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Source:CA Deparment of Education What is Proposition 98?December 2004 Proposition 98 refers to an initiative constitutional amendment adopted by California's voters at the November 1988 general election. It was sponsored by the California Teachers Association and a number of other education organizations. The initiative created a minimum funding guarantee for K-14 education and also required that schools receive a portion of state revenues that exceed the state's appropriations limit. Who is covered by Prop 98?Prop 98 provides a minimum guarantee for funding three types of education agencies: (1) K-12 school districts and county offices of education, (2) community college districts, and (3) the direct elementary and secondary instructional activities of certain state agencies (e.g., state special schools for the deaf and blind, California Youth Authority, Department of Mental Health). What Prop 98 does not cover: (1) state operations (e.g., State Department of Education or Community College Chancellor's Office), (2) funding from non-General Fund sources (e.g., special funds, bond funds, local developer fees), or (3) funding for educational purposes that is not allocated to a local education agency (e.g. certain teacher in-service programs offered by UC or CSU). Pursuant a state Supreme Court case, certain private provider child care administered by the Department of Education is included within the Prop 98 funding guarantee. Is Prop 98 as complicated as it seems?Not really. The principles underlying the calculations are pretty simple. At its most basic, Prop 98 guarantees to education the total amount it received in the prior fiscal year adjusted for increases in the cost of living and increases in enrollment . That is really important, so let me repeat: Prop 98 guarantees to education the total amount it received in the prior fiscal year adjusted for increases in the cost of living and increases in enrollment. In other words, Prop 98 guarantees that per pupil school funding keeps up with the cost of living. The school finance wonks refer to this as "Test 2" or the "Test 2 amount." A few more details about Test 2:The cost of living adjustment for Prop 98's Test 2 is the change in per capita personal income. This will be important later. The Test 2 calculation applies to the statewide, aggregate total of spending from both state general fund proceeds of taxes and local property taxes. Note that since property taxes are not under state control (except for the distribution among local agencies) the state General Fund makes up the difference between the Prop 98 total and whatever schools receive in property taxes. This feature of Prop 98 was what prompted the now (in)famous ERAF shifts of 1992 and 1993: Since Prop 98 guarantees a total of state and local funds, by increasing the amount of local property taxes allocated to schools (i.e., shifting property taxes from cities and counties to schools) the state could lower the amount of General Fund monies it was required to give education. It is also important to note that the Test 2 minimum guarantee is not a function of state revenues. It is dependent only on prior year spending, per capita personal income, and enrollment growth. That's not so hard. But I always thought that Prop 98 guarantees schools a certain percentage of state revenues. What about that?Well, that's partly true. Prop 98 says that the General Fund amount calculated in Test 2 must be at least the percentage of the General Fund that schools received in 1986-87 (the fiscal year before Prop 98 passed). That minimum percentage of the General Fund is about 35%. ( Note:The original calculation of the percentage was about 40%, but it was adjusted downward as part of the ERAF shift to reflect the percentage schools would have received if the ERAF shift had been in place in the 1986-87 base year .) This calculation of the percentage of General Fund revenues (from proceeds of taxes) is known as "Test 1." In other words, Prop 98 requires that schools receive whichever General Fund amount is greater: the Test 1 percentage of the General Fund (~35%) or the General Fund amount needed to reach the Test 2 total of state and local funding. However, from a practical standpoint, the Test 2 amount is almost always greater than the 1986-87 Test 1 percentage. General Fund revenues would have to increase many, many of billions of dollars before Test 1 becomes operative (i.e., before 35% of the GF exceeds the Test 2 GF amount). So, does this mean that school funding is always at least at this "Test 2" level?No. The Legislature and Governor realized that as the economy and state revenues expanded and contracted over time this "greater of Test 1 or Test 2" construct would cause school spending to account for an ever-increasing share of state revenues. That is, school spending could never fall below the rate of inflation (per capita personal income) even though state revenues might grow more slowly, or even decline. Because of this potential (some called it the "Pac Man" that would devour the state budget) the Legislature proposed several important amendments to Prop 98 in what became Prop 111 in 1990. (Prop 111 also made significant amendments to Gann limits). Prop 111 permitted the Legislature to use an alternative COLA to calculate the Test 2 minimum funding level. Instead of using per capita personal income, Prop 111 permitted the Legislature to use per capita General Fund revenue growth as the COLA. Thus, in times of slow economic growth the Legislature could chose to calculate the minimum guarantee on the basis of enrollment and the growth in state revenues rather than enrollment and the growth in personal income. The calculation of the minimum guarantee using this alternative COLA is generally referred to as "Test 3." The difference in funding levels using the alternative Test 3 COLA can be significant. During the current fiscal year, the difference between the Test 2 and Test 3 levels is about $3.5 billion. Is this the only way for school spending to be less than the Test 2 level?No. The Legislature may suspend Proposition 98. Does that mean we're ignoring the Constitution?No. Prop 98 provides for its own suspension. Prop 98 says that the Legislature may suspend the minimum funding guarantee provided: (1) the suspension is for a single fiscal year, (2) the suspension is explicitly contained in an urgency statute, and (3) this urgency statute is not the budget bill. And what does "suspension" mean?It simply means that for one fiscal year, the Legislature and Governor choose to fund schools at a level below that provided by operative minimum guarantee (Test 1, 2, or 3, as applicable). And have we ever suspended Prop 98 before?Yes. Twice. Sort of. In 1989 the Legislature enacted a temporary ¼ cent sales tax to finance earthquake relief for the Loma Prieta earthquake. As part of the sales tax statute the Legislature suspended Prop 98 only with respect to those additional sales tax revenues to avoid any additional school entitlement pursuant to Test 1. In 1992 part of the budget settlement involved several ... shall we say ... unusual school finance accounting transactions proposed by Governor Wilson, the purpose of which was to reduce the Prop 98 funding base to help balance the budget. Governor Wilson also proposed -- and the Legislature eventually adopted -- a "poison pill": in the event these accounting transactions were declared unconstitutional by an appellate court then Prop 98 would be suspended. The accounting tricks were challenged and declared unconstitutional by a trial court (CTA v. Gould) but because the case was settled before it was heard by the court of appeals the suspension "trigger" was never pulled. Thus, in this case the Legislature enacted a conditional suspension statute but the suspension itself never became operative. But isn't there a problem here? If Prop 98 (Test 2) is based on what schools actually received in the prior year then if we use either Test 3 or a suspension to fund them at some lower level isn't their funding base for future years permanently lowered?Good question. The 1990 Prop 111 amendments also addressed that issue. In any year in which schools are funded below the Test 2 (or Test 1, as applicable) level -- whether due to a suspension or to taking advantage of the lower Test 3 COLA -- then Prop 98 requires that an IOU be created. This IOU is called a "maintenance factor" (don't ask me why, it just is) and is equal to the difference between the Test 2 (or Test 1, as applicable) funding level and the level at which schools are actually funded. Thus, if the minimum guarantee (Test 1 or 2) calls for $40 billion in school funding and schools end up receiving $38 billion, then a $2 billion maintenance factor (IOU) is created. Prop 98 goes on to require that the state must eventually restore the school funding base by the full amount of this maintenance factor. Further, the Legislature must begin restoring it when the growth in revenues exceeds the growth in personal income. (This is symmetrical: If we can fund schools below the Test 2 level when revenue growth is less than personal income growth [Test 3] then it makes sense to require that we then restore their funding base when revenue growth exceeds personal income growth.) The minimum amount by which the Prop 98 funding base must be restored in based on the amount by which revenue growth exceeds personal income growth. This will be an important issue for the 2003-04 budget discussion. I think I have it: There really can't be a permanent decrease in the school funding base because it eventually gets restored. But since Prop 98 is a funding floor what happens if we give schools more than the minimum called for in the Constitution? What happens if we give them one-time funding?Constitutionally, there is no such thing as one-time funding for Prop 98. Go back to the Test 2 definition: Schools are entitled to the amount they received in the prior year increased for enrollment and a COLA. Whatever they received in the prior year -- whether it was at or above the minimum funding level, or whether it included funding for some one-time purpose -- is the starting point for determining the subsequent year's minimum funding requirement. The only exceptions recognized in the Constitution are certain fiscal circumstances that are unlikely in the extreme. Does Prop 98 speak to how the funding must be allocated?In a word: No. The Constitution leaves to the Legislature the decisions about how Prop 98 school spending should be allocated. Though probably not good policy, Prop 98 would technically be satisfied if the Legislature spent the entire $40+ billion on textbooks and not a dime on anything else. Likewise, Prop 98 would technically be satisfied if we spent the entire $40+ billion on the State School for the Deaf in Fremont . But what about the K-12/community college "split" I hear so much about? That is a longer discussion, but there are several important points to remember:
OK, now let me make sure I understand the current year cuts we did in education, most of which were "deferrals."We deferred payments to schools by a few days, from late June of 2002-03 until early July of 2003-04. The effect of that was to reduce "what schools received in the prior year" for purposes of calculating their Test 2 entitlement for next year. In other words by reducing the amount we end up giving them this year (by paying them in July instead of June) we will have reduced the minimum we must give them next year. Bingo. You've got it. All right, last question. I keep hearing that if we raise taxes -- whether for the Governor's realignment proposal or just raise them for the General Fund -- we will have to give some huge percentage to schools. What gives?Let's go back to the different parts of Prop 98. There are three circumstances where the minimum guarantee for schools depends on state revenues. First, the Test 1 calculation (35% of General Fund revenue ) and, second, the Test 3 calculation using the alternative COLA (growth in per capita General Fund revenues). Neither of these is applicable in the budget year. However, the third part of Prop 98 where state revenue matters is in the minimum amount of a previous maintenance factor (remember the IOU?) that must be restored. Recall that the minimum amount that must be restored to the Prop 98 base in any fiscal year depends on how much General fund revenue growth exceeds the growth in per capita personal income. Currently, there is a maintenance factor on the books of about $3.5 billion because over the past two fiscal years we chose to use the alternative Test 3 COLA and fund schools below the Test 2 level to help balance the budget. Thus, new tax revenues will trigger an obligation to begin restoring the school funding base (i.e., reducing the IOU/ maintenance factor). At the margin, each dollar of additional revenues obligates the Legislature to restore about 50 cents of the funding base, leaving about 50 cents for non-school General Fund purposes, until the whole maintenance factor is restored. In other words, of the first roughly $7 billion in new revenues about $3.5 billion would be required to go to the Prop 98 maintenance factor. Any new revenues beyond $7 billion would all be available for non-Prop 98 purposes. OK, so now I have another last question: What do we do about that?There aren't a lot of options. In order to avoid the interaction between new revenues and Prop 98 (i.e., be able to use all of any tax increases for non-Prop 98 purposes) we would probably have to suspend the minimum guarantee for the budget year. (Technically, the maintenance factor restoration is not "suspendable," but the underlying Test 2 minimum guarantee can still be suspended to accomplish the same result.) Keep in mind, however, that "revenue" increases like the VLF do not trigger any increase in the Prop 98 obligation because the General Fund benefit is on the expenditure side (i.e., reduced backfill to local governments), rather than the revenue side, of the budget. Similarly, the "split roll" property tax proposal by Senator Escutia and others would not increase the Prop 98 obligation but would, instead, decrease state expenditures for schools by increasing the amount of local property taxes used to meet the Test 2 total. Finally, fee revenues are not "General Fund proceeds of taxes" and likewise do not trigger any increased Prop 98 obligation. Here is the Legistive Analyst Offices' Prop 98 Primer.
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