This paper provides an outline of the origins and present workings of California school finance policies that bear on the fiscal circumstances of the Los Angeles Unified School District. The primary purpose of the paper is to suggest the implications and issues related to finance that are likely to come into play should the LAUSD be reorganized under currently debated initiatives to "break-up" the district into two or more smaller school districts. The authors do not pursue a position on the issue of possible district reorganization, but rather offer an analysis of issues relevant to present debates concerning break-up policies.
School finance is a complex subject anywhere in the USA. California's school finance system is more complex than most, due in large part to the active workings of the state legislature, the courts, and local voters over the years. Through legislation, visible judicial challenges, and voter initiatives, Californians have woven a web of inter-connected structures that both define ultimately the resources available to individual schools districts and also tie the hands of the key interest groups to impact overall levels of investment in education and individual allocation levels to the state's school districts.
There are no specific precedents for taking a district as massive as Los Angeles with its 700 plus schools and nearly 700,000 students and re-structuring its operations into smaller districts. California does have a system of laws and regulations regarding the reorganization of school districts that bear on finances; the proponents of break-up legislation would like to see changes in rules and regulations that would facilitate the achievement of the dramatic reorganizations they favor and these proposals have implications for finance. And if re-organized, the new school districts would be expected to exist within the basic structure of finance that has evolved over the years, apart from dramatic turns in finance policies resulting from future legislation, initiatives, or court decisions.
This paper tries to sort through this complexity and suggest the implications and key questions suggested by its analyses for district break-up proposals.
This paper first begins by presenting the recent history of funding in the state, from the early 1970s through the present.1 Second, the paper examines the maze of legislation and Constitutional Articles which define the way California funds its public school system. Third, it provides a synopsis of the impact of the California Lottery on school funding. Fourth, the paper presents an explanation of special education funding. Fifth, the paper provides an outline of the federal and state categorical funds that districts receive. And sixth, the paper specifically addresses Rodriguez v. L.A.U.S.D. to the issue of intradistrict funding disparities. Where appropriate in these sections, specific issues or implications related to LAUSD reorganization are identified. Finally, the paper raises additional summary questions that would be important to consider if any part of L.A.U.S.D. were to attempt to break up the district or break parts of the district off from the rest of the district.
II. History
A. Serrano v. Priest: School Finance Litigation
Prior to 1972, most K-12 revenues were generated from property taxes through tax rates fixed by local units of government.2 As property values rose, so did property tax revenues. Therefore, enormous variations between districts in the value of taxable property resulted in very large differences in per-pupil property tax revenues. While the state helped to lessen these differences by providing more aid to low property wealth districts than high property wealth districts, the variations in total revenues per pupil from state and local sources were still very large.3
In 1968, in response to these disparities, a parent challenged the state school funding mechanism. The plaintiff argued that the way schools were funded discriminated against students in poorer communities and favored students in more affluent communities. In Serrano v. Priest4 (Serrano I (1971)) the California Supreme Court found that "discrimination on the basis of wealth" to be invalid and contrary to the state's Constitution. The Court rejected "defendants' underlying thesis that classification by wealth is constitutional so long as the wealth is that of the district, not the individual."5 Moreover, the Court held education to be a "fundamental interest" of the state. This classification required that the state must show a compelling interest in order for it to permit education funding to be conditioned on district wealth.
In response to the Serrano I decision, the Legislature enacted Senate Bill 90 (SB 90) and Assembly Bill 1267 (AB 1267).6 Although the primary purpose of SB 90 and AB 1267 was to keep property tax rates from rising out of control, it also altered certain aspects of the educational finance system. The law placed a ceiling on how quickly districts were allowed to increase their revenues. High spending districts were limited to smaller increases than low spending districts. The theory was that over time, low spending districts could catch up with high spending districts. This was based on the assumption that high spending districts would not exercise their prerogative under SB 90 and AB 1267 to vote for a tax override that would lift the ceiling on expenditure increases. Yet between 1972, when SB 90 and AB 1267 became law, and 1974, voters approved approximately 40 percent of 580 referenda brought before them to override the ceiling on expenditure increases. In other words, SB 90 failed to reduce expenditure disparities in any meaningful way.7
In 1974 Los Angeles Superior Court Judge Bernard Jefferson ruled that SB 90 and AB 1267 did not equalize educational opportunity either sufficiently or quickly enough. SB 90's failure stemmed from the fact that SB 90 did not address the $125 per student basic aid grant that every school district received for each student. These basic aid grants magnified inequalities because they were distributed without regard for a district's revenue-raising capabilities. Nor did SB 90's increased foundation levels8 by themselves do anything to end the advantage enjoyed by the wealthier districts and the influence of district wealth.9 As part of his decision, Judge Jefferson established the guideline that the state's school finance system should reduce "wealth-related disparities" between school districts "apart from categorical aids special needs programs . . . to insignificant differences, which mean amounts considerably less than $100 per pupil" by 1980-81.10 He found that higher spending districts were able to purchase services, programs, materials and equipment that low spending districts could not. The Judge held that SB 90 did not meet the requirements set forth in the decision by the Court in the first case, Serrano I (1971).
In September of 1977 the Legislature passed Assembly Bill 65 (AB 65). This law significantly increased the foundation level given to each district, continued the flat grant,11 imposed a revenue limit with a voter override, and equalized the tax override a district could approve. The bill took the state a step closer to meeting the fiscal neutrality demanded by the Court but still left in place large expenditure differences which correlated with the property wealth of a given district. Moreover, the passage of Proposition 13, discussed in detail below, "nullified the structure for reform set out in AB 65, which relied primarily on provisions for redistribution of local property taxes from high to low revenue districts."12
In another attempt to comply with the Court mandates and address the financial impact resulting from the passage of Proposition 13, the Legislature adopted Assembly Bill 8 (AB 8) in 1979, as a comprehensive fiscal relief bill which was designed to lessen the impact of Proposition 13 on local governments. The school finance provisions of AB 8 achieved Serrano compliance without destroying local school districts already hard hit by inflation, declining enrollment, and cutbacks due to Proposition 13.13 AB 8 was also designed to bring high spending and low spending districts together over time by imposing district revenue limits on high spending districts and providing state aid to low spending districts.
In the flush years of the mid 1970s, it was considered politically inconceivable that wealthy districts like Beverly Hills would reduce their per-pupil spending to the level of poor districts. In fact, it was widely assumed that state aid would be increased substantially to bring the level of poorer districts like Baldwin Park up to that of Beverly Hills.14 In fact, initially, state aid was increased to bring the level of poorer districts up. A "leveling up" had begun to occur.
Yet, in spite of legislative action, wealthy communities continued to generate more tax dollars at lower rates than poor ones. In Beverly Hills in the fiscal year 1976-77, a school tax of $1.00 generated about $770 per pupil, while in Baldwin Park that same rate generated only $70 per pupil. The failure to achieve spending neutrality by the Court's 1980 deadline resulted in the Serrano plaintiffs returning to court to seek an order requiring compliance with Serrano II (1976).
In Serrano III (1986) the appellate court held that the state had complied with the mandate of Serrano II (1976) by overcoming disparities in educational spending to the point that the remaining differences in spending were not significant, either mathematically or educationally. The Serrano III (1986) court rejected the order in Serrano II (1976) that spending differences had to be reduced to $100. Thus, "in 1982-83, 93.2% of the state's ADA [were] in districts with a hundred dollar band adjusted for inflation. The comparable figure for 1974 was 56%.15 The remaining disparities were "justified by legitimate state interests."16 These interests included the need for an orderly transition from the old wealth-related system to a new state-funded system and cost differences due to the state climate among other factors.
The court found the new funding system had largely succeeded in "leveling up" low revenue limit districts. High revenue districts, on the other hand, lost revenue due to the combined impact of equalization formulas - which reduced the amount of money these districts received - declining enrollment and inflation. In other words, districts which had previously been considered "high revenue districts," had received more money than the majority of other districts, were now forced to reduce the number of classes available, increase class size, and the like in order to respond to the decrease in revenue they received. The court found that such leveling down had an especially negative impact on districts with high proportions of poor and minority students and held that "further leveling down would produce far more harm than good."17
B. Proposition 13: Tax Payer Revolt and the Consequences for Education
At the same time that the Legislature was struggling to comply with the Court's mandate in Serrano, the voters revolted against spiraling property tax rates. In 1978, after the Serrano II (1976) decision but before Serrano III (1986),18 the voters passed Proportion 13.19 While Proposition 13 set severe limits on the ability of the state to raise property tax rates, it also created a new fiscal climate leaving the state without funds to "level up" all poor districts to the standard of Beverly Hills. In the long run, what had originally been a politically unthinkable alternative -- leveling down affluent, suburban school districts where well-educated parents insisted on high standards for their children -- became a reality.
Overnight Proposition 13 reduced money available to school districts by one-third. This drastic reduction in resources resulted in the immediate need for a state bail out of the public school system. The first bail out bill apportioned $2.5 billion in additional school aid funds to replace nearly all the revenue lost by schools under Proposition 13. In the 1978-79 fiscal year, public schools received a total of about $7 billion. These funds were made up of $2 billion from local sources and $5 billion from state. The state bailout allowed the average district to maintain its previous year's level of general revenues. This translated into small increase in per-pupil terms because of continuing enrollment declines.
For the first time the state provided the majority of public school funds rather than local property taxes. Although the wide gap in per-pupil spending between rich districts and poor districts became all the more indefensible, the first bail-out bill gave substantially more state aid to rich districts than poor ones. Because Beverly Hills took a greater cut than Baldwin Park, Beverly Hills got $1,578 per pupil in state aid, compared to $1,275 for Baldwin Park. The second bail-out bill in 1979 put public schools on the path to bring 89% of school districts into apparent compliance with Serrano by 1983-84, including inflation.
Following this second bail-out, the Legislature was able to appropriate an 8 to 10% budget increase for school districts in general, and in their per-pupil allocations. These increases were due to continued state revenue growth over the previous year. The subsequent two years were much leaner for schools because of the economic recession that hit the nation in the early 1980s, and the exhaustion of the treasury's accumulated surplus. As a result, there was minimal growth in per-pupil funding between 1981 and 1983.
State school finance legislation for the 1982-83 fiscal year was among the most austere in recent history. Additional growth of state revenues for any district turned out to be minimal or nonexistent. The general revenues for California schools had fallen far short of what might have been expected if previous patterns of revenue growth had been maintained. Additionally, actual school budgets fell even further short of allowing schools to keep up with general increases in cost of living. General per pupil expenditures increased approximately 33% in these years. It might have been expected to increase by more than 50% during this time according to historical patterns had Proposition 13 not limited potential revenue sources.
The general cost of living in the state, on the other hand, rose by more than 60%. The net effect of this shift was that in 1983 California schools had about 20 % less real resources per pupil than in 1978, and had overall budgets 25% below those of 1978 in real dollar terms.
A continuation of tax collections at pre-Proposition 13 levels could have provided school revenue growth at levels previously experienced and at rates approximating the general cost inflation. These "would-have-been" tax collections plus giant state revenue surplus could have combined to create robust public finance picture statewide.20
The longer term consequences of Proposition 13 for the quality of education in the public school system began to come to light in the mid 1980s. As the state took over decisions regarding funding levels for school district operations after 1978, it began to dictate uniform and austere budget changes from year to year. Proposition 13 effectively eliminated the possibility of raising taxes locally for schools. Additionally, the continuance of spending equalization provisions of the law put extra pressures on large school districts like Los Angeles and San Francisco. Few districts, if any, were able to maintain program levels from year to year. As a consequence, schools offered a reduced range of services to the state's children.
Additionally, the financial effects of Proposition 13 were closely linked to the curriculum schools were able to offer. Financial hardship translated into program reductions. Curriculum changes began to occur at a time when there were financial strains and recurring demands for improved pupil proficiencies. In addition to the curriculum changes, reduced funding forced schools to layoff a substantial number of teachers. The reduced numbers of teachers meant class sizes grew larger and fewer sections of given classes were offered. There were also reductions in multiple class sections, which in turn reduced scheduling options for pupils.
Due to schools' inability to replace teachers, mathematics and science curricula suffered.21 School districts reported difficulty in securing sufficient numbers of qualified math and science teachers due to single salary schedules and the availability of higher rewards for such skills elsewhere in the market.22 The districts' incapacity to hire new teachers of any sort during these years exacerbated this problem. Course consolidation took place, especially in social sciences and English classes. Furthermore, increased state control led to a decrease in decision making that took place on the local level. Schools were denied the opportunity to decide for themselves what programs were expendable and what should remain in the curriculum offered.23
Proposition 13 continues to significantly impact both the way and the level at which the state can fund its public schools. Because school districts are unable to increase revenues they receive through an increase in local property taxes, they are now dependent on the state general fund budget and, the state's economy, and especially changes in state tax collection. Anything that has a negative impact on state revenues - from the repeal in 1996 of the 10% and 11% income tax brackets to the 1992 repeal of the sales tax on snack foods - has a negative impact on the state's ability to fund education.24 Moreover, education funding is impacted by any shortfalls experienced by the state. From 1978-79 through 1992-93, shortfalls in state aid appropriations resulted in deficits that could only be funded by additional state aid appropriations. These shortfalls translated into continued deficits in funding for education and the eventual establishment of a fixed deficit factor for school district and county office revenue limits. Similarly, Proposition 13 severely limited the ability of a district or county office to raise discretionary revenues, since there is no longer any authority to increase the property tax rate for operating expenditures. Only a handful of districts have been able to secure the 2/3 vote needed to pass a parcel tax or square footage tax for additional funding for educational programs.25
In 1994-95 the state's average per-pupil expenditure of $4,724 was $1,170 less than the United States average of $5,894. This per-pupil expenditure level placed California 42nd in the nation. The expenditure level per child continues to rank this state in the bottom 10 among the 50 states.26 Even after Serrano, there is still a significant range in funding between districts. Until recently, the dependence on a lagging state economy led to significant budget cuts for school districts. The 1995-96 school year state revenues exceeded predictions and translated into full funding of the statutory COLA and program growth for not only revenue limits but for all categorical programs as well as an increase in ADA.27 LAUSD projected that the 1994-95 budget would provide a per-pupil ADA of $4,292, an increase from the 1994-95 per-pupil ADA of $4,231. 28
III. Constitutional and Legislative Frameworks for Funding
Public schools receive their official funding from three primary sources: federal, state and local government. Of these three sources, state aid comprises the majority of these funds. For the 1996-97 fiscal year, the Governor's Budget Proposal anticipates that 55.8% of school funding will be provided by the state, 26.95 percent will come from property taxes, 8.06% from federal aid, 1.99 % of its available resources from the state, 2.19% from Lottery revenues, and 7.21 % from miscellaneous sources.29
State funding is controlled by both Constitutional and legislative requirements. A minimum funding guarantee works in conjunction with state and district revenue spending limits.
A. Constitutional Provisions
The California Constitution establishes school funding as a state priority. Article XVI, ¤8(a) states "From all state revenues there shall first be set apart the moneys to be applied by the state for support of the public school system . . ."30 In the same Article, the conflict between the state's desire to make education a priority and the desire to limit state spending is visible. All spending appropriations made pursuant to Article XVI ¤¤8 and 8.531 are subject to Article XIIIB.32 Article XIIIB is dedicated exclusively to government spending limitations. Article XIIIB ¤1 states: "The total annual appropriations subject to limitation of the state and of each local government shall not exceed the appropriations limit of the entity of government for the prior year adjusted for the change in the cost of living and the change in population . . ."33
The net effect of these provisions is that while school funding is considered to be a state priority, it is held at an almost constant level of spending from year to year. The only increases in education funding allowed from year to year are adjustments for cost of living increases and increases or decreases in the size of the school age population.
Article XIIIB was passed as Proposition 4, the Gann limitation, shortly after the passage of Proposition 13.34 Spending has only exceeded the Gann limit once, in 1986. Unexpectedly high state income tax revenues - triggered largely by taxpayers taking advantage of favorable capital gains tax rates before federal reform took effect - pushed the state $1.1 billion over its Gann limit. The state chose to rebate the entire $1.1 billion to taxpayers rather than make the statutory changes necessary to raise the Gann limit.35 In 1990 Article XIIIB was amended by Proposition 111, liberalizing the inflation factor used to calculate growth in order to account for the steadily increasing school population.36 Proposition 111, in essence, allows for faster growth in the state's Gann limit and makes it highly unlikely that the state will have any Gann limit excess revenues for the foreseeable future.37
B. Statutory Provisions
By the end of the 1980s the need to protect school funding was obvious. Proposition 98, The Classroom Instructional Improvement and Accountability Act, was passed in 1988.38 The purpose of Proposition 98 was to guarantee a minimum funding level. Section 41200 states in pertinent part:
(b) It is the intent of the Legislature that the annual Budget Bill, required by Section 12 of Article IV of the California Constitution, include a section that specifies the respective percentages and amounts of General Fund revenues that must be set aside and applied for the support of school district, . . . as required by subdivision (b) of Section 8 of Article XVI of the California Constitution.39
While Proposition 98 determines what the required minimum funding level is, it has also become the measure used by the Legislature to determine the ceiling for school funding.40 It is also unable to control the state of California's economy or the revenues generated.
The Proposition 98 minimum funding level depends on numerous factors, including both current year state tax revenues and the rate of growth of those tax revenues over the prior year, changes in personal income, statewide growth in ADA, and statewide property taxes for schools - as well as the exact amount of state aid for schools in the prior year.41 The minimum funding limit guaranteed by Proposition 98 is determined by applying one of three tests. Test 1 provides that a minimum of 33 % of state taxes will go to K-14 school agencies. Test 1 is applied only in very good economic years. Test 2 provides that K-14 school agencies will receive at least the same amount of tax revenues as the prior year combined state aid and local income, plus statewide ADA growth plus inflation. Test 2 is the test most frequently applied to determine Proposition 98 funds. Test 3, applied in poor economic years, is similar to Test 2 in that it provides K-14 school agencies with at least the same amount of combined state and local resources adjusted for growth and inflation, but the inflation factor is different. Under Test 3 the inflation factor is equal to the annual percentage change in per capital state General Fund revenues plus _ % - if that inflation factor is lower that the Test 2 inflation factor.42
While reliance on state funding can help to equalize funds, one of the consequences of such a heavy reliance on state funding is that it also places schools at greater risk when state revenues decline. In 1991-92, California was faced with nearly a $14 billion dollar shortfall. As a consequence of this shortfall, the Proposition 98 minimum funding level fell to the point to where it would not even maintain the prior year level of K-12 funding per ADA.43 In order to maintain K-12 spending levels at the same levels as 1991-92, the state appropriated $1,083,000,000 over the course of the 1992-93 and 1993-94 school years. These sums were treated as pre-payments" or "loans" to be repaid out of future Proposition 98 entitlements.44 In 1995 Governor Wilson proposed to withhold funding in 1995 and 1996 in order to pay back these "loans" made during 1992-93 and 1993-94.
The California Teacher's Association (CTA) filed a lawsuit against the Director of the California Department of Finance, Russ Gould, in response to what it considered to be inappropriate manipulations of Proposition 98 funding calculations and the "loans" -- CTA v. Gould. In 1993 Superior Court Judge James Long ruled that: (1) the $1.8 billion in Proposition 98 "prepayments" did not have to be repaid to the state; and (2) these appropriations must count toward the Proposition 98 funding base in 1992-93 and 1993-94, thereby raising the ongoing minimum funding level by about $600 million in both 1994-95 and 1995-96. The state appealed the Superior Court decision. Then, in the summer of 1995 the Governor and CTA reached an out of court settlement.
To further complicate the situation, each school district's basic revenue is linked to a revenue limit. Revenue limits are the prime revenue component of every school district's budget. They are determined by a long and complicated worksheet. The limit calculations begin with the previous year's revenue limit, adjusted for inflation and increases in enrollment. The inflationary increase is based on a statutory Cost of Living Adjustment (COLA).45 The COLA is applied to the average revenue limit for each of three types of districts (unified, elementary and high school). This determines the dollar increase per ADA. A second adjustment is made for districts with growing enrollments. Once a district's revenue limit is determined, property tax collections are calculated based on a county wide formula determined by the Legislature. A district's general or revenue limit aid for the state equals the difference between its revenue limit and the property taxes it collects from the state.46 Over the previous five years the COLA proposed or adopted by the Legislature has either been a zero percentage or significantly less than the statutory percentage required. Although the 1995-96 Budget provided for a COLA allocation, it was only the first step toward making up for the years of under funding endured by the system.
For example, Los Angeles Unified School District, a unified district, had a revenue limit in 1994-95 of $4,231 per student. A COLA of 2.73% was provided for the first time in approximately 5 years in the 1995-96 Budget. The estimated COLA is then added to the 1994-95 base revenue. Once the estimated COLA is added, resources are allocated for any growth in student population LAUSD is expected to experience. Statewide ADA growth was anticipated at 2.62% plus additional monies for growth in the number of special education in the state. Next, the property tax rate for LAUSD is calculated and that sum is subtracted from the newly adjusted revenue limit. The state provides that difference.
The state's extended fiscal crisis illustrates a major point about Proposition 98 -- it only works well when the state's economy is doing well. It is only under the "Test 1" formula -- or when state tax revenues grow quickly enough to trigger restoration payments - that the minimum funding level is sufficient to pay for statewide ADA growth and inflation and still have revenue left over for program augmentations. Under "Test 2," there is only enough revenue to fund statewide ADA growth and an inflation factor. And under "Test 3," the inflation factor can be a very low or negative number.47
For 1996-97, Governor Wilson has proposed total K-12 education spending of $32,053 billion. Just over half of these funds are to come from the state. This represents a dramatic decline from the two-thirds of total educational revenue provided by the state in most years since the passage of Proposition 13 in 1978 and reflects the Legislature's decision to shift property tax revenues away from counties and cities and give them to school districts, reducing the amount of money that the state has to provide. California operates what is essentially a traditional foundation program for school finance. Rather than one foundation level, each district has a unique "revenue limit" which determines its general revenues for the year. The legislature determines how the property tax collections will be distributed and then funds the balance of each district's revenue limit. Property taxes were distributed among taxing jurisdictions in a county using the same formula from 1979-80 through 1993-94. Beginning in 1994-95 and continuing in 1995-96, the legislature "shifted" a portion of the property taxes formerly allocated to cities and counties to the school districts. This shift accounts for the decline in the share of state revenues.
IV. The Lottery
In 1984 the voters of California passed the California State Lottery Act.48 Proponents of the Lottery hailed it as a way to provide additional revenue to school districts, county offices of education, and community college districts which would be free from state control. Pursuant to ¤ 8880.4 of the Government Code, these funds are allocated "in addition to other funds appropriated or required under existing constitutional reservations for educational purposes [and n]o program shall have the amount appropriated to support that program reduced as a result of funds allocated" from the proceeds of the Lottery.49 The Lottery proceeds are broken down as follows: 50% of the total annual revenues must be returned to the public in the form of prizes; at least 34 % are allocated to public education; all unclaimed prize money reverts to public education; and no more than 16% of the total annual revenues are allocated for payment of Lottery expenses. To the extent that expenses are less than 16% of the total annual revenues, any surplus funds are also allocated to public education.50 Although the public still perceives the Lottery as making a significant difference in the funds available for education, such is not the case. The Lottery provides approximately 2% of the total kindergarten through grade 12 (K-12) public school budget.51 While the Lottery revenue is useful, it is a minor source that cannot be expected to provide major improvements in K-12 education.52 For example, in LAUSD, Lottery income for the 1994-95 final budget remained constant with the 1993-94 sum of $90 per ADA.53 Therefore, while the Lottery has provided up to 4% of the K-12 school budget, it is unlikely to generate sufficient funds to significantly impact these schools. Furthermore, it is an inconsistent source of funding at best.54
The impact of the Hayden Bill on general school funding is unclear. One of the first issues that will have to be addressed is the base revenue limit to be set for both a newly created district or districts and for the remaining configuration of LAUSD. The determination of the revenue limit is made by the Legislature. It is not clear how the Legislature would begin to determine the new revenue limits to be set for both newly created or broken-off districts and the remaining District. Presently, when a district loses students, it retains the revenue limit it received during the year preceding the loss for one year following the loss. In other words, if LAUSD were to lose 100,000 students, for the year following the loss of these students it would continue to receive ADA for these students as a transition year. The new district would also receive ADA for these same students. The state would essentially be paying for these students twice for a year. This has the potential to be extremely expensive for the state.
On the other hand, while a reorganization of LAUSD may cause the largest one time reorganization and/or creation of new school districts at one time, it will not be the first time that a new district has been created or a school district has been reconfigured. Therefore, what will be important is that all parties to a reorganization work with members of the Legislature and the Department of Education to ensure that they have as complete an understanding as possible of the funds they will and will not receive as a result of the reorganization.
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