LAO Forecasts a Less Dire–But Still Dicey–Budget Outlook

Due to a combination of a revenue upturn and reduced spending, Legislative Analyst Elizabeth Hill writes in a November 16, 2005, report that California�s budget outlook for 2006-07 has “improved significantly” but “still faces major operating deficits in the next several years.”"We’re not out of the woods yet,” Hill later told a group of Capitol reporters.

This forecast–the annually produced “California’s Fiscal Outlook”–is the first real peek at the fiscal context for the 2006-07 California State Budget, and not only is it the earliest, it is also widely hailed as being the most objective and accurate. (The entire report is available online at: http://www.lao.ca.gov/2005/fiscal_outlook/fiscal_outlook_05.pdf.)

For schools, the most significant short-term projection is that the natural increase in the Proposition 98 minimum guarantee (3.6%) will be insufficient by more than $700 million to fund $2.5 billion in �base� costs for COLA and growth. While statewide ADA is actually projected to decline by 0.1% in 2006-07, the statutory COLA for 2006-07 is now projected at 5.2%. This doesn�t include an additional $428 million in revenues and expenditures for Proposition 49, an initiative passed by the voters in 2002. By contrast, the long-term projection for Proposition 98 funding is far better.

State Budget Overview

The 2005-06 fiscal year will wind up, according to the Legislative Analyst�s Office (LAO), with State Budget reserves of a projected $5.2 billion, nearly $4 billion more than was projected at the time the Budget was adopted. (Of this, $1 billion is attributable to 2004-05 and prior years and $2.8 billion to 2005-06). This surplus would be enough to balance out the projected $4 billion operating shortfall for 2006-07, even without any new taxes or increased revenue projections due to a strengthened economy.

On the downside, the LAO still projects �multibillion dollar� operating deficits down the road through 2009-10, and warns that those numbers could skyrocket if the economy stumbles with a downturn or even a �sharp slowdown.�

Proposition 98 Details

The LAO projects that current year total funding for Proposition 98 will drop about $150 million due to a decrease below budgeted levels in K-12 attendance. Additionally, an increase in local property taxes dedicated to schools, decreases the state�s General Fund obligation by another $225 million. The LAO also projects that the Proposition 98 minimum funding level will increase due to state General Fund revenue increases generating maintenance factor repayments. However, since Proposition 98 was originally �overappropriated� this year by $741 million, the increased funding minimum will not result in any actual increase in the current year for school funding under Proposition 98. (The LAO projects that the budgeted Proposition 98 appropriations for 2005-06 will still be $65 million above the minimum guarantee after taking all adjustments into account.)

Budget Year and Beyond

Through 2010-11, the LAO projects an average annual increase in the Proposition 98 minimum guarantee of 5.7% (compared to a 5.4% increase in overall state spending). But this increase is concentrated in the last three years, which show an average 6.4% annual increase.

The 2006-07 Proposition 98 minimum guarantee reflects an increase of 4.4%, from $49.9 billion to $52 billion. Of that, 0.8% is due to increased funding�and payment obligations�under Proposition 49 . In out years, the LAO forecasts an increase of 5.0% in 2007-08, 6.6% in 2008-09, 7.0% in 2009-10, and 6.7% in 2010-11.

This would be more than sufficient to fund �the base� (growth and COLA) for every year but 2006-07. In 2007-08, the LAO projects that an additional $867 million would be available above growth and COLA, with that amount jumping to $2.1 billion in 2008-09, $2.5 billion in 2009-10, and $2.7 billion in 2010-11.

Why the sudden jump in 2008-09? Somewhat surprisingly, the LAO projects that Test One (which hasn�t been operative since the very first year of Proposition 98) will kick in again beginning in that year. This is partially due to the slowdown of the state�s enrollment growth. (The Test One minimum guarantee is based merely on a flat share of the State Budget, and it isn�t increased to account for student enrollment growth, as is Test Two and Test Three.) But also significant is the impact of Proposition 1A and the �triple flip,� which will increase Test One�s minimum share of the State Budget from 34.5% in 2003-04 to 41.6% in 2006-07. Since the Test One share excludes the state�s rapidly increasing property tax revenues, the LAO projects that it will provide strong revenue growth to Proposition 98.

It is important to note that all of the LAO projections�particularly regarding Proposition 98�are based on current funding levels and do not predict any funding above the Proposition 98 minimum guarantee. And this may not be the case by the time the State Budget is inked. Given the inability in 2006-07 for the minimum guarantee to provide for even mere growth and COLA, and given the drubbing given to Proposition 76 by a pro-education electorate just one week ago, an appropriation above the minimum is certainly possible in 2006-07. In fact, Sacramento Bee reporter Gary Delsohn reported last week: �Schwarzenegger said he told legislative leaders at a meeting earlier: �We should try everything we can to give education as much money as possible, and we just have to find the revenues.�”

Should an overappropriation occur, any amount above the minimum guarantee will be built into the base and will affect out-year amounts, possibly delaying the onset of Test One�s application. But what is new in this projection is that any augmentations would be overshadowed by the funding provided under Test 1. This is the main reason why the LAO actually offers overappropriation above the minimum level as a legislative option for 2006-07.

However, until Test One territory is reached, Proposition 98 is also extremely sensitive to state revenues as they factor into the repayment schedule for the maintenance factor obligation during Test Two years, which the LAO projects will be in play from now until Test One kicks in. These revenues could be at risk because of rising interest rates, high energy costs, and even accounting vagaries regarding tax amnesty dollars and in which years they should be accrued. Additionally, the LAO believes that legislative action will be required to re-bench the Test One formula subsequent to Proposition 1A. And even after Test 1 applies, Proposition 98 funding would still be sensitive to state economic changes, since we would get a fixed share of the State Budget pie �a pie that still depends on the level of state tax revenues.

Questions Regarding the LAO Report

[Editor�s Note: In the wake of the Legislative Analyst�s Office (LAO) report �California�s Fiscal Outlook�2005-06 through 2010-11� released on Wednesday, November 16, 2005, a number of questions have arisen.]

Q1. Now that the LAO projects a statutory COLA of 5.2% for 2005-06, should we use that COLA for our planning for 2006-07?

A1. No, for three reasons. First, as the LAO report notes, the jump in the statutory COLA is largely the result of the spike in energy prices. With the recent moderation of gas prices, we wouldn�t be surprised to see the statutory COLA come in at less than 5.2%. Remember that the index used for the statutory COLA reflects price changes for the
12-month period ending March 31, 2006 (ref. Education Code Section 42238.1), so there are still several months to see changes to this index.

Second, the LAO notes that the statutory COLA is based on a national measure of price changes for state and local government�and this year, that index may overstate government price changes in California. (We sure hope the Legislature doesn�t act on this information.)

Third, even if the final COLA is 5.2%, it may not be fully funded, given the LAO�s forecast that the growth in Proposition 98 funding for 2006-07 would be insufficient to fund COLA and growth.

So, our suggestion is to hold tight for now at the 4.4% COLA we�ve predicted on our Dartboard, but to keep an eye peeled for the number floated in the Governor�s Budget on January 10�less than two months from now.

Q2. Assuming that the LAO forecast of both Proposition 98 funding and the statutory COLA are accurate, will this lead to the 5.2% COLA applying�but being offset in part by a bigger deficit?

A2. Not necessarily. The LAO forecast indicates that the growth in Proposition 98 funding, starting in 2007-08, will be more than sufficient to fund COLA and growth. As a result, the LAO reports that it may make sense to use one-time monies to fund the COLA in 2005-06 even though that is an ongoing cost. Among the options that the LAO lists are:

� Using Proposition 98 settle-up dollars from prior years�that is, funds owed under the Proposition 98 minimum funding level for 2003-04 and several prior years. This is money the state must appropriate anyway. A major advantage to using this approach from the state�s perspective is that it would not increase Proposition 98 funding for 2006-07 that is carried into the future. In total, more than $1 billion is owed to schools for prior years.

� Using Reversion Account funds�that is, funds appropriated under Proposition 98 in a prior year that were not used. Typically, several hundred million dollars per year in Reversion Account funds are available.

Q3. In a recent Update article, you wrote that schools probably wouldn�t get more in 2005-06, even though state tax revenues were up $1.8 billion over prior budget estimates. Now that the Legislative Analyst�s Office forecasts a jump in state taxes of almost $4 billion, won�t schools get more in 2005-06?

A3. As described in our prior article �Ask SSC . . . Will the $1.8 Billion in New State Revenue Trigger Higher Funding for Schools� (see the November 10, 2005, Update, page 295), we noted that the critical factor for determining new funding for schools is the growth in state tax revenues from one year to the next. According to the LAO�s forecast, while total state tax revenues are now projected to be up about $3.8 billion over earlier budget estimates, the LAO attributes $1.0 billion to 2004-05 and $2.8 billion to 2005-06. This allocation between fiscal years is important, since more than $1.0 billion of the new money from 2005-06 is needed to �keep pace� with the increased revenue for 2004-05.

Taking the projection of $3.8 billion in new revenues into account, the LAO estimates that the 2005 Budget Act appropriation for K-14 school agencies�which was calculated to be $741 million more than the Proposition 98 minimum funding level when the 2005-06 State Budget was adopted�is now only $65 million more than the minimum But the LAO also acknowledged that if as little as $200 million of the $1 billion in additional state revenue assumed to apply to 2004-05 is recorded, instead, as 2005-06 state income, then the Proposition 98 minimum funding level would be higher than the amount already appropriated, and �the state would face a large Proposition 98 settle-up obligation in the current year and added base spending for future years.� While the LAO report did not specify an amount, we estimate that, under the scenario of a $200 million shift in taxes between 2004-05 and 2005-06, the settle-up obligation would be between $100 million and $150 million.

Q4. Why is the LAO now projecting no State Budget shortfall for 2006-07, but a return to shortfalls starting in 2007-08?

A4. It is important to recognize that the LAO is still projecting a State Budget structural unbalance of about $4.0 billion in 2006-07�that is, 2006-07 state expenditures are projected to exceed 2006-07 state revenues by $4.0 billion. But the LAO also forecasts a carryover balance of $5.2 billion from 2005-06, which is enough to cover this shortfall. Thus, the LAO continues to forecast operating shortfalls for 2006-07 and subsequent years.

The burst in revenue in the current year, however, requires some explanation. There are many factors that seem to be in play, but two of the main factors are:

� Much of the recent increase in state tax revenues over prior budget estimates appears to be one-time in nature, and are the result of rapid appreciation in home prices, taxes on oil companies, and capital gains from the stock market, none of which are likely to continue into the future. One press report quoted Ted Gibson, a former chief economist for the state Department of Finance, referring to the �Google Effect,� meaning that the capital gains from the stock of that one company alone accounted for a large portion of the unexpected state tax revenue.

� The recent state tax amnesty program has generated some $3.8 billion in receipts, but only about $380 million of that amount represents a net increase in state taxes. The other $3.4 billion will either be refunded or, alternatively, only represents early payments of taxes that would have been paid anyway at a later date. Thus, the tax amnesty resulted in big increases in tax revenues now�but fewer revenues later.

In short, thanks to these one-time effects, we have a lot of cash on hand, but still have a structural imbalance. As Legislative Analyst Liz Hill cautioned at her press conference on Wednesday, November 17, 2005, �We�re not out of the woods yet.�

Chancellor�s Office�s 2006 State Legislative Program

Prior to the start of a new legislative session, the Chancellor�s Office solicits legislative proposals from local community college districts and statewide organizations to develop its state legislative program. This year, 40 proposals were received from the field. In collaboration with a task force from the Consultation Council, the proposals were reviewed and prioritized for consideration by the Board of Governors. It is anticipated that the Board of Governors will take action on all or some of the proposals at its December 2005 Board meeting. Chancellor�s Office staff will then start the process of seeking authors as soon as the Legislature returns in January 2006.

The following is a summary of the consensus proposals supported by the task force of the Consultation Council:

1. Pursue changes to relax restrictions on concurrent enrollment. The task Force recommends that we should encourage our K-12 partners to take the lead on this issue.

2. Seek legislation to reauthorize the Economic and Workforce Development Program.

3. Pursue changes to improve the facilities project plan check review process while maintaining safety standards. Explore using the �Facilities Bond Act� bill, AB 58 (Nunez, D-Los Angeles), as a vehicle for incorporating changes to the plan check review process. (A Board of Governors discussion item pending to seek legislative and fiscal relief to enable colleges to acquire resources, or provide additional flexibility for bond funds to maintain facilities.)

4. Pursue minor, technical changes to allow for the purchase of offsite facilities (buildings that substantially meet the Field Act and were constructed on or after January 1, 1998).

5. Continue to support legislation that secures the fiscal integrity of the community college system, such as the property tax backfill and a contingent appropriation.

6. Support legislative changes that support the community college system budget proposal, and defer specific budget changes to the budget task force.

7. Pursue uniform guidance to address natural disasters and special needs (details must be reviewed through the community college system process so as to maintain local authority).

8. Pursue legislation to give the community college system greater authority over regulations.

9. Legislation that appears to violate the community college system�s legislative principles should not be pursued.

10. Pursue positions on pending legislation as described in Board of Governors Standing order 317.

The 2006 legislative session is the second year of the two-year legislative cycle, so all legislation introduced in 2006 must be acted upon that year. The last day for the Legislature to introduce bills is February 24, 2006.

Should Community Colleges Issue High School Diplomas?

Questions are being raised about the legal authority of the California Community Colleges to award high school diplomas. These questions are being asked at this time because many California high school seniors are in jeopardy of not passing an exit examination in math and English this year, thus severely handicapping their ability to receive a diploma from the high school they are attending. However, under a seldom used authority, community colleges can create basic skills programs and present such diplomas.

A legal opinion obtained by the Chancellor�s Office says that community colleges need not abide by the high school exit examination requirements. �Community colleges are authorized to operate their own adult education programs, including high school diploma programs, independent of those offered by K-12 school districts,� the opinion reads.

Potentially, community colleges could create second chance diploma opportunities for thousands of teenagers. Realistically, however, even if the political will exists to create a widespread safety net, the prospects would be tempered by facilities, staffing, and other limitations.

The Chancellor�s Office indicates that it is aware of only seven community college districts that are currently awarding high school diplomas. Nonetheless, talks are occurring behind the scenes between officials of the California Department of Education and the community college system about academic standards and the potential expansion of such programs. A consulting firm for the California Department of Education recently cited community colleges� high school diploma programs as one of several possibilities for serving the estimated 50,000 students who will finish the 12th grade in 2006 without passing the high school exit exam.

Community colleges could launch new high school diploma programs without legislative approval, thus sidestepping potential political issues (Education Code Section 78401 authorizes community colleges to award diplomas). Money could be an obstacle, though, because basic skill courses are funded by the state at a rate much lower than traditional college classes.

State Superintendent of Public Instruction, Jack O�Connell, is concerned about standards, raising the possibility that academic expectations could be too low, now or later. He was quoted as saying, �Any entity that would award a student a diploma without the knowledge and skills to back it up does a great disservice to that student.� Chancellor Drummond said he is gathering information on academic requirements from each campus that awards high school diplomas. He said he is �fairly well convinced� that their standards are solid.

Legislators who have weighed in on the issue believe that community college high school diploma programs are a �huge loophole� that contradicts legislators� intent to require passage of the exit exam before any source grants a diploma.

Stay tuned�this issue will not likely go away and we could see legislation in 2006 that addresses the concerns of the Legislature regarding high school exit exams and what role, if any, community colleges should play.

Board of Governors Certifies District Obligation for Full Time Faculty Hires

By November 20 of each year, the Board of Governors determines whether adequate growth funds and adequate cost-of-living adjustment (COLA) funds have been provided to allow full or partial implementation of a district�s full-time faculty hiring obligations. Generally, districts must employ a specified minimum number of full-time faculty each fall term. This requirement is expressed in terms of full-time faculty equivalent positions and is commonly refered to as the full-time faculty �obligation.� In years in which the BOG determines that adequate COLA and growth funds are available for full implementation, each district�s obligation increases approximately by its percentage increase in funded full-time equivalent students (FTES) in credit courses.

Current law specifies a goal of having 75% of the hours of credit instruction taught by full-time instructors. Most districts over the years have been unable to reach the 75% goal. The difficulty in attaining the 75% goal reflects, in part, the chronic underfunding of community colleges and also the specific failure of the Legislature to designate adequate amounts of funding for �program improvement.� The Chancellor�s Office budget request for 2006-07 includes $40 million to boost progress toward the 75% goal.

The 2005-06 Budget Act includes $136.7 million for enrollment growth for general apportionment (a statewide average of 3% growth) and also includes $198.5 million for a general apportionment COLA of 4.23%. This appropriation fully funds the COLA called for under state law. Thus, the Chancellor�s Office analysis indicates that the 2005-06 Budget Act provides adequate growth and COLA funds for full implementation of the increases in district obligations to employ full-time faculty. Under this action, each district�s obligation would be increased by its percentage increase in funded credit FTES.

Ask Arnold. . .

What Is Maintenance of Effort, and How Is It Measured?

Q. We are in the middle of negotiations with our teachers� union. The union has indicated to us that it thinks that our district�s �maintenance of effort� for the unit is not very good. What do they mean by �maintenance of effort,� and how is it measured?

A. In its simplest form, maintenance of effort means that what you are offering in compensation and working conditions will allow you to maintain relative comparability over time. The Educational Employment Relations Act requires that factfinding panels consider a �comparison of the wages, hours, and conditions of employment of the employees involved in the factfinding proceeding with the wages, hours, and conditions of employment of other employees performing similar services and with other employees generally in public school employment in comparable communities.�

There are many ways to demonstrate your effort to a specific bargaining unit. A percentage of expenditure budget allocated to a specific bargaining unit is one way. Showing that the percentage allocated to that unit has remained constant or has increased over time can be compelling. In addition, comparing your percentage to your neighbors� or to the statewide average can demonstrate your effort toward that unit.

Another way is to lay out the salary increases given over a set number of years, along with step and column and health benefit increases, compared to the same information from neighboring districts that are in comparable communities. If your total over that period of time is in the mid range of the comparable districts or higher, you could argue that you have maintained your effort. In addition, including other working conditions, like class size or extra preparation periods, is appropriate if you are providing extra effort in areas other than salary and benefits.

Yet another way is to compare your total compensation ranking at the beginning of a time span to your total compensation ranking today. If you have maintained or improved your relative position or ranking over the time span, you can again argue that you have maintained your effort.

Maintenance of effort is not the same as comparability. A district could be ranked near the bottom of the salary rankings, but if it is now giving higher raises or spending a greater share of its budget in the bargaining unit, it could have greater maintenance of effort and still have low salaries.

Like many aspects of negotiations, demonstrating your maintenance of effort to specific bargaining units is not a science and there are many ways to do it. However, demonstrating it in a way that is reasonably explained and that the bargaining teams or a reasonable third-party can understand is the best way.

By the Way . . .

New Community College Board of Governors Member Appointed. The Governor has appointed Porterville resident Gary Reed to the California Community College Board of Governors. Mr. Reed has been a partner in the investment management firm of Reed, Shoemaker, and Brookshire since 1993. He previously served as chief of staff to former Assembly Member Bill Jones from 1991 to 1992, and as a Tulare County Supervisor from 1988 to 1990. He is a member of the California State University, Bakersfield Advisory Board, the Porterville Chamber of Commerce, and the Porterville Education Foundation.

Senate Confirmation will begin when the Legislature returns to Sacramento in January 2006.

Commission Reaffirms Vote to Terminate Compton College�s Accreditation. The Accrediting Commission for Community and Junior Colleges has reaffirmed its June 2005 decision to terminate Compton Community College�s accredited status.

State Chancellor Mark Drummond expressed disappointment over the Commission�s finding, citing the improvements that the college has made in recent months. Improvements in the college�s fiscal management, shared governance, human resources, and planning and research operations have occurred since the Commission�s initial findings. Chancellor Drummond has promised Compton College students, faculty, and staff that his office will pursue every legal remedy to keep the college open. During the interim, Drummond indicated that, for the foreseeable future, nothing has changed. The college is still open and accredited.

The college continues to be under the administrative authority of the Chancellor�s Office with Interim President Jamillah Moore, Special Trustee Dr. Charles Ratliff, and Associate Special Trustee Dr. Sally Chou.

Californians Rank the Economy as the Number One Problem Facing the State. A recent statewide survey by the Public Policy Institute of California (PPIC) found that the state�s economy remains the top issue. Californians continue to rank the economy (19%) and education (14%) as the most important problems facing the state, followed by immigration (9%). As further evidence of economic concerns, 56% of residents say that the state will have bad economic times in the coming year. They are also twice as likely to say that the state is headed in the wrong direction rather than the right direction (60% to 30%).

The economy and education were also the top two issues in May, August, and September. At the beginning of the year, the State Budget ranked as one of the top two issues, along with education, while the economy was ranked lower than it is today. Today, the economy is one of the top two concerns in all major regions of the state.