Cash Flow & Debt Concerns of California School Districts in 2012-13

1. Cash Flow & Debt Concerns of California School Districtsin 2012-13 Prepared and Presented by: Alameda County Office of Education Jeff Potter, Executive Director, District Business & Advisory Services Spencer Mead, Director, District Advisory Services September 25, 2012

2. Today’s Discussion • The Cash Crisis for California School Districts • Current school district funding model • Impact of state budget crisis on school districts • Elimination of RDAs in 2011-12 • The Debt Crisis for California Schools, the State, and Beyond • The global debt crisis • The debt tipping point • School district borrowing - and the emergence of extreme borrowing techniques

3. Education in California • California served 6.3 million K-12 students in 2010-11 with 261K teachers • Total K-12 schools statewide - 10,340 • Pupil/teacher ratio of 24.12 (national average = 15.97) • Source: National Center for Education Statistics (nces.ed.gov), 2011 • Ranked 35th nationwide in per pupil spending in 2010 • Ranked 23rd before recession • Education spending grew just 2% from 2007 to 2010, compared to national average of 10% • California spent $9,375 per pupil in 2010 – 12% below the national average • Source: U.S. Census Bureau • Fourth highest average teacher salary in U.S. ($67,871) • Source: National Center for Education Statistics • Student achievement ranked below the national average in 2011 on all standard assessment exams (reading, writing, math, & science) • Source: National Center for Education Statistics

4. Cash Concerns

5. California School District Funding • Primary funding model known as the “revenue limit”. • A mix of property taxes and state aid for most districts. • The revenue limit is typically two-thirds of a district’s General Fund revenue. • Each district has a different revenue limit calculation, based on the district type (elementary, high or unified), size, historical spending patterns, and a multitude of other variables, which together make for a complicated and lengthy formula. • A district’s individual base revenue limit is multiplied by the district’s average daily attendance (ADA) to determine it’s total revenue limit funding each year. • Other “regular” funding will typically come from the following sources: • Other state revenue used to fund various programs within the district (known as “categoricals”). • Federal revenue • Local revenue (interest income, donations, etc.). Does not include property taxes, which are part of the revenue limit calculation.

6. Revenue Limit Funding Reported on J-29 • Imagine a bucket • Revenues raised through local property taxes are first dumped into the district’s bucket. • If the bucket is not filled, the state tops it off with state tax revenues (state aid).

7. Basic Aid Funding Reported on J-29 • If the bucket is completely filled by local property tax revenues, the state has no need to "top off" the bucket. If the bucket overflows with local property taxes, the district gets to keep the overage. • Districts whose buckets are completely filled by local property taxes are called “excess tax districts” (or "basic aid districts"). • There are typically less than 100 districts categorized as “basic aid” each year (out of a total of 1,131 districts). Because property tax revenues fluctuate each year, some districts are basic aid one year but not the next.

8. Additional Information • In the past, the state also gave districts with high property tax revenues an additional $120 per ADA (or $2,400 per district-whichever was greater). The California Constitution says that the state should contribute this additional money to fulfill its constitutional guarantee to provide all public schools with "basic aid." However, because of budget constraints in 2002-03, lawmakers decided to eliminate the $120, saying that the state met its constitutional obligation to these districts with other state funding from categorical programs. • At the time of the second principal apportionment (which is made in June), the California Department of Education officially certifies which districts are basic aid for the school year that is ending. Basic Aid Funding

9. The California state budget crisis has resulted in a revenue limit funding reduction to schools of over 20%. Additional cuts (“triggers”) may occur if Governor Brown’s tax initiative fails in November (Prop 30). • “Basic aid” districts don’t receive revenue limit state aid; they are cut through other state revenue sources (known as “categoricals”). K-12 Revenue Limit – Oakland USD Base revenue limit per ADA Revenue Limit Deficit Source: School Services of California, Inc.

10. State Apportionment Deferrals • State aid is received by schools throughout the year. • Amount of state aid varies depending on each district’s revenue limit calculation. • Total state aid is “apportioned” to districts on a “5-5-9” schedule (5% in July & August, 9% in September through June). • First state aid deferral to schools occurred in June 2003. • Deferred from June 30th to the first week in July. • Purpose was to assist state budget by reflecting one less payment to schools in 2002-03 fiscal year. • Nearly 10 years later, there are now numerous deferrals. • Eight inter-year deferrals from 2012-13 to 2013-14, totaling $7.2 billion. (Ed Code 14041.5, 14041.6) • Five intra-year deferrals within 2012-13, totaling $3.5 billion (AB 103). • Monthly deferrals in 2012-13 in accordance with the Education Protection Account (EPA), per the Governor’s November tax initiative, totaling nearly $7 billion.

11. Deferral Impact on District Cash Flow • Impact to each district varies depending on the amount of state aid in their revenue limit calculation. • Intra-year and cross-year borrowing has become far more prevalent, and the loans are a much larger percentage of total district revenue. • Borrowing options include: • TRANs • for property taxes paid in December & April • for intra-year and cross-year state deferrals • Borrowing from County Treasurer • Interfund borrowing by the district (self-funded borrowing)

15. Impact of Prop 30 on Deferrals • Prop 30 is the Governor’s tax initiative – the Schools and Local Public Safety Protection Act. • Increase in state sales tax from 7.25% to 7.50% • Resulting increase in revenue - estimates vary from $9 billion (Governor) to $6.8 billion (LAO) • If approved by the voters in November 2012, $2.24 billion in cross-year deferrals will be paid down. • If the initiative fails, cross-year deferrals will remain unchanged from 2011-12 fiscal year levels. In addition, mid-year trigger cut reductions of $2.6 billion will be implemented (approx. $441 per ADA statewide). • Competing initiative Prop 38 – The “Molly Munger Initiative” • Increase in income tax for most Californians • Results in increased revenue to schools of $10 billion • No impact on state deferrals

16. Impact on Schools of ABX1 26 – The Elimination of Redevelopment Agencies (RDAs) • LEAs (Local Educational Agencies) and other affected taxing entities previously received only one type of identified revenue from RDAs— pass-throughs. In most counties, generally paid via warrant from RDAs. • Under ABX1 26, LEAs and non-LEAs now receive THREE types of identified revenues from (former) RDAs: • Pass-throughs • Additional property taxes from Residual Distributions • Additional distributions of Other Revenues • Typically by electronic funds transfer from the County Auditor-Controller. • All distributions are supposed to be based on post-ERAF percentage shares of property taxes within each RDA Project

17. Impact on Schools of ABX1 26 – The Elimination of Redevelopment Agencies (RDAs) • The California Department of Finance previously estimated LEA share of residual distributions and other revenues for FY 2011-12 at $1.037 billion statewide, including: • $887 million for K-12 Districts • $ 3 million for County Offices of Education • $147 million for Community College Districts

18. Impact on Schools of ABX1 26 – The Elimination of Redevelopment Agencies (RDAs) • Actual LEA shares of residual distributions and other revenues in FY 2011-12 were much lower than DOF estimates, due in part to the following: • First distribution from RPTTF on May 16, 2012 was zero, since over • 50% of tax increment was already allocated to RDAs before they were dissolved on Feb. 1, 2012. • Former RDA debt service and enforceable obligations were much greater than DOF expected. • Other revenues were smaller than DOF expected, and will require additional time to be liquidated and distributed.

19. Impact on Schools of ABX1 26 – The Elimination of Redevelopment Agencies (RDAs) For Alameda County schools, the impact is shown below:

20. Debt Concerns

21. Why discuss debt? • Debt affects us in many ways and at many levels. • As individuals, we are familiar with debt on a personal level. • Whether it’s a mortgage, car note, credit cards or a payday loan, we understand that borrowing allows us to afford things we otherwise couldn’t. • However, we know that too much debt can be harmful. • It could lead to annoying or threatening creditor phone calls, poor credit ratings, increased interest rates on future borrowing, default, lawsuits, bankruptcy, depression, and fraudulent behavior.

22. Why discuss debt? • At the local government level, state level, national level and • international level debt can also be helpful because it allows us the same borrowing power. But, too much debt at these levels has the same • kind of devastating effects. • For instance, there has been a lot of talk about the European debt crisis. The primary countries involved (Portugal, Italy, Ireland, Greece, and • Spain) have had to undergo strict scrutiny from their lenders and had • to take measures to reduce their expenditures or restructure their • obligations in order to avoid defaulting on their debt. • This overwhelming debt threatens to ruin the European Union and • harm the Euro. American banks fear that a collapse of the European • banks could negatively affect them and the U.S., which could in turn • affect California and local governments.

23. Why discuss debt? • Closer to home, the U.S. government has seen its National Debt increase to over $16 trillion. Many believe that this level of debt • is unsustainable. • At the state level we are familiar with the deficit issues that • California is facing. We understand how the state has manipulated the cash flowing to local governments. • However, to understand the magnitude of the debt, refer to the • State Treasurer’s Debt Affordability Report (issued October 2011). www.treasurer.ca.gov/publications/2011dar.pdf

24. Why do we care about too much debt at the international level, national level, or state level? International and National Levels • At the international and national levels, countries might choose to liquidate debt • in ways that could have negative fiscal impacts on its citizens and local governments. • The working paper called Liquidation of Government Debt (Issued in April • 2011, http://www.imf.org/external/np/seminars/eng/2011/res2/pdf/crbs.pdf) discusses ways that sovereign nations have historically liquidated overwhelming debt. • Three ways that have negative impacts to individuals and local governments • are: • Financial repression, • Austerity measures, and • Default/Restructuring of debt.

25. Why do we care about too much debt at the international level, national level, or state level? • Financial repression can cause hidden or stealth inflation. This could lead • to reduced purchasing power. As organizations have to spend more on goods and services, it may also lead to layoffs and higher unemployment. • Austerity measures can have a ripple effect to citizens and local • governments also. Reduced expenditures could result in loss of jobs not • only at the central government level, but also at the local level. This could • result in higher unemployment, and less money spent on social programs and infrastructure projects. • Default/Restructuring of debt, may lead to devaluation of the currency, which drastically reduces purchasing power. This could result in inflation, higher unemployment, and less money spent on social programs and infrastructure projects.

26. Why do we care about too much debt at the international level, national level, or state level? State Level At the state level, too much debt can lead to default/restructuring of debt or austerity measures. This could result in job loss, higher unemployment, and less money spent on social programs and infrastructure projects. Local Level At the local level, we see bankruptcy, default/restructuring of debt or austerity measures. This could also lead to job loss, higher unemployment, and less money spent on social programs and infrastructure projects.

27. When is there too much debt? Economists look at states' and nations' debt-to-GDP ratios to determine the level at which debt starts to cause growing problems. A debt-to-GDP ratio of 90% is where many economists agree the negative consequences of debt become serious. At this level, residents will see more and more of their tax dollars used for interest payments rather than the state services they rely on, and economic growth is likely to slow down. See the article “State’s Finances Threaten Whole Country” By Emily Washington, Updated 7/30/2012 Emily Washington is associate director of state outreach at George Mason University's Mercatus Center.

28. When is there too much debt? See the article – “10 Countries Deepest in Debt,” by 24/7 Wall St. - Michael Sauter, Charles Stockdale, Ashley Allen - February 14, 2012

29. When is there too much debt?

30. When is there too much debt? Buffett’s Exit From Muni-Bonds Signals Trouble Ahead for Local Govts By Morgan Korn, Daily Ticker – 8/21/2012 Warren Buffett's Berkshire Hathaway ended its five-year bullish bet on the municipal bond market. Buffett's move may very well signal his fear that more cash-strapped cities, states and municipalities will default on their debt. Local authorities have been making severe budget cuts (affecting both personnel and services) over the past two years to stave off bankruptcy but many are still short on funds. There have been six Chapter 9 municipal bankruptcy filings this year, compared to 13 in 2011. Muni bankruptcies have totaled 268 since 1980, according to Reuters, with cities, villages and counties accounting for 49 of the filings. Nebraska, California and Texas have the highest number of bankruptcy filings. Stockton, Calif., became the largest U.S. city to ever declare bankruptcy when city officials were unable to reach a deal with creditors, and San Bernardino, Calif., filed its bankruptcy paperwork on Aug. 1, making it the third California city, after Mammoth Lakes, to seek bankruptcy protection.

31. How Should We Measure Whether There Is Too Much Debt? The Deceptive Debt Ratio By Erik Voohrees - June 8, 2010 The statistic normally used to measure debt is the "Debt to GDP" ratio, referring to the amount of debt versus the nation's sum total of transactions. However, debt is not serviced from a portion of the economy's activity as a whole; it is serviced from tax revenues. As such, the ability to repay debt should be measured based on tax revenues, not on the GDP. "Debt to Tax Revenue" is a much better statistic for examining government debt.  

33. Questions? Contact Info: Jeff Potter (510) 670-4277, jpotter@acoe.org Spencer Mead (510) 670-4195, smead@acoe.org