Thursday, April 12, 2018

Spending Authority Explained

Spending authority is a unique concept to Iowa public schools that is designed to ensure equity in spending for public schools across the state. Largely formula driven, a primary goal is to ensure school districts don't raise taxes in an effort to provide unequal access to programming in different parts of Iowa. While there certainly are equity issues within the formula that we have seen debated in our legislature and in some parts of the state, for the most part the idea of spending authority has stood the test of time.

Essentially, what spending authority does, is limit by statue the maximum amount of money that can be spent in the general operating fund of a school district. Exceeding spending authority is a violation of state law, and in some cases can lead to a state takeover of the school district and a dissolution of that school. This most recently happened in 2015 when the state dissolved the Farragut Community School District for financial insolvency.

Spending authority is comprised of three main components: combined district cost, miscellaneous income, and unspent balance. The combined district cost is the largest component of the budget and is the most dependable of our revenue sources. Driven by pupil count, the revenue for the combined district cost is composed of a blend of property tax and state aid. We sometimes refer to the combined district cost as the 'controlled budget' because it is entirely dependent on the formula and is a known quantity. In other words, absent an across the board cut, we can count on the combined district cost annually. Miscellaneous income, on the other hand requires a bit more deliberation, consideration, and forecasting to arrive at the total for this revenue stream. In a nutshell, anything that isn't property tax or state aid lands in the miscellaneous income bucket. This includes federal title money and tuition for students who are attending a school district under open enrollment laws. In Hudson, open enrollment makes up a large component of our miscellaneous income stream so it is very important for us to be thoughtful about the calculations we use to arrive at this revenue stream. Unlike the controlled budget, if a student open enrolls and then decides not to enroll in our school district, that is an automatic loss in revenue. The third and final component of spending authority is the unspent balance, which is the districts savings account. In years where a school district's spending plan consumes only the combined district cost and miscellaneous income, the unspent balance will remain stable. In years where the district overspends these two components, it will decrease. If the district spends less, then the unspent balance will grow. Put all three together, and it resembles something that looks a bit like this:

It is important to understand the function of the unspent balance. It is helpful to think about this as a savings account to determine when and if it is appropriate to utilize these resources. In any given year, a school district may deficit spend their budget for a variety of reasons. Sometimes it is a planned deficit, while other times it may be an unplanned deficit. Whenever these deficits occur, the district uses the unspent balance, or savings account to  make up the difference. A situation where a planned deficit might be appropriate could be a case where a teacher or teachers need to be hired to address an unmet and unplanned need. An unplanned deficit could occur when utility consumption is greater than the budget or if miscellaneous income revenue projections don't materialize. Nonetheless, using the savings account or unspent balance for recurring expenses isn't good budget practice. Quite simply stated, once the savings account is depleted that resource is gone and there is no way to replenish it. Consider the following scenario:

Albeit a rudimentary example, this illustration does an adequate job of demonstrating the impact of using the unspent balance, or savings account. At the far left, our sample school district has total spending authority of $10,000,000. They execute a budget and spending plan whereas overall general fund expenditures are $9,000,000, using $1,000,000 of the unspent balance. That means the next year, their spending authority has decreased by $1,000,000 to $9,000,000. If in the next year they spend $9,000,000, their spending authority for the following year will be $8,000,000. Obviously if the district spends $9,000,000 the following year, the school district has violated Iowa statute and is in petty significant crisis.

Not to complicate the issue any further but instead to add more clarity to how this works, it is important to understand that total spending authority does not automatically represent cash in the bank. Authority quite simply means that you have the ability to spend those funds. It is not uncommon in school districts to  have more authority than they have cash in the bank. The only way to create the revenue to fund the authority is to increase the property tax rate and fill the cash reserve. But, by Iowa law you can only fund to what you have authority for. In other words, [looking at] our example above, if we wanted to create a scenario where we had $11,000,000 in spending authority, you cannot levy for more cash. That is the beauty and the danger of the Iowa public school finance law. Cash creates cash to fund authority. Cash does not generate authority.

At some point, the question becomes: how much savings should a school district have? Well, frankly that depends on who you talk to, the wishes of the school board, and what your overall priorities for student learning are in the school. Yet at the same time, it is imperative that school districts have the ability to 'look around the corner'. For example, what does the forecast model do? In our case, if the growth in cost per pupil were to continue at a rate of 1% annually and our expenditures increased at a rate of 4% annually; we would consume over $1,500,000 of our savings account over a five year period. However, it is also worth debating whether or not the revenue is going to increase at even a 1% per pupil rate. There are signs that it may not.

Consider this: the legislature is currently debating a tax reform bill that, if enacted will reduce state revenue by over $1 billion a year. To put that in perspective, the entire state budget is roughly $7.3 billion in revenue. As the largest line item of the state budget, school aid accounts for 55% of state budget expenditures. It seems nonsensical to assume schools won't be impacted by this type of legislation. And that's not all. Last week we learned the state is considering eliminating the 'back fill' that was promised when the commercial and property tax reform legislation was signed in 2013. For Hudson, that would be a cash loss of roughly $30,000; ironically the same amount of revenue that is being generated by the cost per pupil growth rate for this year. If that weren't enough of a reason to be concerned, it is also important to consider changes in federal policy that undoubtedly will have tertiary effects for local school districts. The implementation of tariffs between China and the United States will impact our soybean and pork producer markets. A recent decision by the Administration to grant hardship waivers to oil refineries in an effort to avoid ethanol blending will have a negative impact on our corn market. We can't forget, Iowa's economy is driven by agriculture.

But there is some good news in those dark clouds. A silver lining if you will. Right now we have ample reserves to weather the storm. If we are smart about the allocation of our resources, strategic about the deployment of our capital, and mindful of the extraneous forces that are impacting our ability to do the work of educating our youth--we will be just fine.  

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