Monday, May 27, 2013

Kansas Tax Plans: What They Means for School Funding

Last Thursday, the Kansas Senate passed a new tax plan in HB 2085 on a vote of 24-14.  Friday morning, the House overwhelmingly rejected that plan, with only five voting in favor and 109 voting against.  Friday afternoon, conference committee negotiators for the first time reached an agreement that Republican tax leaders on both sides would sign. This bill that could be sent to the House for a vote Tuesday.  If the conference committee report passes the House, the Senate would vote next.  A conference committee agreement cannot be amended by either chamber - it can only be passed or rejected (usually by sending it back to conference committee).

Given the difficulty the Legislature has had in reaching even tentative agreements on tax policy, it might be surprising that the new agreement proposed by the House, put in SB 84, would raise $856.8 million over the next five years - which is $40 million MORE than the Senate plan the House defeated Friday.  One reason it is so difficult to reach agreement is that both Democrats and some conservative Republicans consider any of these proposals a tax increase.  That's true - when comparing it current law.  But state tax policy has already shifted significantly.

Impact of Tax Policy: Current and Proposed

State general fund revenues - which include most of the income and state sales taxes paid in Kansas - totaled $6.4 billion for the fiscal year that ended June 30 last year, Fiscal Year 2012.  Due to the income tax rate cuts passed last session and the scheduled expiration of the three-year sales tax passed in 2010, revenues are projected to drop to $6.2 billion this year (FY 2013) and fall to $5.45 next year - a reduction in state taxes of approximately $1 billion in FY 2014 compared to FY 2012.

What if the tax cuts had not passed?  For simplicity, let's assume the sales tax did not expire and continued to go into the state general fund, and tax revenues would grow at the same rate as projected for Kansas personal income by the state's consensus revenue estimating process: 3 percent in 2013 and 4 percent in 2014, and then continue to grow at 4 percent per year through 2018.  With no change in tax rates, state general fund revenues would likely increase to over $8 billion, a $1.5 billion increase over 2012.

However, under current law the Kansas Legislative Research Department estimates SGF revenues will not even equal FY 2012 levels until 2018.  All of the tax plans proposed this year by the Governor, passed by either the House or Senate, or proposed in conference committee, essentially "take back" some of the one billion dollars in tax cuts over the next few years, but also enact future tax cuts over the next five years. The conference committee agreement on SB 84 would keep half of the 0.6 percent sales tax due to expire this summer (dropping from 6.3 percent to 6.0 percent, rather than 5.7 percent), reduce the value of itemized and standard state income tax deductions, and adopt future income tax rate cuts through 2018.  The net effect is expected to not only generate almost exactly the same SGF revenue in FY 2018 as current law, but also raise more revenue between 2014 to 2017 to avoid deeper reductions in state spending.

As the chart above shows, even with the "tax increase" in SB 84, state tax revenues will be far below what they would have been under previous rates.

Even with the additional revenue, the budget estimates prepared by the Legislature Research Department project the SGF will spend more than it takes in every year from 2014 to 2018, dropping the ending balance from 10 percent this year to 1.5 percent in 2018.  In fact, since the SGF is projected to spend more in 2018 than it brings in, the state would likely face a significant deficit in 2019. However, Legislators have limited their projections to the next five years.

All of these budget assumptions are based on the budgets for 2014 and 2015 adopted by conference committee last week, but not approved by either the House or Senate.  For 2016 through 2018, the estimates assume the state will add funding for human service caseloads, school finance and KPERS retirement contributions based on historical experience.

Finally, all of these assumptions are based on essentially "average" growth in the economy.  If the state economy grows faster than normal, which supporters of the income tax cuts expect, revenues will be higher.  If the state or national economy shows or falls into another recession, revenues will be lower.

What does this mean for school finance?

The conference committee budget for K-12 education is basically the same as proposed by Governor Brownback: funding to keep the base budget per pupil level at $3,838 in FY 2013 and 14, with a $14 increase in FY 2015 due to more revenue from the statewide 20 mill levy.  It contains no change in funding for local option budget and special education state aid.  Additional funding is provided for KPERS contributions and capital improvement (bond and interest aid).  The Legislative Research Department budget assumptions project general state aid will increase $52.2 million in FY 2016, $53.2 million in FY 2017 and $54.3 million in FY 2018.

Those assumptions mean school district general fund budgets, including special education, would increase an average of just 1.6 percent per year over the next five years (2014-2018).  Assuming Local Option Budgets usage (as a percent of total general fund) increases 0.1 per year, total general fund, special education and LOB operating budgets would increase 1.7 percent per year. (LOB use is unlikely to increase much because so many districts are at or near the statutory maximum unless they hold an election.  Without an increase in LOB state aid, increased LOB use will result in higher property taxes for all districts that receive state aid.)

A five-year average increase of 1.7 percent per year is more than the previous five-year average of 0.6 percent during the Great Recession and recovery.  But is less than half or one-third of every other five year period going back to 1989. With enrollment growth of approximately 1 percent per year over this period, the per pupil increase will be less than 1 percent annually.  This does not take into account inflation, which typically rises around 2 percent per year.

As this chart shows, state and local funding for school district operating budgets increased more than Kansas personal income from 1988-93, less from 1994-98, and about the same from 1993-03.  However, since 2004, operating budgets have been increasing less than KPI.  This trend will continue over the next five years based on the budget and tax assumptions currently under consideration. (This does not include funding for KPERS contributions, capital spending on construction and equipment, debt payments, federal aid and school meals.  When these areas are included, total school spending has increased at about the same rate as personal income since 1990.  However, most of these funds cannot be spent for "regular" classroom instruction and current educational operations.)

Shrinking Kansas Government

Whatever happens to the tax policy this session, the structure of Kansas government funding has already been changed when measured against Kansas personal income, which represents both the size of the state economy and ability to pay taxes.

If KPI increases by 4 percent per year over the next five years - modest by historical standards - both state general fund revenues and expenditures will at their lowest point as a percentage of KPI since at least 1975.  In other words, Kansas state government will be taxing and spending the lowest share of state income in over 40 years.  The State General Fund peaked at around 6 percent of KPI in the late 1990's - largely because the state assumed a larger role in school finance to reduce property taxes.  State aid increased from about 55 percent of school operating budgets in the 1970s and 1980s to over 80 percent in 1999, and has remained at that level.

Because school districts now rely so heavily on state aid, tax reductions that reduce or limit state aid have a major impact on school budgets.  This year, school operating budgets are estimated to equal 3.2 percent of Kansas Personal Income - also the lowest level since 1975.  As calculated above under the proposed tax and budget plans, this percentage would drop to 2.9% by 2018.

In other words, the next five years of school funding is not expected to be as bad as the previous five, but still far below "normal" in recent decades.  With average growth below the rate of inflation and the rest of the state economy, school districts will continue to face budget cuts or re-allocation as they balance rising costs with higher expectations.

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