Brendan P. Walsh

As everyone acknowledges the reality of the financial distress facing public schools, the focus must shift from assigning blame toward crafting solutions.  Understanding fund equity is essential to a meaningful dialog on this topic.  An objective view of data shows that fund equity will help districts cope, but is clearly not a long-term solution to the root cause problems.

Remember the first time you saw the picture below?  Look at it one way and you see an old woman, but with a subtle shift in focus it looks like a young one.

A view of the state’s K-12 budget and those of the local school district’s can have  a similar effect – most notably in relation to a school district’s fund equity.  You can learn much more about fund equity in this installment of the GPPSS Financial Transparency Series, but in short fund equity can be defined as the aggregate of a district’s revenue less its expenses over the history of its operations.

Sometimes called a  “rainy day fund”, fund equity draws attention in times of budget contraction because it is viewed, rightfully, as an alternative to other imminent and unattractive cuts.  The key question, however, hinges on the nature of the budget shortfall.  Is it temporary or an annually recurring one? A recurring shortfall is referred to as a structural deficit.  The distinction is significant.  I view the budget contractions that Michigan K-12 schools are now experiencing as permanent, what I previously wrote about as the New Normal.

Fund equity, to the extent a district has any, will be a frequent topic for Michigan public schools over the next couple of years.  I ran across a good example the other day in this article about Port Huron schools.  In short, the local bargaining units want the district to spend down fund equity in response to the recent financial challenges. 

The Port Huron superintendent counters that if nothing else changes, the district will be in a deficit position in just a few years.  He sees the revenue reductions, like I do,  as structural – permanent.  Using fund equity to cover the shortfall brought about by structural factors is ill-advised.  If alternative revenue sources are not identified, once the temporary source (fund equity in this case)  is inevitably depleted, you are left with the same root cause problem and fewer options with which to respond. 

Enter Proposal A.  New revenues are not an option local school districts have under Proposal A.  Lansing holds all those cards, and new revenue ideas aren’t going over so well these days – unfortunately neither are expenditure reducing options. 

What happens if an alternative revenue source is not identified AND the structural deficits persists AND fund equity is depleted?  You have a negative fund balance, the inverse of equity, which is an illegal position for Michigan public schools, triggering a variety of actions that may include the appointment of an Emergency Financial Manager (e.g. a Robert Bobb in Detroit Public Schools).  Yes, Bobb has done a great job, but as I wrote before, that is NOT a position districts envy.  In the Grosse Pointe’s and Harper Woods the appointment of an Emergency Financial Manager would be the Seventh Sign of the Apocalypse.

Nonetheless, there are those who still view fund equity as a solution to the K-12 funding crisis.  It is not a logical position to take –  a statement supported by data. 

If Michigan public schools leverage the same financial strategies as they have the last five years, nearly every district’s fund equity will be depleted within three years.

I analyzed the K-12 financial data for the entire state.  I calculated a five-year annual percentage rate of all school districts’ general fund expenses – real data, not hypothetical “doom and gloom” assumptions.  This is important because the actual expenditures comprehend the actions school districts have already taken to cope with the financial challenges. I then applied those rates onto the same expense categories over the ensuing three-year period, meaning this is what the big picture would look like if the same financial strategies are used.  Here is the snapshot:

[scribd id=24564930 key=key-1p2jz7uayfma8qollfm7]

Do you see an old lady or a young lady?  Let’s take a closer look.

Some costs are indeed trending down – most notably salary expense.  This is attributable to the massive employee layoffs happening around the state – not just teachers.  Entire district employee units are being outsourced (e.g. custodians, bus drivers, food service workers).  Outsourcing shifts those expenses from Salaries to Purchased Services, a cost that not coincidentally is rising 6.6% annually. 

Teachers can’t be outsourced, but student population is decreasing statewide which means fewer teachers are required. (I previously detailed how the rate of teacher loss exceeds student loss, thus resulting in higher class sizes statewide.)  Capital expenditures are also down sharply.  This may be attributable to the rise of Sinking and Bond Fund spending as well as simple project reductions.

But more costs than not are increasing.  Employee Benefits cost escalations are the most troubling.  This category is comprised mostly of health care and retiree pension and health benefits under the state run MPSERS system.  A $3.5 billion Employee Benefits state-wide spend in 2003-4 is on pace to reach almost $4.3 billion in 2010-11 – a 21% increase in the state’s second largest K-12 budget category.  Note that this cost is rising despite the reduction in employees discussed above.  It is staggering to contemplate and showing no signs of slowing down.  As I have asked before, is it becoming more clear why Andy Dillon is focused on this issue?  It is an utterly unsustainable trend.

In total, aggregated and annually recurring cost increases from 2008 to 2011 are on pace to exceed $1.25 billion… and it gets worse.

Why?  Because per pupil funding is simultaneously decreasing.  This year all school districts absorbed a mid-year cut of $165 per pupil.  Some districts (such as GPPSS) also took section 20J cuts.  The Senate Fiscal Agency just projected a $215 per pupil cut for the 2010-11 school year (see page 41 of this Dec. 22nd report on Economic Outlook and Budget Review).  The two-year total revenue reductions for Michigan schools exceeds $669 million. 

Combine the $1.25 billion in cost increases with $669 million in revenue reductions for a tidy $1.9 billion of structural budget gap accrued in just this three-year period.  This exceeds the combined total General Fund Equity of every district in the state as of 2008 by over $100 million.  Disregard for the moment that there is no practical way to pool all districts’ Fund Equity.  Even if there were the facts make it clear that barring significant change in expense and revenue trends, reliance on Fund Equity to “fix” the structural budget challenge would “work” for less than three years at which time fund equity would be depleted, and the root cause problems would remain unsolved, and fewer options would remain.

Think it can’t happen? To paraphrase the state’s motto, if you seek a school district in receivership, look about you.

We’ve become so accustomed to the headlines about the school funding crisis it has become white-noise.  As I keep saying, these have been tough times for school districts – and it is only getting worse.

How does the Grosse Pointe Public School System compare?  Let’s examine the same statewide metrics compare to GPPSS in the same 5-year span, 2003 through 2008:

GPPSS vs. All Michigan Public Schools Annual Percentage Rate of Change in General Fund Expense Categories from 2003 – 2008 (Source: State of Michigan)

	Statewide APR	GPPSS APR
Students	(0.85%)	(0.14%)
Teachers	(1.36%)	(2.42%)
Salaries	(0.48%)	0.87%
Employee Benefits	2.46%	2.63%
Purchased Services	6.67%	3.11%
Supplies & Materials	3.05%	(3.24%)
Other	1.65%	(24.14%)

 

GPPSS student loss is less than the state average, but General Education teacher reductions outpace the statewide average.  Why might this be?  Because our salary costs are increasing on an absolute basis (despite fewer employees) while on a statewide level they are actually decreasing.  (Read this blog entry for more details as well as all the installments of the GPPSS Financial Transparency Series.) Further,  the rate of GPPSS Employee Benefits increase exceeds the state average as well.  If GPPSS’ trends continue along this trajectory the results will be decidedly unfavorable to almost all parties.  In all other major expenditure categories, GPPSS compares favorably to state averages – as does our fund equity. 

So will fund equity help us cope during the transition to the new normal?  Yes, it already has in Grosse Pointe and undoubtedly hundreds of other districts who had to absorb the mid-year cuts of October 2009.  Unfortunately, this emergency situation is the best example of maintaining a responsible level of fund equity.  But fund equity as a long term solution?  Clearly it is not the answer, particularly if used only to fuel the escalating costs that are our root cause problem.

Distinguishing between the business models of commercial enterprises and non-profit organizations is helpful in the analysis of fund equity.

Fund equity is often interjected during school district contract negotiations – as exemplified by the Port Huron article above. These are healthy discussions we should not shy away from.  What defines market value for school employees?  Available funds within a district or market price/conditions across a region or the state?   In other words, should the mere availability of funds influence compensation?

This is a central question in collective bargaining in organizations where profit is the agreed upon objective.  Commercial enterprises are designed to generate profits and pass those profits on to shareholders.  Labor rightfully recognizes their role in the value chain and bargains collectively to be fairly compensated for the value they add to the end goal.  How are things the same or different for non-profits, such as Michigan K-12 schools? 

It’s the same in that our business model is dependent upon a qualified work force that enables the district to deliver its core service, a quality education, that attracts families and students.  For Michigan public schools, student enrollment translates directly to revenue – a direct correlation there between workforce value and revenue.  As we attract more students, we derive more revenue. 

Beyond that, it gets different quickly.  Unlike a commercial enterprise, Michigan public schools cannot increase fees for the real or perceived incremental value they offer consumers, mainly because profits are not the end goal of school operations.  After all the revenue at issue is derived from taxpayer dollars.  It could be argued that this WAS the model before Proposal A when local millages were an option. Taxpayers approved tax increases presumably because they were satisfied with the services rendered.  Not anymore.  Today operating revenue decisions are almost exclusively the domain of the state government.  Again, that’s Proposal A.

Who is really benefitting by a healthy fund equity in a school district?  We don’t pay a dividend per se to shareholders (i.e. taxpayers).  We aren’t trying to drive up a stock price.  No employee has any compensation bonus tied to fund equity.  A responsible fund equity simply demonstrates a school district is being financially responsible with taxpayer dollars.  It is being operated to work within its means.  It also helps reduce borrowing costs through better bond ratings and cash flow fluidity.  In that respect, a responsible level of fund equity is a direct benefit to taxpayers and consumers.

Fund equity must be evaluated in the context of the whole – a composite view of a school district’s financial, operational management, and service delivery strategy.

If a school system were consistently and disproportionally collecting tax revenue in great excess over expenses (which I would submit GPPSS is not) many variables would require analysis:

1. Do employees receive competitive wages and benefits in comparison to other districts?  (The GPPSS Financial Benchmarking Report is a good reference.)
2. Is the level of fund equity as a percentage of the annual budget disproportionately high in comparison to comparable entities? (Here’s a great benchmark report on this topic.)
3. Are locally controlled tax policies reasonable and competitive? (An excellent reference chart here.)
4. Is the proportion of employees to student in a healthy position?  (Class size is the best practical example.)
5. Are facilities being properly maintained for long-term health?

Naturally occurring checks and balances govern all of these questions.  Benchmarking and collective bargaining address the first and second.  Tax paying voters have the loudest say on the third.  Parents, other community voices, and professional staff have a large say for the fourth and fifth.  Each one presents a healthy discussion in which we should eagerly engage to satisfy ourselves.

In GPPSS’ case, we have established a responsible fund equity position – not disproportionately high or low.  By no stretch do we have a fund equity so high as to be either unfair to our employees or, more significantly, to allay rational fears about the state’s financial health. 

The revenue reductions of 2009-10 and 2010-11 will push scores of districts into a deficit position.  Responsible fund equity levels will prevent many more from the same fate.  But above all, the responsible financial management that enabled the accrual of fund equity levels in the first place is what will allow some districts to emerge from this current fiscal crisis still delivering services that meet the expectations of the communities they serve.