What economic turmoil means to school finances |
On Board Online • Opinion • November 24, 2008
By Donald Boyd
The stock market is down 40 percent, the financial services sector has collapsed, and the state is forecasting a $47 billion budget gap over the next three years. Governor Paterson has proposed school aid cuts of 3 to 10 percent this year, and more cut proposals are on the way. Are things really this bad, what should we be watching for, and what does this mean for school districts?
Why the outlook is so bad
The national economy almost certainly already is in recession. Over the last 50 years, recessions have declined in severity and length, so much so that Federal Reserve Chairman Ben Bernanke and other economists have a name for it: “The Great Moderation.” The last recession, in 2001, was barely perceptible and lasted just nine months. But this one will be different. In the latest quarter consumer spending declined more sharply than it had in two decades and dismal reports from retailers keep rolling in. More than a million jobs have disappeared.
Some of the worst effects will be in New York. While everyone knows that Wall Street is here, many underestimate how much the state’s economic health depends on the fortunes of brokers, portfolio managers and bankers. Only 6 percent of New York’s workers are employed in financial services, but they earn more than four times the average of other industries and accounted for 41 percent of all wage growth during the boom from 2003 to 2007. And capital gains on stocks, bonds and real estate, which account for one in eight dollars subject to state income tax, tripled over this period. The top one-half percent of taxpayers receive 90 percent of all capital gains income, virtually all of it taxed at the top rate.
About a fifth of the state’s tax revenue comes from the financial services sector, with more coming indirectly from investment gains. In good times this has fueled state spending, including sizeable increases in school aid.
But Wall Street is fickle. New York’s budget office predicts that financial sector bonuses will decline by 43 percent in 2009 and another 21 percent in 2010. It predicts that capital gains will decline by 36 percent this year and 20 percent next year. Along with lesser factors, these assumptions account for the huge projected multi-year budget gaps.
A new Siena Research Institute poll reports that three-quarters of New Yorkers want the state budget to be balanced with spending cuts, buttressing the governor’s position that budget cuts are preferable to tax increases or “one shot” gimmicks (such as deferred spending, accelerated revenue, and reserve fund raids) that just defer budgetary pain. But only 7 percent would cut education and only 6 percent would cut health care, effectively exempting the two largest areas of state spending and making it difficult for state leaders to follow the will of the people.
What to watch for
The Senate majority is changing hands in January, which does not portend well for the governor’s plans for cutting the budget in November. It would be surprising for an outgoing majority to use its budgetary power to cut aid now rather than leave that dubious spoil to the victors. [Editor’s Note: The governor called off a special legislative session on Nov. 18 after Senate Republicans balked at his proposal to reduce spending in the current fiscal year by $2 billion, including an $836 million reduction in school aid.]
The governor must propose a balanced budget, and without a cooperative Legislature he will have to use reserves and other techniques to roll much of this year’s problem into his budget for next year.
New York is notorious for disagreements between the governor and the Legislature on revenue projections. Perhaps the Legislature will convince the governor that his forecast is too conservative? Not likely. In a November “quick start” budget meeting, the Assembly’s revenue projections were $1.4 billion lower than the governor’s. The Senate was more optimistic but with the majority changing from Republican to Democratic, incoming staff’s forecasts are not yet known. The state comptroller, who can step in this spring if the governor and Legislature do not agree on revenue, was within 0.04 percent of the governor. So unless evidence changes – an improving economy, or a surge in tax revenue – the budget gap is unlikely to shrink simply from a rosier outlook.
Some evidence will come between now and budget adoption. January and February will show whether holiday sales tax collections are as bad as retailers’ reports suggest they will be. Many financial sector bonuses are paid near year-end. Surprises here could alter the size of the budget problem by many hundreds of millions of dollars but almost certainly cannot alter the fundamental conclusion that large spending cuts or large tax increases will be needed to close the gap.
If the state budget is a month or more late beyond the April 1 deadline, the big Kahuna will come in May as budgeters glimpse revenue from April 15 tax returns. Analysts might raise or lower their forecasts by a billion dollars or more. But even this is unlikely to alter the need for large spending cuts or tax increases.
Perhaps the most likely scenario for avoiding significant school aid cuts is a combination of a large temporary tax increase and extensive use of reserves and gimmicks. Even though New Yorkers don’t want a state tax increase, fully 77 percent of Siena poll respondents expect the governor to wind up supporting one. It would not be the first time a governor is dragged by the Legislature into supporting a tax increase. Governor Paterson may choose to hold his nose and accept one-shots, as well. This would serve to minimize school aid cuts.
What does this mean for school districts?
School districts can’t build their budgets on political prognostications, though. Best to prepare now for large cuts and hope for better.
The good news is that locally-raised funds should be quite stable during an economic downturn. Property taxes account for 88 percent of the typical district’s locally raised revenue, and research shows that revenue source is far more stable than the income, sales and corporate taxes the state relies upon. Property taxes may decline with the economy, but often only slightly and with a lag of one to three years.
The most immediate risk to school district finances is state aid. The typical district relies on state aid for 42 percent of its total general fund revenue, and the STAR reimbursement accounts for about another 8 percent in most places. If either or both are cut, districts will be hit hard. Over the next few years, districts also will be hit by rising pension costs as the stock market decline works its way into pension contributions that districts must make. The state projects that its own pension contributions will rise by about 9 percent a year.
While the state can cut aid to other governments, school districts do not have that luxury. They must cut services to children, or cut payments to those providing services through efficiencies or other means, or raise taxes on their citizens.
Furthermore, many school costs are extremely difficult to cut in the short term. In the typical district, 26 percent of general fund spending goes to employee benefits and debt service – costs that simply cannot be cut in the short term. Another 25 percent goes to instructional salaries – an area that districts often try to protect, and that is not easy to cut quickly because much of it requires waiting for new labor agreements, opening up closed agreements, waiting for attrition, or laying off instructional staff. All of these things can be done, but not quickly or easily.
Midyear cuts are the most damaging: if a typical district faced a 5 percent aid cut and exempted the spending items listed above, it would need cuts elsewhere averaging 9 percent. As a practical matter, midyear cuts would lead many districts to draw down reserves.
Perhaps the best thing districts can do is start tightening belts now – as many have begun doing – and plan on at least three years of difficult times. Although politically it is not easy, districts should address any aid cuts with a multi-year plan, using some reserves early while working on savings that may take more than one year to achieve.
Donald J. Boyd is the principal of Boyd Research and is a previous director of economic and revenue analysis for the New York State budget office. Prior to that he directed a tax staff in the New York Assembly Ways and Means Committee. He is a member of the Cambridge school board in Washington County.