Analysis of the 2005-06 Budget Bill Legislative Analyst's Office February 2005

Charter Schools

Ever since it was first implemented in 1999-00, we have had concerns with the calculation of the charter school categorical block grant funding level. The basic area of disagreement has revolved around which programs are in and out of the block grant. The Governor's budget addresses these existing disagreements in one way by "delinking" the charter school categorical block grant from any set of underlying categorical programs. This delinking approach, however, undermines the purpose of the block grant and is very likely to be unworkable. We recommend the Legislature pursue an alternative reform strategy based upon a new control section in the annual budget act that would provide charter schools a share of categorical funding that is equivalent to the proportion of K-12 students they serve. This alternative approach would be simple, workable, and consistent with the original intent of the block grant.

Below, we identify the basic problems with the existing charter school block grant funding model. These problems became so significant in 2004-05 that the budget act essentially suspended the existing model and authorized a working group to try to improve it. We summarize the progress the working group made toward developing a new model. We then describe the Governor's budget proposal to reform the model, discuss our concerns with the proposal, and recommend an alternative reform approach. We conclude this section with a brief discussion of a related budget proposal that would allow colleges and universities to authorize charter schools. As we recommended last year, we think a system of multiple charter authorizers, with certain accompanying safeguards, could enhance charter school oversight and accountability.

Existing Block Grant Funding Model Has Become Virtually Unworkable

The charter school block grant was established in 1999 to provide charter schools with categorical program funding similar to public schools serving similar student populations. The block grant currently suffers from two basic problems. The primary problem is a lack of consensus regarding which programs are in and out of the block grant. A secondary problem is the funding formula used to calculate the block grant funding level is overly complex.

Categorical Confusion. Since its inception, our office and the Department of Education (SDE) have interpreted statute to include several programs in the charter school block grant that the Department of Finance (DOF) has excluded when determining the block grant funding level. Several of the programs at the center of contention are large programs with large fiscal implications for charter schools—Targeted Instructional Improvement, Regional Occupation Centers and Programs, Teaching as a Priority, Library Materials, Deferred Maintenance, and Mandates. In addition, statute is ambiguous as to whether county-administered programs, such as the California Technology Assistance Project, County Office Fiscal Oversight, California Student Information System, and the K-12 High Speed Network, are to be in or out of the block grant. A new area of ambiguity involves the block grants created by Chapter 871, Statutes of 2004 (AB 825, Firebaugh). Four of the six new block grants consolidate programs that are in the charter school block grant with programs that charter schools formerly had to apply for separately. It is unclear whether these block grants are to be subsumed into the charter school block grant, whether charter schools now have to apply separately for all six block grants, or whether all the pre-existing programs need to be tracked separately just for charter school funding purposes.

Methodological Madness. A secondary problem with the block grant is its overly complex funding formula. The formula uses 1998-99 as a base year and measures all changes from this year. Locking in 1998-99 as a base year has led to accidental funding errors (when the base year was not correctly updated to reflect budget-year adjustments). The base year also has become increasingly obsolete, with few of the categorical programs in the original block grant still remaining and many new categorical programs since created. These changes have made the formula increasingly difficult to use and have called into question the validity of the formula to account accurately for current categorical funding. In addition, the formula is sensitive to changes in revenue limits—changes that occur throughout the year and for which information is not generally available.

Working Group Makes Some Progress Toward New Model

As of a result of these problems, the 2004-05 Budget Act contained language directing the Legislative Analyst's Office and DOF to coordinate a working group to "develop a simpler and clearer method for calculating the charter school block grant appropriation in future years." The working group, which held three meetings during fall 2004, included representatives from SDE, the Office of the Secretary for Education, the California Charter School Association, the Charter School Development Center, EdVoice, the Association of California School Administrators, the California School Boards Association, the California Teachers Association, the California County Superintendents Educational Services Association, and legislative staff. Although the group did not ultimately agree as to exactly which programs should be in and out of the block grant or on all aspects of a new block grant method, it did achieve notable consensus in important areas.

Agreed on Purpose of Block Grant. The group generally agreed that existing statute provided sufficient guidance as to the basic intent of the charter school funding system. Existing statute states, "It is the intent of the Legislature that each charter school be provided with operational funding that is equal to the total funding that would be available to a similar school district serving a similar pupil population." Moreover, the group generally agreed that the specific purpose of the block grant was to provide charter schools with funding in lieu of categorical programs.

Agreed on Principles to Guide Development of New Block Grant Model. The group generally agreed that the following principles should guide development of a new model.

• The block grant calculation should be simple.
• The calculation and its outcome should be transparent.
• The calculation should entail as little administrative burden as practicable at the local level as well as the state level.
• The calculation should result in comparable funding rates for similarly situated charter schools and other public schools.
• The calculation should not require the state to overappropriate the Proposition 98 minimum guarantee.
• Charter schools should retain existing flexibility to use block grant funds for general education purposes.

Agreed on Some Methodological Changes. The group agreed the model should no longer rely on a base year. It also preferred having one budget section govern the block grant appropriation rather than having charter provisions embedded within the budget items for every associated categorical program. It also agreed changes should be made to clarify which programs did not apply to charter schools as well as which programs charter schools were to apply for separately. However, the working group did not achieve consensus on all aspects of a new block grant model.

Governor's Proposal Is Not Viable Reform Option

The Governor's budget contains a charter finance reform proposal that attempts to address the difficulties with the current system. The Governor's funding proposal provides $68 million for the charter school block grant—a $10 million augmentation over the current year. As Figure 1 shows, this augmentation funds anticipated growth in charter average daily attendance (ADA), a cost-of-living adjustment, and a $2.9 million base augmentation. The DOF states the base augmentation is provided in recognition of charter schools' low participation in certain categorical programs and inability to access funding for other categorical programs.

The funding proposal is associated with accompanying trailer bill language that would significantly change the charter school categorical block grant by delinking it from any underlying set of categorical pro grams. That is, the block grant funding level would no longer represent in-lieu funding for a set of specified categorical programs. Under the proposal, once the 2005-06 funding level has been set, the block grant funding level would be adjusted in future years for growth in ADA and inflation. The block grant funding level would be reviewed every three years, beginning in 2008-09, to determine how its growth compared with growth in K-12 categorical funding generally, less a small set of special categorical programs.

Proposal Undermines Purpose of Charter School Block Grant. Despite controversy regarding exactly which programs are in and out of the block grant, the general purpose of the block grant, as indicated above, has rarely been questioned and remains quite clear—the block grant is to provide charter schools with in-lieu categorical funding. When originally established, the block grant provided charter schools with in-lieu funding for 33 categorical programs. By disconnecting it from categorical programs, the Governor's proposal undermines the policy basis of the block grant.

Proposal Very Likely to Be Unworkable. Under the Governor's proposal, it is unclear how charter schools, the Legislature, and state agencies would know which programs charter schools could apply for separately. The DOF suggests charter schools could apply separately only for those programs for which they currently can apply separately. Given the existing disagreement over which programs charter schools can apply for separately, this new statutory ambiguity is likely to generate even greater confusion over which programs are in and out of the block grant. Moreover, despite DOF's intention, the proposed language would seem to allow charter schools to apply separately for all categorical programs except Economic Impact Act. Having to apply separately for virtually every categorical program undermines one of the primary legislative purposes of charter schools, which was to offer schools greater fiscal autonomy in exchange for performance-based accountability. Nonetheless, if charter schools actually did apply separately for all categorical programs, then their categorical block grant appropriation would represent a windfall—providing charter schools with almost $300 more per ADA than noncharter schools.

Alternative Approach Could Achieve Simplicity, Clarity, and Comparability

We recommend the Legislature repeal the existing block grant model, reject the Governor's reform proposal, and adopt an alternative reform approach. The alternative approach we recommend would link charter schools' share of categorical funding with the share of K-12 students they serve. The resulting block grant amount then would be distributed among charter schools using a simple conversation factor to ensure more per pupil funding was provided for disadvantaged students. This approach is simple to understand, yields comparable charter and noncharter categorical funding rates, protects against an unintentional Proposition 98 overappropriation, remains dynamic such that it can respond to a changing array of categorical programs, and might become so automated and uncontroversial that the Legislature would not need to address the charter school finance system every year.

As with the Governor's reform proposal, we recommend the Legislature repeal the existing code sections that detail the charter school categorical block grant and its funding formula (Education Code Section 47634 and Section 47634.5). In its place, we recommend the Legislature create a new in-lieu categorical funding system for charter schools. Below, we describe each component of this alternative reform approach.

Clarifies Programs for Which Charter Schools Are Not Eligible. To address existing statutory ambiguity regarding certain types of county-run programs, we recommend the Legislature adopt a new code section that would list the categorical programs for which charter schools are not eligible. For these programs, charter schools neither could apply nor receive direct or in-lieu funding. We recommend this list contain programs funded and administered directly by a select group of county offices for nonclassroom-based county-level activities. Figure 2 lists the programs we recommend including in this category.

Clarifies Programs for Which Charter Schools Must Apply Separately. We also recommend a new code section to clarify exactly which categorical programs charter schools must apply for separately. This section would be intended to reduce potential controversy regarding which programs are out of the block grant. Figure 3 lists the Proposition 98 programs for which we recommend charter schools be required to apply. As the figure shows, we recommend charter schools continue to apply separately for testing and student-information monies (to ensure their performance can be tracked), special education, and programs intended for non-K-12 populations (adult education and child development). This list is almost identical with existing statute governing the block grant funding formula and is largely consistent with the Governor's proposed trailer bill language for reviewing the block grant funding level. It also tries to be as consistent as possible with statutory directives that the charter school funding model be simple and allow for fiscal autonomy. (Nonetheless, this list still includes ten programs representing almost $5 billion in categorical funding, or approximately 40 percent of all Proposition 98 categorical funding.)

Automates Funding While Ensuring Parity and Protecting Against Overappropriations. Third, we recommend the Legislature adopt a new system for providing charter schools with in-lieu categorical funding. The system would be described in statute but implemented through an annual budget control section. For all remaining Proposition 98 categorical programs (those that do not fall into the two above categories), we recommend control language that would provide charter schools a share of funding equal to the share of K-12 students they serve. Specifically, as part of the annual May Revision, SDE would project charter school's share of ADA in the budget year. This estimate would be included in the control section, accompanied with language providing the same share of funding from these remaining categorical programs to charter schools. This approach would allow SDE to distribute categorical funds immediately following enactment of the budget.

This approach eliminates the need for a base year, is not sensitive to changes in revenue limits, contains all relevant funding information in a single place, is dynamic such that it can reflect ongoing changes to the categorical landscape, and establishes a funding process that automatically produces parity. Thus, if any midyear adjustments, year-end pro-rata adjustments, or deferrals are made to any of these categorical programs, charter schools are automatically affected to the same degree as noncharter schools. Moreover, these adjustments are made without affecting overall Proposition 98 spending.

Simplifies Process, Strengthens Incentives to Serve Disadvantaged Students. Once charter schools' overall categorical funding level has been determined, we recommend a simple conversion factor be used to ensure charter schools receive more per pupil funding for the disadvantaged students they serve. Serving disadvantaged students is one of the legislative objectives of charter schools, and a supplemental disadvantaged-student funding rate is a core aspect of the existing charter school funding model. A conversion factor (for example, providing 25 percent more for every student eligible for free and reduced price meals) would be a simple means to generate incentives to serve disadvantaged students while ensuring the aggregate charter funding allocation is not exceeded.

Equalizes Funding Without Major Disruption. The model described above would provide charter schools with just over $200 million of in-lieu categorical funding in 2005-06. (This is based on DOF and SDE's assumption that charter schools will serve approximately 3 percent of all K-12 ADA in 2005-06 and on the Governor's proposed funding levels for categorical programs.) It is difficult to calculate how this compares to the amount charter schools currently are receiving. In a 2003 report, RAND found that, in California, charter schools received less categorical funding compared to noncharter public schools. If this is so, then our proposal, which provides similar funding for charter and noncharter schools, would likely result in charter schools receiving an increase in funding and noncharter public schools experiencing a slight decrease. Since the decrease would be spread over approximately 40 categorical programs, the impact on any district for any program would be minimal.

The reason that we are not able to quantify the exact impact on charter and noncharter schools is because we do not know precisely what share of categorical funding charter schools currently receive. For example, charter schools currently do apply separately for some programs (such as K-3 Class Size Reduction and English Language Learner Assistance) for which, under our alternative approach, they would receive direct in-lieu funding. To derive a precise estimate of "new" funding would require a comprehensive accounting of charter schools' existing categorical participation. Nonetheless, it is likely that charter schools with very high categorical participation and very few disadvantaged students would experience a slight reduction in funding. Similarly, noncharter schools with very high categorical participation rates would experience a slight reduction in categorical funding. In contrast, charter schools with low categorical participation and many disadvantaged students would experience an increase in funding. Noncharter schools with low categorical participation would be virtually unaffected by the new model. In short, the new system would involve some equalization and benefit charter schools with low categorical participation and many disadvantaged students.

Alternative Approach Creates Reform Structure. This alternative approach is not dependent upon any particular view of categorical programs. In other words, the Legislature might adopt the basic reform structure even if it decided to modify the list of programs for which charter schools would not be eligible or would have to apply for separately. Regardless of the treatment of specific categorical programs, we think the basic reform structure would simplify and clarify charter school finance.

In sum, we recommend the Legislature repeal the existing charter school block grant model, which has become virtually unworkable. We also recommend the Legislature reject the Governor's reform proposal, which too is very likely to be unworkable. Instead, we recommend the Legislature establish a simpler, more transparent model that results in more comparable charter and noncharter funding rates. A major advantage of the new model we describe is that it would be able to respond to an ever-changing categorical landscape—perhaps the greatest challenge confronting the existing system. The model would be directly linked to underlying categorical programs and automatically adjusted as funding for these programs changed. Indeed, it could operate so automatically that the Legislature would not need to review the charter school finance system every year. This would allow the Legislature to turn attention from the relatively technical issue of a funding formula to more meaningful issues of oversight and quality.

Alternative Authorizers Could Improve Quality

We recommend the Legislature adopt in concept the Governor's proposal to allow colleges and universities to authorize and oversee charter schools. We think a system of alternative authorizers has the potential to notably improve charter school development, oversight, and accountability. In establishing an alternative authorizer system, we recommend further attention be given both to the criteria an entity should meet prior to chartering schools and the conditions under which the state would revoke an entity's chartering authority.

The Governor's Budget Summary includes a proposal to allow alternative authorizers to charter K-12 schools. The proposal currently is not associated with a funding request. At the time of this writing, bill language had not yet been released, but the intent apparently is to allow colleges and universities, upon approval by the State Board of Education, to charter schools. In our January 2004 report, Assessing California's Charter Schools, we recommended a multiple authorizer system as one strategy for enhancing charter school development, oversight, and accountability. Below, we discuss our concerns with the existing authorizer system, explain how a multiple authorizer system might address these concerns, and highlight components of the Governor's proposal that require additional development.

Poor Incentives Embedded Within Existing System. Under the existing authorizer system, school districts are required to initially approve charter petitions that are adequately developed—even if the school districts are unlikely later to be able to conduct the oversight needed to ensure schools are honoring their charters. We have concerns with three particular types of school districts.

• Those Authorizing Few Charter Schools. RAND's 2002 charter authorizer survey found that slightly more than two-thirds of charter authorizers had authorized only one charter school. School districts authorizing only one charter school are likely to be unfamiliar and inexperienced with the petition review, oversight, evaluation, and renewal process.
• Those Experiencing Fiscal Difficulties. Some school districts are facing serious fiscal problems but nonetheless are required to authorize charter schools. We question whether these types of school districts can devote sufficient attention and resources to conducting rigorous charter oversight.
• Those Likely to Be Overly Receptive or Unreceptive to Charter Schools. School districts face various incentives stemming from their local environments that might contribute to lax or inappropriate oversight. For example, school districts experiencing facility problems or rapid growth might view charter schools as expedient solutions and be less likely to revoke charters. Conversely, school districts experiencing declining or shifting enrollment might be unreceptive to charter schools and conduct inappropriate oversight. In either case, the charter school accountability system is weakened.

Multiple Authorizers Could Improve Incentives and Constrain Costs. Allowing charter groups choice among potential authorizers might notably enhance the quality of charter development, oversight, and accountability. Charter groups might connect with authorizers who are familiar, experienced, and reputable at conducting high quality oversight and providing meaningful local assistance. They might bypass school districts that are distracted with serious fiscal problems or otherwise likely to be unable to provide adequate oversight and service. A multiple authorizer system also could have the ancillary benefit of constraining oversight costs, as schools might act as savvy consumers, selecting authorizers who provide the best service for the lowest price.

Certain Safeguards Likely to Be Needed. Although we think allowing colleges and universities to charter schools could potentially improve the charter school system, two components of the Governor's proposal require further development—the criteria entities must meet to be allowed initial chartering authority and the conditions under which this authority would be revoked. The state can provide some safeguard against errant authorizing by setting clear expectations as to the minimum qualifications expected of new authorizers. Minnesota, for example, recently began requiring initial training for new authorizers. (Minnesota has a relatively broad array of charter authorizers. Currently, the state department, 29 school districts, 20 postsecondary institutions, and 14 nonprofit organizations charter schools.) The state can provide further safeguard by setting clear expectations as to the conditions under which authorizing power would be revoked. For example, the state would want to retain power to revoke chartering authority from agencies that were negligent, mismanaged, or corrupt.

In sum, we think the Governor's proposal to allow colleges and universities to charter schools has the potential to notably improve charter schools generally, but we think some of the proposal's details require further development.