionments to districts in the current year; those provisions include elimination of the partial cost-of-living adjustment—a $287 million reduction—with the remainder evenly split between categorical program funding and revenue limits at $944 million each. Categoricals will suffer an across-the-board cut of 15 percent for all but eight programs, as explained below.

2009-10 K-12 cuts

The 2009-10 budget includes the following K-12 education provisions:

• elimination of the estimated 5.02 percent statutory COLA ($2.5 billion) for school district and county office revenue limits
• a further reduction of K-12 spending within Proposition 98 spending levels by $530 million; this decrease will be split equally between revenue limits and categorical programs, with $265 million taken from school district and county office of education revenue limits (and added to the Proposition 98 deficit factor) and another $265 million taken from the same categorical programs reduced in 2008-09 (a 4.4 percent reduction across the board to Tier II and III categoricals, as explained below)
• elimination of the High Priority Schools Grant Program for $114.2 million in additional K-12 cuts

In 2009-10, a deficit of 13.094 percent will be applied to school district revenue limits and 13.360 percent to county office of education revenue limits.

Categorical program cuts and flexibility

There are three tiers of categorical program cuts. The programs in Tier I will receive no funding cuts, but for those programs there will be no “program flexibility” in the use of the funds, and no ability to waive statutory requirements. Programs in Tier II will receive a funding reduction of 15.4 percent in the current year and 4.4 percent in the budget year, but there is no program flexibility and the programs are to be operated in accordance with current statute. Tier III will also take an approximately 15 percent cut, but with “maximum flexibility.” Districts will be able to use these funds for any purpose. The changes to these categorical programs will be in effect for the remainder of this fiscal year and for four additional years.

The programs in Tier I are:

• child development
• child nutrition
• economic impact aid
• K-3 class-size reduction
• Proposition 49 after-school programs
• special education
• Quality Education Investment Act
• home-to-school transportation

The programs in Tier II are:

• adults in correctional facilities
• agriculture-vocational education
• apprenticeship programs
• Charter School Facilities Grant
• English Language Acquisition Program
• foster youth
• K-12 high-speed network
• multitrack year-round education
• partnership academies
• state testing

Tier III includes all other categorical programs. These programs will receive an approximate 15 percent reduction in the current year and for four additional years.

Other flexibility provisions include:

• routine maintenance reserves: reduces the amount that school districts are required to set aside in "routine restricted maintenance accounts" from 3 percent to 1 percent of their general fund budgets for the current year plus four years
• deferred maintenance: eliminates the local 0.5 percent statutory match for deferred maintenance for the current year plus four years

The budget makes no changes to the current reserve requirements under Assembly Bill 1200 and does not include the governor’s proposal to suspend mandates for the budget year.

K-3 class-size reduction flexibility

Technically, there will be no change to the statutory requirements of the K-3 class size reduction program. However, there will be changes to the penalty provision for classes that exceed the current 20.4 to 1 ratio of students to teachers. The changes to the penalties are as follows:

• up to 20.5 students per teacher—no penalty
• up to 21—5 percent penalty (20 percent penalty is current law)
• up to 21.5—10 percent penalty (40 percent penalty is current law)
• up to 22—15 percent penalty (80 percent penalty for 21.9 is current law)
• from 22 to 25—20 percent penalty
• over 25—30 percent penalty (with no cap)

It is important to note that districts will not receive additional funding for any students beyond 20. While there are no changes to the implementation priorities, there is not a requirement that class sizes in one grade be smaller than another. Additionally, there are no requirements for school or districtwide averaging.

Prior-year categorical reserves

The budget authorizes districts to access ending fund balances as of June 30, 2008 (from the 2007-08 school year only) from most restricted, categorical program accounts—and to use the money for any educational purpose. Categorical programs “protected” from such access are:

• economic impact aid
• Targeted Instructional Improvement Grant
• instructional materials
• special education
• Quality Education Investment Act
• California High School Exit Exam
• supplemental instruction
• home-to-school transportation

Maintenance factor

An issue arose in January regarding the long-term funding levels under Proposition 98. During downturns in state revenues, Proposition 98 allows for a lower level of funding for schools, known as Test 3. However, the constitution also provides that the loss of funding be restored over time through a maintenance factor. The Department of Finance, in calculating the revised funding levels for 2008-09 and 2009-10, determined that both years would be Test 1 years, and in this determination they also asserted—incorrectly, in the view of most school finance experts—that no maintenance factor was created, resulting in a loss of $9 billion for schools.

This issue was part of the negotiations on the budget deal, and an agreement was reached that calls for the electorate to vote on a constitutional amendment that would provide $9.3 billion in payments to schools and community colleges—an amount equal to the estimated existing maintenance factor. Specifically, the proposal would establish annual supplemental payments beginning in 2011-12 that would be in lieu of a maintenance factor for 2007-08 and 2008-09. The supplemental funding would be adjustments to school district revenue limits and in addition to the Proposition 98 guarantee. The supplemental payments would subsequently be built into the base for each year. Up to $200 million would be set aside in the first payment to fully fund any remaining equalization.

Establishing these supplemental payments is linked to the establishment of a rainy day fund, because the funding source for these payments would be half of the annual set-aside for the fund. Proposition 1B on the May 19 ballot, would create the Supplemental Education Payment Account for the purpose of making the payments to schools and require that 1.5 percent of general fund revenues be transferred to that account annually. The entire $9.3 billion would likely be paid out over five years.

Budget stabilization

Proposition 1A on the May 19 ballot, establishes a state rainy day fund. Beginning with the 2011-12 fiscal year, the state would be required to calculate “unanticipated revenues,” which would be actual revenues (plus transfers and prior year reserves) that exceed revenue forecasts for that year. The calculation of forecast revenues would be based on actual revenues received for the prior 10 years, using a linear regression analysis.

The first priority for any unanticipated revenues would be to satisfy any outstanding Proposition 98 obligations for that year. Any remaining funds would be transferred to the Budget Stabilization Fund until the amount in the fund reaches 12.5 percent of general fund revenues. However, the transfer to the rainy day fund could be less than the difference between actual and forecast revenues if a portion of the excess revenues is needed to maintain a “workload” budget, defined as the general fund expenditures for the prior year as increased for the so-called “Gann factors” (California Consumer Price Index and population growth).

After the Budget Stabilization Fund reaches its cap, any unanticipated revenues would be spent in the following order of priority:

1. outstanding Proposition 98 obligations
2. debt service
3. one-time infrastructure or other capital outlay purposes
4. additional debt retirement
5. unfunded liabilities for vested non-pension benefits for state annuitants
6. transfer by statute to the Budget Stabilization Fund

Voter approval of the Budget Stabilization Fund is tied to the proposed revenue package and to the maintenance factor payment. If voters approve the fund, then the new revenues would be in place for the balance of the current year plus the next four budget years. If rejected, the new revenues would be in place for the next 24 months. In addition, approval of the Budget Stabilization Fund is necessary to provide the funding source for the Proposition 98 maintenance factor payment contained in Proposition 1B.

What’s next?

This budget package covers the balance of the current fiscal year and the next budget year. However, there will still be a May Revision after May 26 (one week after the May 19 special election) to make any changes needed on the basis of updated information regarding state revenues and to address the failure of one or more ballot measures, if that should occur.

Additionally, there will be budget committee hearings throughout the spring. Items to be discussed include mandated-program reimbursements, which were once again deferred. The Legislature chose not to approve the governor’s proposal to suspend all but two mandates and instead put the issue—including funding for Behavioral Intervention Plans reimbursements, as required under a settlement recently negotiated by CSBA’s Education Legal Alliance and other education advocates—in the hands of the budget subcommittees.