Policy Changes Can Help Districts Avoid a Funding Cliff

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When fiscal year 2012 begins later this calendar year, we will see many school districts hit what education law and policy experts call the “funding cliff ”: Revenue from state and local sources will not yet have rebounded—state and local governments are usually the last to recover from a recession—and the billions of dollars of federal stimulus funding poured into public schools over the past two years will nearly have run out.

Sadly, some districts already have plunged down that cliff.

Consider California, where 16 percent, or 174, of the state’s 1,042 school districts are on what California calls its “financial watch” list. In Illinois, 11 percent, or 94, of the 868 districts are on either the “financial watch” or “early warning” list. Ohio has designated 10 of the state’s 613 school districts to be in “financial emergency,” and Arkansas has labeled eight of its 305 school districts in “fiscal distress.”

Are these states and these districts aberrations? It seems unlikely, though it is impossible to say. Few states monitor their school districts’ fiscal health as closely as these four, and so no one knows how many districts nationwide are in or nearing fiscal crisis. It is probably dozens, if not hundreds, more than the 286 districts identified by Arkansas, California, Illinois, and Ohio.

That is the bad news—indeed, the very bad news. But there is hope in the policy arena: If federal and state lawmakers act decisively now and make some tough but smart choices, they could go a long way toward helping districts avoid future funding crises.

—Gregory Ferrand

Fiscal Accountability in the ESEA: When Congress reauthorizes the Elementary and Secondary Education Act, which it could do this year, it has an opportunity to add new fiscal-accountability measures to the law.

Specifically, Congress could require that as a condition of receiving funding under the ESEA, each state must: (1) help school districts create immediate, additional cost savings; (2) publicly monitor districts’ fiscal health and create a plan for escalating involvement when a district nears and reaches fiscal crisis; and (3) assist in stabilizing districts’ revenues for the long term.

Such fiscal-accountability measures are not a panacea for districts’ present fiscal challenges, though. The real promise of these measures lies in the possibility of minimizing the funding-cliff problem in the future, if not avoiding it entirely.

Increasing States’ Oversight of Districts’ Fiscal Health: What actually happens when a school district becomes insolvent? In 19 states, no one can say. Because all students must have access to a free public education, it seems that all states must be involved in a district’s insolvency in some way, if only to assign students to another district. But the fact remains that in nearly 40 percent of states, the type and extent of state involvement in district insolvency are not established by statute or regulation.

In 31 states, however, formal legal mechanisms are available to districts in fiscal crisis. In 24 of these states, insolvent school districts can file for federal municipal bankruptcy, although bankruptcy is not a good fit for the multifaceted problems that lead most troubled districts to insolvency.

Bankruptcy mainly readjusts districts’ major liabilities, such as collective-bargaining agreements and debt. Although this may provide a district with short-term relief, it does not address systemic problems such as internal mismanagement, costly but ineffective educational policies, and rare cases of corruption. Even if bankruptcy judges could address those problems, their reach often would exceed their expertise. For similar reasons, receivership (the state-law version of bankruptcy, available in two states), also is a poor fit for school districts in fiscal crisis.

Another legal mechanism, available in 17 states, is some form of state fiscal takeover of districts. This approach is not perfect, either: It is an aggressive form of state intervention in local government and usually—and understandably—generates a great deal of local resistance. However, it holds the most promise for helping districts emerge from a current crisis, maintain their long-term fiscal health, and maximize the quality of education they provide to students.

This promise stems from the flexibility of the scope of a takeover. First, a state’s involvement can start small, as nonbinding advice to a financially troubled district. A state might then gradually remove authority for financial decisionmaking from a district, but only if that district proves unable to change course. Second, a state takeover can allow individuals with expertise in both municipal finance and education policy to be part of the decisionmaking, thus addressing the complicating factors that are unique to school districts. Third, the sophisticated technical assistance necessary to make intervention effective could be provided by the state itself or outsourced to private-sector consultants.

"What actually happens when a school district becomes insolvent? In 19 states, no one can say."

Especially when coupled with an annual assessment of districts’ fiscal health—which allows early identification of fiscal crisis, when intervention can be the most helpful—the monitoring/takeover mechanism can substantially help a state and its districts.

Helping Stabilize Districts’ Revenues: Districts also often face instability in their revenue streams. Slightly less than half of an average school district’s revenues comes from its state, or at least that was the case before the recession. This means that uncertainty about the amount of state funding a district will receive can complicate a district’s budgeting process and sometimes delay that process significantly.

Like state revenues, local revenues have fluctuated substantially in recent years, although school districts generally receive more notice about variations in local revenue and consequently have more time to decide how to adjust their budgets accordingly. When state funding not only fluctuates, but also is announced or amended after the fiscal year has begun—or sometimes even after the school year has started—it is even more difficult for districts to make the necessary adjustments to their budgets.

There are various ways for states to help stabilize districts’ revenues. For example, a state could guarantee a minimum level of per-student funding based on the previous year’s allocation. Alternatively, a state could choose to adequately fund an education reserve fund, restrict its own ability to tap that fund for other purposes, and use that fund to fill the gap when state education funding drops.

Solutions involving the private sector are also possible: A state could authorize private-sector agents to insure school districts against fiscal crisis, possibly even requiring districts to pay into the insurance plan at a given rate. Or, a state could authorize its districts to enter into particular types of private contracts, such as derivative instruments, which could be designed to stabilize a district’s revenues over the long term. Because these complex contracts can be risky for municipalities, state regulation and oversight are especially important.

In conclusion, the recent recession has been a major factor in districts’ fiscal troubles, but it is not the only factor. States can help head off districts’ future fiscal crises by monitoring districts’ fiscal health and providing technical assistance to districts in or nearing fiscal crisis. States also can stop exacerbating the problem of unstable revenues in any of the various ways discussed above. And the federal government can require each state—in its own unique way—to do both of these things.

Although a future recession seems inevitable, in education, a future funding cliff does not have to be.

Vol. 30, Issue 28, Pages 32, 40

Published in Print: April 20, 2011, as Pulling Back From the Funding Cliff
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