Analysis of the 2007-08 Budget Bill: Education

Proposition 98 Priorities

We recommend the Legislature reduce current-year K-14 spending to the minimum permitted under Proposition 98. For the budget year, we recommend the Legislature provide baseline increases for growth and cost-of-living adjustments. These recommendations would generate substantial General Fund savings with only minor impacts to ongoing K-14 programs.

Governor Proposes a “Baseline” Budget

The Governor’s budget proposes a net increase to Proposition 98 expenditures of $1.8 billion in 2007-08 compared to the revised 2006-07 spending level. Figure 1 displays the major funding changes proposed in the budget year. As the figure shows, the budget provides a baseline cost increase of $2.2 billion. A projected 4 percent cost-of-living adjustment accounts for most of the new spending in the budget year ($2.1 billion). Net new funding for attendance adds another $38 million, which consists of growth in the community colleges ($115 million) offset by a projected fall in attendance in K-12 education (-$77 million).

Baseline increases are partially offset by a net reduction of $358 million in Proposition 98 spending that result from several budget-year policy proposals. The budget reflects a $627 million cut in General Fund support due to the proposal to fund the K-12 Home-to-School Transportation program from the state Public Transportation Account (PTA) rather than the General Fund. The administration proposes to permanently reduce the Proposition 98 minimum guarantee (known as “rebenching”) by the same amount, thereby generating long-term General Fund savings from this funding shift.

The budget also includes a $269 million increase for child development programs. This increase in state support would offset a reduction in federal Temporary Assistance for Needy Families funds for the program. The budget uses these federal funds to free up General Fund dollars in the California Work Opportunity and Responsibility to Kids (CalWORKs) program. Thus, similar to the transportation proposal discussed above, the child care proposal would result in General Fund savings. Unlike the transportation proposal, this proposal does not require rebenching the Proposition 98 minimum guarantee.

For the community colleges, the budget includes $115 million for 2 percent growth in the number of new full-time equivalent students. This is $19 million more than what is called for by a new statutory guideline based on underlying growth in the adult population. This guideline calls for 1.65 percent growth. (The $19 million is included in attendance growth in Figure 1 and is not separately identified).

LAO Proposition 98 Forecast—Lower Revenues, Higher Guarantee

Our revenue forecast results in a Proposition 98 minimum guarantee that is $609 million lower for 2006-07 and $261 million higher in 2007-08 than the Governor’s budget. These differences are due primarily to our forecast of lower General Fund revenues. As we discuss in the “Proposition 98 Update” section of this chapter, our estimate of General Fund tax revenues is lower than the administration’s by roughly $940 million in 2006-07 and $500 million in 2007-08.

Our forecast creates several new issues for the Legislature. The lower current-year guarantee means the enacted budget spends more than required under Proposition 98. Thus, using our estimates, the Legislature would have the option of reducing Proposition 98 spending in 2006-07 and still meet the minimum funding guarantee. Our higher 2007-08 guarantee also would increase demands on the state General Fund in the budget year. Satisfying the higher guarantee would require the Legislature to draw down the General Fund reserve by $261 million or reduce other non-Proposition 98 spending by that amount.

The Legislature, however, could address both issues in a way that generates significant General Fund savings in both years. Specifically, reducing the overappropriation in 2006-07 would also reduce the Proposition 98 guarantee in 2007-08 by about the same amount. As a result, this option would create one-time savings in 2006-07 and ongoing savings in Proposition 98 costs beginning in 2007-08.

Achieving Proposition 98 Savings

The implications of the LAO forecast on the General Fund condition are serious. Our projection suggests the Governor’s budget overestimates General Fund tax revenues by $1.4 billion over two years. In addition, our estimate of property tax revenues going to K-14 education is $204 million lower—and the General Fund share of Proposition 98 is $204 million higher—than assumed in the proposed budget. Our revenue forecast also generates a budget-year Proposition 98 minimum guarantee that is $261 million higher than under the administration’s estimate.

The result of these differences means the 2007-08 year-end General Fund balance would be $1.9 billion lower than assumed in the Governor’s budget—basically wiping out the budget’s projected year-end reserve. In addition, we have serious policy and legal concerns about the administration’s proposed $627 million transportation shift, which call into question the General Fund savings identified in the budget. Given these General Fund threats, it is important for the Legislature to consider all options for balancing revenues and spending—including any options that are available within the parameters of Proposition 98.

For these reasons, we recommend the Legislature generate General Fund savings by reducing K-14 spending in the current year to the minimum permitted by Proposition 98 (including Proposition 49 after school funds). Since this also would reduce the minimum guarantee in 2007-08, this option offers a way to maximize General Fund savings while still covering baseline costs of schools and community colleges in the budget year.

Determining how to use this option to greatest advantage requires two steps. The first step involves finding savings that permit a reduction of Proposition 98 in the current year. Under our forecast, the Legislature could reduce 2006-07 Proposition 98 spending by $609 million. We have identified this amount of K-14 spending reductions, which we discuss in more detail below.

The second step involves assessing how this reduction would affect the proposed 2007-08 K-14 budget. Reducing current-year Proposition 98 spending by $609 million lowers the 2007-08 guarantee by $634 million (the current-year savings increase by the Proposition 98 growth factors). We believe that even at this lower level the Legislature can cover Proposition 98 baseline costs in 2007-08 (also discussed below).

Figure 2 illustrates the impact of our proposal on Proposition 98. The left-hand bar shows the current-year Proposition 98 spending level of $55 billion under the Governor’s budget. Our proposal would reduce expenditures by $609 million, lowering the minimum funding level by that amount. The right-hand bar represents the Proposition 98 guarantee in 2007-08. Note that the LAO estimate of the guarantee is $261 million higher than the Governor’s budget if no current-year action is taken, but $373 million lower if current-year spending is reduced to the minimum guarantee. Thus, by lowering current-year spending, our proposal would save $634 million in Proposition 98 spending.

Reducing the guarantee by $373 million from the Governor’s proposed level in the budget year, however, would not provide sufficient funding to cover baseline K-14 costs. Therefore, we first recommend the Legislature not implement the child care shift in 2007-08. In effect, our option saves the $269 million in Proposition 98 spending that was assumed in the Governor’s budget by keeping those expenditures in the CalWORKs budget. (The option to do the shift, however, would still be available to the Legislature in future years.) Regarding the remaining roughly $100 million difference, we believe the Legislature can find savings of this magnitude without affecting base programs. For example, we identify in our “California Community Colleges” analysis enrollment related-funds that will likely not be needed for their intended purposes in 2007-08.

In summary, to provide a measure of relief to the General Fund, we recommend the Legislature adopt our two-year savings option by reducing Proposition 98 spending in 2006-07 by $609 million. This represents real one-time General Fund savings. In 2007-08, our recommendation would reduce the budget-year guarantee by about $634 million, yet still leave K-14 education at an equivalent level of ongoing services in 2007-08 as the Governor’s budget. (Partially offsetting these savings would be a cost of $269 million in the CalWORKs budget due to the rejection of the child care proposal). In addition, our option reserves for a future year the possibility of using the child care shift to generate General Fund savings.

Current-Year Proposition 98 Savings

As previously discussed, the Legislature would need to reduce current-year Proposition 98 appropriations in order to achieve savings in 2006-07 and 2007-08. Our proposed current-year reductions come from two sources—transferring funds from the PTA and reverting unused 2006-07 Proposition 98 funds to the General Fund. Our PTA proposal has some similarities to the Governor’s proposed use of these funds. We propose to use $300 million from the PTA in the current year to replace the same amount of Proposition 98 funding for the Home-to-School Transportation program. Our review indicates that the PTA would have sufficient revenues to support this diversion of funds. Under our proposal, however, the transfer would be one-time in nature and would not involve rebenching the Proposition 98 minimum funding guarantee.

We identify $309 million in Proposition 98 funds that we estimate will not be needed in the current year. Figure 3 displays the source of these savings. We identify $240 million in savings that are not captured in the proposed budget. Of this amount, $41.7 million in special education savings result from lower growth in the student population. Similarly, the savings in CCC growth stem from differences between the amounts budgeted for enrollment growth and the amount we anticipate they will spend this year. The $35.2 million in child care program savings are the result of a lengthy preschool implementation process. Finally, the $33.1 million in “overcap” funding is available as it is double-budgeted in the current year. All of these projected savings represent our best estimates of current-year overfunding. Additional information will become available later in the spring to update these estimates.

Our recommendation also would “sweep” $69 million in current-year funds that the budget proposes to spend for other purposes. These represent 2006-07 savings that were identified by the Department of Finance and proposed for the following programs:

• $50 million for the low-performing school enrichment program, which is designed to attract experienced teachers to low-performing schools. The budget proposal would fund the program in 2007-08.

• $10 million for a new Encorps program that would train “experienced retirees” to become K-12 teachers.

• $9 million for equipment, curriculum development, and other enhancements for nursing programs in the community colleges. (These funds would not directly support additional nursing enrollment.)

In other words, we are suggesting using these savings in the current year for budgetary balancing, rather than new activities or expansions.

Maintain Priority on Reducing Credit Card Debt

We recommend that, if new funds become available, the Legislature place a high priority on paying for the ongoing cost of state-mandated local programs and reducing the level of deferrals.

The Proposition 98 credit card represents amounts the state owes to K-14 education for costs that were not fully funded during the fiscal year in which services were provided. This “debt,” or obligation, can be retired with one-time or ongoing Proposition 98 funds. Figure 4 displays the balance of the credit card in 2005-06 and 2006-07 and our estimate of the amount owed in 2007-08. We project the credit card balance will total $1.9 billion by the end of 2007-08. Funding deferrals—shifting payments for services provided during the budget year to the next fiscal year— accounts for $1.3 billion. The other $550 million represents the ongoing costs of mandated local programs that were not addressed in past budgets.

The figure also illustrates the Legislature’s actions to reduce the outstanding credit card balance as part of the 2006-07 Budget Act. The final budget included more than $800 million in one-time funds for state mandates, which retired almost all district and college claims (plus interest) through 2004-05. In addition, the Legislature also eliminated the K-12 “deficit factor,” which represented foregone inflation adjustments to revenue limits in 2003-04.

The amount owed to K-14 education, however, actually increases again in 2007-08. This is because the proposed budget includes no ongoing funding for K-12 mandates and only $4 million for mandates in community colleges. We expect K-14 claims for mandated local programs to reach about $185 million in 2007-08.

In the past, we have recommended that the Legislature use available ongoing funding to restore the annual appropriation for mandates. These programs are part of the base education program. Failing to include these costs in the budget represents increased borrowing at a time when the state should be repaying the education credit card. Unfortunately, based on our estimates, there are no additional sources of discretionary K-12 funds in the 2007-08 proposed budget that could be redirected to pay for mandates.

If additional discretionary funds become available, however, we recommend the Legislature use these funds to reduce its education credit card debt. In our view, the first call on any new ongoing funds should go to pay for the budget-year cost of mandates so that the credit card debt does not increase over time. One-time funds could be used to reduce the level of program deferrals or pay past-year mandate costs. Thus, we recommend the Legislature give first priority for any additional ongoing or one-time funds that materialize this year to reducing these Proposition 98 obligations.

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