Report of the Working Group on Finance and Facilities - K-12 Education

LINKING THE COMMUNITY AND THE SHOOL: RAISING REVENUES LOCALLY
PART 3. EXPLORING LOCAL REVENUE OPTIONS

Introduction

Under the current system, the State of California is the funding agent for any increase in K-12 Proposition 98 revenues^[17]. This places significant added pressures on the state and has the effect of giving the Capitol strong control over the delivery of educational services and programs. Local control is whittled down to a limited form since local agencies are not the funding agent for added revenues.

Under the current system, the state raises and provides revenues for local education, and local school boards and agencies make decisions on how to spend those revenues. This divided authority muddles accountability. The state lawmaker must face the electorate for taxing decisions while the local official can easily claim that “the state” is not doing enough to meet minimum educational needs. Sometimes the conflict becomes very visible: schools cry “foul” since they are dependent on others for income, and state lawmakers cry “foul” when expenditure decisions of local agencies do not match their vision of how education dollars should be spent.

Finally, under the current system, any local responsibility for adding optional education programs – and raising the funds for those options – is lost. Local agencies do not have a realistic opportunity to make decisions to increase local taxes for the addition of local programs. There is no realistic option for a local agency to tax itself for support of a local program. The accountability inherent in public representatives raising taxes for public education and then standing for election based on that decision is no longer available to California’s school governing boards and communities.

As stated in the Framework to Develop a Master Plan for Education, we share the belief that school district governing boards can be more responsive to local educational needs and priorities, and can be held more accountable by local electorates for programmatic decisions, when they are able to generate revenues locally and can demonstrate a direct connection between a revenue source and specific educational services. The framework establishes the following parameters for review:

• Options should be explored that permit school districts to develop additional revenues to support programs and activities they wish to offer in addition to the high quality education that is guaranteed by the state; and,
• Any new local revenue options must be generated or shared locally in accordance with state-defined parameters, which preclude the development of significant inequities in the level of educational offerings provided to students.

This part of our report explores the viability of local revenue options for school districts.

Background

Historically, the ad valorem^[18] property tax was the single largest source of support for K-12 schools. In 1975, property taxes accounted for more than two-thirds of all school district revenues. Property tax rates were determined locally with voter approval. Therefore, the communities of local school districts held significant discretion over the amount of funding that would be made available to the schools through a self-imposed property tax assessment. Local revenue raising authority was matched by a local governance structure, with school boards elected by and from the same communities that approved the level of fiscal effort in support of their schools.

School finance equity litigation (Serrano) and a property tax limitation initiative (Proposition 13) provided impetus for dramatic change in the structure of school finance in California. The state responded by assuming responsibility for funding the schools, and, as chart 1 shows, state resources came to provide the bulk of support for K-12 education.

Sources of revenue for K-12 education^[19]

(Chart 1)

While nearly 30 percent of public school funding still comes from local sources, K-12 schools now have very limited ability to raise revenues locally. The bulk of “local” revenue in the current financing system comes from the local property tax, and property tax revenues allocated to local school districts are a dollar-for-dollar offset to state aid. In fact, in lean budget years, property tax growth often accounts for the majority of new “state” money provided for K-12 education programs. Finally, property tax rates are set by constitutional and statutory provisions not subject to local control.

Currently, school districts can receive locally raised revenue through a few previously authorized special taxes. School districts can, with approval of the electorate, impose a parcel tax and they can participate in a local sales tax through a local public finance authority. Schools raise funds locally through foundations and other parent-centered fundraising. While these sources of revenue may be significant for some school districts and schools, they are limited in their application across the state.

Why a local revenue option?

There are many compelling reasons to once again establish meaningful local revenue raising options for school districts:

• Authority to raise revenues locally and to allocate those revenues for local discretionary uses will encourage and strengthen local responsibility and accountability.
• School district governing boards could more easily respond to local educational needs and priorities if local revenue-raising options were available. They can demonstrate a direct connection between a revenue source and specific educational services, and can be held more accountable by local electorates for programmatic decisions.^[20]
• Educational needs that are unique to communities can be best financed through locally approved and derived revenue sources. This would reduce pressure on the Legislature to address through state-level action the unique circumstances of individual school districts. Even some needs closely related to state interests may best be funded locally, where an expansion beyond current program levels is a priority within a local community.^[21]
• Local revenue raising capacity is high. California is near the top (4^th) nationally in state tax revenues, and near the bottom (47^th) in local revenues when compared with other states.

Keeping the “Local” in Local Revenues

It is critical to recognize that a meaningful local revenue option must link local revenues to those purposes that are best developed and resourced locally. In particular, we would caution that local revenues raised from an optional tax must not become a means of mitigating inadequate basic educational funding that is a statewide responsibility. Rather, revenues raised from a local option tax must be available wholly at local discretion to augment all other funds received for the educational program.

Evaluation Criteria

The working group identified specific criteria to assist it in evaluating four different local revenue options:

• Is this a revenue source that can provide a meaningful increase to school district revenues? (Tax yield) A broad-based tax with the potential for relatively high yields for a given tax rate is desirable.

• How sensitive is this revenue source to the economic cycle? (Stability and dependability) Is the revenue source stable and dependable? High stability, or low sensitivity to the economic cycle, is desirable.

• Who pays the tax, and who benefits? (Tax and expenditure incidence) On whom does the burden of the tax fall? Is the tax progressive or regressive in its application? Do the taxpayers benefit from the revenue raised for the local public schools?

• How much do revenues raised from similar tax rates differ among communities? (Tax yield neutrality) Related to incidence, this factor recognizes that few tax sources are yield or wealth neutral. How much state equalization aid would be required to equalize local fiscal effort?

• How easily can tax revenues be collected? (Administrative feasibility) Can local revenue be collected and distributed using existing administrative structures, or would new structures need to be developed? Can the tax be administered efficiently and effectively, with a high degree of voluntary compliance?^[22]

• To what extent would the imposition of the local tax distort taxpayer behavior? (Economic efficiency) Achieving satisfactory yields should not become a cause for taxpayers to change their behavior so as to avoid the tax.

• How closely does the revenue source correspond to district boundaries and relate to the education community? (Association) The linkage between the school board, the schools, the electorate, and the payers of the tax should be direct, rational and understandable.

• Is the tax deductible? A tax source that is federally deductible may be more attractive to taxpayers because it will be partially offset by a reduction in other tax liability.

Options considered – description and proposed recommendations

The working group has considered four local revenue options, and assessed each against our evaluation criteria: The parcel tax, the sales tax, the ad valorem property tax, and the income tax. We are recommending that the Legislature consider three levels of commitment to local revenue options, each corresponding to one of the three tax options we are recommending^[23]. The three levels represent our assessment of the perceived or actual degree of change necessary to implement our recommendations. The first option we present, a modification to the parcel tax, represents what we believe would be a relatively small step beyond current practice. The third and last option, amending the ad valorem property tax, would require a change to constitutional and statutory provisions adopted through Proposition 13, and so is likely to represent a much more substantive change.

The Parcel Tax

Since the enactment of Proposition 13, school districts have been authorized to levy a parcel tax with approval of two-thirds of the voters. However, the parcel tax is used in only a small number of school districts – a total of 48 school districts (<1%) levied a parcel tax in 1998-99. Moreover, a review of successful parcel tax elections shows that the parcel tax has been approved primarily in school districts with higher income, well-educated families. In those districts that have adopted parcel taxes, the average revenue exceeds $500 per pupil. Districts with predominantly lower income families tend to be less successful in gaining approval of parcel tax proposals. ^[24]

In successful districts, implementation of the parcel tax varies. In addition to a single, fixed assessment per parcel, some districts have adopted parcel taxes with differential rates for residential and commercial parcels (Davis Unified School District). Other districts have adopted parcel taxes based on a per-square-foot assessment (Berkeley and Albany unified school districts). Specific exemptions, such as senior citizens, have been granted, and annual automatic COLA adjustments have been provided. Most, but not all, parcel taxes have a time limit, when the school district must return to the voters for reauthorization. All parcel tax referendums state the purposes for which the revenue may be used. Parcel tax revenues for a given assessment can vary among communities, in that districts encompassing more parcels of land can raise more revenue for a given parcel tax rate than other districts with fewer parcels.

Although in limited use now, we believe that the parcel tax may be among the most viable local revenue options for school districts at this time, for the following reasons:

• The parcel tax is authorized for school districts under existing law and constitutional interpretation.
• Parcel tax yields are proven to be robust, based on the experience of those districts that have successfully adopted parcel taxes.
• Revenues are resistant to fluctuations caused by the economic cycle because the parcel tax is not value or income based.
• Incidence can be balanced by establishing different rates for residential and commercial property. Regressivity can be mitigated by the use of assessments based on square footage, and specific exemptions.
• Tax yield neutrality can be assured through equalization formulas.
• Existing local agencies can administer the tax.
• Because quality schools and high property values are closely linked, taxpayer behavior is less likely to be negatively influenced by the imposition of a parcel tax.
• Property-based taxes are more directly associated with local schools than any other revenue source.

Of the 128 parcel tax elections that failed to achieve a two-thirds majority vote, 87 (68 percent) were approved by a margin of 55 percent or better of the voting electorate. Recent electoral support for local school facility bond measures based on a 55 percent threshold lead us to believe that public support for schools is strong. Therefore, the working group recommends that a Constitutional amendment be considered:

The Sales & Use Tax

The sales and use tax (SUT) is the second largest tax levied in California, with revenues totaling $32 billion annually. Levied at both the state and local levels, three-fourths of the revenues accrue to the state and one-fourth to local government. A component of the sales tax is a local option levy, which causes sales tax rates to vary by county, ranging from 7 percent in those counties with no local levy to a high of 8.25 percent.

California has a high SUT rate when compared with other states, but because of its many exemptions SUT revenues per $100 of personal income are slightly below the national average. The SUT has been a reliable and stable tax with relatively good growth. However, the SUT has represented a declining share of personal income over the past 20 years, which may raise questions about its long-term viability.^[25]

The portion of the SUT that can be levied at local option is used in just 24 of 58 counties. Local option levies cannot exceed a total of 1.5 percent, and currently range from 0.125 to 1.25 percent. They can be adopted by counties, cities and special districts, for use to fund local programs in transportation, public libraries and other services, including public education. The largest use of local option SUT levies supports transportation projects. Our review shows the following characteristics that support the sales tax as a local option for school districts:

• The sales tax is robust; each ¼ cent increase yields more than $1 billion dollars statewide.
• Administration is straightforward on a countywide basis because it can be collected and distributed through existing agencies.
• The sales tax does not have a high association with schools, and may be paid by taxpayers who have no relationship to the schools it supports.

However, the sales tax also is less desirable for several reasons:

• The sales tax is sensitive to the economic cycle, subject to a falling share of expenditures on tangible (taxable) goods with a shift toward non-taxed services. The sales tax is regressive, somewhat mitigated by statutory exemptions.
• May affect consumer behavior if a higher sales tax rate encourages consumers to cross county boundaries to lower tax environments without inconvenience.

Although a local option SUT levy can currently be proposed and approved for the benefit of public education, the process has not been conducive to widespread use by the schools. Therefore, we make the following recommendation so that schools can put directly to local voters a sales tax increment increase to support public education in their community.

The Property Tax

The ad valorem property tax accounts for nearly one-third of all tax revenue accruing to local governmental agencies. Statewide, more than half of property tax revenues are allocated to support K-12 schools, but the specific percentage among counties varies widely across the state due to historical differences in the local distribution of property taxes. Property tax distributions among local governmental entities have been set by the state since the voters approved Proposition 13 in 1978. This tax initiative severely limited the ability of local governments to raise revenues through the property tax, by (1) setting the countywide tax rate at no more than 1 percent of assessed value^[26]; (2) allowing local reassessment of real property only upon resale, based on the sale price; and (3) limiting annual growth in assessed value to 2 percent. In addition, as noted earlier, the state response to Serrano incorporated local property tax revenue to schools as a dollar-for-dollar offset to state general-purpose aid. In essence, then, local property taxes are no longer subject to control by the local electorate and the school's share of those taxes simply supplements state-established per-pupil funding levels for the schools.

Nonetheless, based on our evaluation criteria, the property tax arguably provides the best source of local revenues for schools:

• Local residential and commercial property values provide a broad base to raise revenues.
• Historically, property taxes have been a stable source of revenue, less sensitive to economic cycles.
• The ad valorem tax is value based, and so is less regressive than the parcel tax.
• A property tax is easily administered by existing tax collection agencies.
• Any potential disincentive to property buyers due to higher local taxes is offset by the increased attractiveness of property in areas with high quality schools.
• Because of the natural relationship between property owners and the local schools in a community, the property tax has high association among the school district, school board, electorate and taxpayers.
• Equity, so that similar revenues would be raised with similar fiscal effort among different communities, can be supported through a fiscal “power equalization” formula.

Since Proposition 13 established its key provisions in the state Constitution, a Constitutional amendment would be required if the property tax were to again become a viable option as a discretionary local revenue source for schools. If the Joint Committee believes that this option is politically viable, we recommend consideration of a proposed Constitutional amendment: