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Arizona Is Facing E.D. Sanctions Over Aid System

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The state of Arizona faces a severe disruption in its budget, and some of its school districts face the loss of millions of dollars in federal impact aid, because the U.S. Education Department has declared the state's system for equalizing resources among districts inadequate.

The decision marks the first time the agency has passed such judgment. But the impact-aid rules at the center of the dispute could cause similar disruption in other states and plunge the federal government into local controversies over education finance.

"It's one of those cases where the potential implications are so big that they defy a resolution with the implements at hand," Charles E. Hansen, director of impact aid for the Education Department, said last week.

Impact aid, the oldest federal education program, assists school districts whose tax bases are limited by the presence of federal property or workers. The law has long barred states from reducing their own aid to impact-aid districts, since such cuts would negate the effect of the federal subsidy.

In 1974, an exception was added allowing states to consider impact aid part of a district's resources for the purpose of implementing an equalization plan. To prevent states from withholding funds from impact-aid districts without actually moving to equalize funding, the federal government drafted rules defining an acceptable equalization plan.

Under these rules, the Education Department has certified the plans of seven states, including Arizona. But the impact-aid office is apparently examining these plans more closely than in the past.

In April, the department told Arizona officials that they could not deduct state funds from their impact-aid districts in the current fiscal year, and that their applications for the 1989 and 1990 fiscal years were denied as well. The state has appealed the ruling to an administrative-law judge.

If the state loses the case, Arizona in theory would owe more than 50 of its school districts a total of about $50 million.

But the federal government has no authority to force payment, and if the state did not comply, the law states that the districts would be ineligible for impact aid for the years in question. The districts would thus be liable for repaying approximately $120 million to the federal government.

Observers agree that the Congress is virtually certain to prevent such a result with legislation, and that lawmakers are also likely to revamp the law when the impact-aid program is reauthorized in 1993.

"We were going to recommend changes to the equalization section anyway," said John Forkenbrock, executive director of the National Association of Federally Impacted Schools. "This made it a priority issue.''

But any such measures will not resolve the immediate budgetary tangle in Arizona, which could also arise in other states. Mr. Hansen of the impact-aid office said Kansas' plan might be rejected this year, and that other states could face the same problem in later years.

"We've submitted our data to [the federal office], and the initial ruling is that we don't qualify," Veryl Peter, director of school finance for Kansas, said last week.

He said the state had made a similar case each year since the mid-1970's and that Kansas officials were surprised at an apparent change in policy at the federal agency.

"The only thing we can gather is that they are reviewing their policies," Mr. Peter said. "They feel that maybe they've been misinterpreting the regulations."

The Geary County, Kan., school district has requested a hearing, set for September, to sort out the facts, said Mary Devin, the district's deputy superintendent.

She said district officials had no specific criticism of the state equalization formula. But "if [the formula] doesn't meet the Education Department's standard," she added, "we ought to take a look at it."

In Arizona, property-poor districts have criticized the state's plan almost since its adoption in 1980.

In theory, the plan fosters equity by limiting the amount each district can spend--a figure based on student counts and factors that increase costs, such as disabled students and transportation costs--and mandating a theoretical tax rate. The difference between local revenue raised and a district's permitted spending level is to be made up with state and county funds.

But critics argue that plan does not live up to its theoretical goals.

Patrick E. Graham, an administrative assistant for the Window Rock Unified School District, said that while the theoretical tax rate is currently $4.72 per $100 for a unified school district, property-rich districts routinely set rates as low as 2 cents per $100 and still raise millions of dollars in property taxes.

As a result, he said, districts' per-pupil expenditures range between $2,500 and $12,000 per child.

Forbis Jordan, a professor of school finance at Arizona State University, said that while the formula is, in theory, "one of the most equitable in the country," costs have risen in the years since it was approved, while state funding has declined. And voters in many districts have approved exemptions to the spending caps.

"They're disequalizing," he said.

Mr. Graham said he and other district officials had protested federal approval of the plan for years without success.

"We argued up and down that federal officials didn't understand how Arizona's system really worked," he said. "But we had no luck at all."

A review of the federal impact-aid office's files on the Arizona equalization plan suggests that the dissatisfied districts often made the wrong arguments, complaining about inequities rather than arguing that the plan did not meet federal criteria.

But the files also contain letters that make relevant points--and no record of any reply from state or federal officials.

Mr. Hansen took over the impact-aid office in 1988, and the analyst who had reviewed equalization plans for the office retired.

"We had fresh sets of eyes looking at the data and talking to Arizona about the proposal they were contemplating submitting," Mr. Hansen said. "At the same time, in the state, there were districts that had invested time and energy in learning how the state program works in order to really ask some questions."

Officials in the affected impact-aid districts--and also some disinterested observers--say the Arizona plan should never have been approved.

"That's possible," Mr. Hansen said, "but I'm not raising that question."

To qualify under federal rules, an equalization plan must meet one of two tests. The simplest requires that the disparity in per-pupil spending between a state's poorest and richest districts be no more than 25 percent.

The more complicated formula, which both Arizona and Kansas have used successfully, requires that 85 percent of a state's school funds be ''wealth neutral," or raised and distributed in such a way that each district receives the same amount from an equal local tax effort.

In Arizona, district officials say, the state used its theoretical tax rates and spending limits in the calculations that verified that the formula was producing "wealth neutrality," rather than examining the money actually available to school districts--an assertion that is supported by the Arizona documents on file in Washington.

"When we asked [state officials] about that, there was a dead silence in the room," Mr. Hansen said.

According to Education Department documents, Arizona officials first intended to apply for fiscal years 1989 and 1990 under the wealth-neutrality standard, but changed that position in the fall of 1990, when they submitted final data.

Mr. Graham of the Window Rock district said they changed their minds after calculations showed that the state would fail to meet the requirements.

While Mr. Hansen agreed that the state had apparently been applying the test incorrectly--usingel10ltheoretical rather than actual figures--he would not speculate on whether Arizona would have failed.

Arizona officials instead sought approval under a third standard, which allows states to qualify without meeting either the spending-disparity or wealth-neutrality standard if they can prove that "exceptional circumstances" exist.

This test requires a state to show that applying either of the other standards would be inappropriate and unfair--an ironic argument for Arizona, since the state had qualified under one of the tests six times. The Education Department ultimately rejected the state's arguments about the feasibility of the two tests.

The "exceptional circumstances" standard also requires a state to prove that resources are more equal among its school districts if impact aid is taken into account than if it is not. In their decision, federal officials stated that this test is the "core criterion," because it ensures that impact-aid deductions are not allowed to increase inequity.

The department concluded that Arizona failed this test, and the federal analysis suggests that the state's method of calculating disparities has basic flaws.

"We don't care about theory," Mr. Hansen said. "What is the actual production of revenue? How does it turn out?"

According to federal documents, the state assumed in its calculations that the legislature would reduce state aid if it could not make deductions based on impact aid; used theoretical spending limits, rather than actual spending or revenues, in its calculations; excluded funds derived from tuition students; and used a weighted student count that included some factors that might be impermissible under federal rules.

In particular, poor districts argued in testimony on the application, a factor that assumes increased needs for districts employing more experienced, higher-cost teachers unfairly aids affluent districts.

In their decision, federal officials termed the use of these assumptions and methods "highly questionable." In addition, they said, even if the as4sumptions were allowed, resources were less equal when impact aid was deducted than when it was not--once calculation errors in the state's application were corrected.

Gene Gardner, Arizona's director of school finance, said last week that he was reluctant to discuss the specifics of the calculations. He conceded, however, that errors were made.

And state officials admitted that they had used the same questionable weighting factors and theoretical spending limits in earlier years.

Mr. Gardner said the state might raise that point during the appeal process in defending its actions.

State officials say the root of the problem is miscommunication.

"We have some elements in our formula [federal officials] don't understand," said Judy Richardson, the state's administrator for school finance. "It has some components that are not seen in other states."

But critics of the plan say that what has happened is that federal officials have finally woken up.

"I have looked at the formula, and I think [federal officials] understand it very well," said Molly S. McUsic, a lawyer who helped draft a legal challenge to the equalization plan.

The lawsuit, filed late last month on behalf of four school districts, asks a state court to void the plan on the grounds that it effectively penalizes poorer districts that cannot raise the revenues needed to upgrade facilities.

Ms. McUsic acknowledged that issues raised in the suit differ from those raised by the federal government, which considers only equalization of current operating expenses, not capital expenditures.

However, she argued, the suit highlights the "most egregious" inequities among Arizona districts.

The overlapping premise between the lawsuit and the impact-aid dispute, said Mr. Graham of Window Rock, which is not a party to the suit, ''is that we've been arguing the qualifying tax rate is only a theory.''

Other observers agree that state officials are determined to appeal the Education Department's finding at least partially because of its potential impact on the finance litigation.

"There's a bigger issue than impact aid here as far as the state is concerned," Mr. Forkenbrock said.

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