Funding phantom students: state policies insulate districts from making tough decisions.
Roza, Marguerite ; Fullerton, Jon
Many state education leaders are taking a fresh look at school
finance in hopes of containing costs. Some are reworking transportation
formulas, or zeroing in on special education eligibility, or merging
districts. Others are investing more in digital learning, charter
innovations, and information systems. But state leaders too often
overlook a common practice that inhibits both efficiency and
productivity, namely, funding students who do not actually attend school
in funded districts, herein called "phantom students."
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Policies that fund phantom students take several forms:
* protections against declining enrollment
* hold-harmless provisions for districts competing with charters
* small district subsidies
* minimum categorical allocations.
In each case, affected districts receive funds in excess of what
they would receive if only the students on their rolls were funded. An
obvious downside is that these policies cause less funding to be
available for all other districts. But such allocations also insulate
district leaders from having to make tough (and often
productivity-enhancing) changes in the way they serve the students they
have. Policies intended to "protect" districts weaken the
incentives that should drive change and adaptation as enrollments
fluctuate.
The Economics of Enrollment
While state policymakers often try to base funding allocations to
districts on "costs," the fact is that costs and revenues are
interdependent. It is true that a district with more funds per pupil
than its neighbors can afford to offer more or better services (in the
form of extracurriculars, smaller classes, and individualized learning
time, for example). It is also the case that the cost of delivering the
same services as neighboring districts can increase with revenues, often
as the result of concessions extracted by employees as part of the
collective bargaining process. Each year, districts are under pressure
from constituents and employee organizations to match expenditures to
available revenues. If expenditures are projected to be higher than
revenues, the district, to avoid running a deficit, will need to reduce
spending. But if revenues are projected to come in significantly higher
than expenditures, districts will also have a hard time squirreling away
the surplus. As one of us has noted in these pages (see "Mounting
Debt," forum, Winter 2004), a surplus may suggest to employee
unions that a raise is due and to parents that class sizes should
shrink. There is immense political pressure for surpluses to be quickly
soaked up, often in a manner that raises the per-pupil cost of services
without fundamentally changing their delivery.
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This adjustment works as revenues rise but not so well as they
fall. In times of shrinking enrollment, districts can suddenly find
themselves with unsupportable cost structures. Many a district leader
has found that raising salaries and reducing class sizes is quite a bit
more palatable politically than vice versa.
Consider a 10,000-student district that has an enrollment increase
of 200 students from one year to the next. The district receives $10,571
in state and local funds per student enrolled, the national average in
2010. As Table 1 illustrates, insofar as state and local revenues are
generated on a per-student basis, the school district will receive
roughly $2.1 million in additional revenues for the new students.
Enrollment Boon (Table 1)
New students can cost less than schools receive.
Revenues
State and local revenue per student $10,571
Additional students enrolled 200
Total additional revenues $2,114,132
Expenditures
Students per classroom 20
Students per classroom 10
Total compensation per teacher $74,543
Book and supplies per student $826
Total cost for new students $910,427
Surplus generated by enrollment growth $1,203,705
NOTES: Average state and local revenue per pupil In 2010 (NCES).
U.S. average public school teacher salary: 2009-10. 35 percent
benefit rate assumed. Books and supplies: US. average 2008-09,
expenditures on supplies per pupil.
SOURCE: National Center for Education Statisics (NCES); authors'
calculations
Direct costs are unlikely to increase as dramatically. Even
assuming that the additional students are all placed into newly created
classes with new teachers making the average national salary, the
additional costs are likely to be much less than the additional
revenues. Assuming that no new schools are built to house these
students, the district will have a large surplus to spend on other
things, such as new district-wide programs, class-size reductions, and
employee raises.
Now consider what happens in the same district when enrollment
shrinks by 200 pupils and state and local funding declines accordingly.
Assume the district reduces its teaching force by 10 teachers and no
longer pays for these students' supplies. It could reduce its
expenses by about $910,000, but it is losing more than $2.1 million in
revenue. If the $1.2 million surplus from prior growth is indeed being
spent across the district, it will need to make general budget
reductions or "cuts due to declining enrollment." With their
tendency to spend all that they have, districts create financial
asymmetry around enrollment growth and decline.
A similar mind-set has dominated the thinking on small districts,
namely that services should be delivered in small districts in much the
same way as in large districts. Small districts, the argument goes,
still require a full-time librarian, counselor, nurse,
physical-education teacher, and so on, and thus some minimum level of
fixed costs is unavoidable.
As a result, the discourse around enrollment loss and small
district expenses often focuses on high "fixed costs." This
reflects a misunderstanding of what costs are fixed. Few in other
industries consider personnel costs (which constitute the majority of
district expenditures) fixed. Administrations could shrink, pay raises
could slow, and schools could be closed if enrollment declines. In the
case of small districts, many services could be purchased in smaller
increments with part-time staff or by contracting with service providers
(e.g., for online learning).
It does seem to be the case, however, that people feel worse about
losing something they had than not gaining something they would like. As
a result, declines in enrollment can be painful. And so state lawmakers
have enacted phantom student-funding policies to help districts cope.
The annual cost of phantom student funding varies by the types of
policies in place across different states. Table 2 highlights provisions
in several states and computes their value as the portion of total state
education funding to represent the relative scale of these policies.
While the dollars at stake are obviously not a major driver of state
education expenditures, they are significant, especially during times of
tight budgets. At a time when districts may not be receiving funds to
cover cost growth, however, even 1 percent of the state's total
spending is meaningful.
State Sampler (Table 2)
Phantom state funding adds up in states across the country.
Type State Description Estimate Percent of
state
education
spending
Finance CA Declining $436 1.2%
Formula enrollment million
Protection protection [dagger]
(FY
2011)
Finance MA State aid held $180 3%
Formula harmless at million *
Protection previous year's (FY
total 2013)
regardless of
enrollment
changes
Charter School MA Tuition $45 0.8%
Hold-Harmless reimbursements million
to districts (FY
sending 2013)
students to
charters
Charter School CT Hold-harmless $286 4.7%
Hold-Harmless for districts million
losing students
to charters or
transfers
Small District NM Total public $69 2.6%
Subsidies (2009) funds above the million
average
provided to
districts with
enrollments of
100 to 1000
WA $104 1.5%
(2009) million
NOTES: [dagger] Total enrollment decline across districts between
2010 and 2011 was 89,234 students. Authors adjusted for average
state attendance rate and calculated revenue per student at $5,244.
* Authors summed positive gaps between Foundation Aid Fully Reduced
(what the Chapter 70 Program calculates should be supplied to
districts) and actual foundation aid provided to districts in 2013.
If Foundation Aid Fully Reduced for a district Implied increasing
local contribution, the positive hold-harmless gap amount was
reduced by the amount of this Increase.
SOURCES: california Department of Education; California State
Budget 2010-11, Summary Charts; Massachusetts Department of
Education. FY13 Chapter 70 and Net School Spending Formula
Spreadsheets and Preliminary FY13 Charter School Tuition Payments
and Reimbursement for Sending Districts (Q2); Massachusetts Budget
and Policy Center; authors' calculations
Protections against Declining Enrollment
As the 2012-13 school year opened, districts in Tucson, Cleveland,
Newark, Philadelphia, and elsewhere were facing steep enrollment
declines and a corresponding dip in revenues. Five years before,
Baltimore, Seattle, and Portland, Oregon, topped the list of districts
in fiscal chaos brought on by falling enrollment.
Enrollment shifts are certainly part of the landscape, and at any
given time just as many or more districts may be facing enrollment drops
as are seeing enrollment gains. But each time enrollment falls, district
leaders seem to be caught off guard, forced to dip into reserves, pare
down extracurriculars, and make out-of-cycle pleas for rescue funding in
order to avert salary freezes, seniority-based layoffs, or school
closures.
And so it goes. States attempt to ease the pain by jumping in with
extra funds. In California, core funding for students (known as the
Revenue Limit) is made to districts on the basis of average daily
attendance (ADA). When district enrollment declines year over year, the
allocation is made on the basis of the previous year's average
daily attendance. While this provides districts with only a one-year
reprieve, the amount spent is substantial. According to the Public
Policy Institute of California, in 2005-06 the total cost of this
protection was $402 million or about $111 per student in
declining-enrollment districts. Taken together, the 89,234 phantom
students funded last year by California's declining-enrollment
provision would have been California's third-largest district,
larger than Long Beach, Fresno, or San Francisco.
Massachusetts distributes state aid to districts on the basis of a
complex formula that considers enrollment, student need, and local
ability to pay. However, the state legislature usually inserts into the
budget a "hold harmless" provision that does not allow total
state aid to any district to go down, essentially ignoring the careful
rationale behind the state's own formula. Extra payments to select
districts are projected to total $180 million in FY13, more than 3
percent of total state education spending. Districts that are overpaid
have no incentive to attract new students, as their state aid would not
go up, and, in fact, would be better off on a per-pupil basis if some of
their current students left. In other states, protection policies take
the form of one-off allocations made to large city districts as students
disappear. Pennsylvania, for instance, funds the Pittsburgh and
Philadelphia districts according to a different formula than it does all
other districts in the state. The effect is to grandfather them in under
a higher expenditure structure than their current enrollments warrant.
Holding Harmless Districts Competing with Charters
Buried deep in numerous state charter laws are promises to
districts, often made during charter law negotiations, that they will be
protected financially when they lose students to charters. Called double
funding in some states, these provisions work much like the
declining-enrollment protections. The state funds students attending
charter schools while still funding districts as though those students
had remained.
In Connecticut, districts receive revenues based on the enrollments
of students living in their region, regardless of whether those students
attend the district schools or attend charters (or technical schools).
According to researchers Bryan Hassel and Daniela Doyle, double funding
students in 2008 cost Connecticut $186 million.
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In Massachusetts, charter school students take with them the
per-pupil net school spending (state and local) from their sending
districts. To soften the blow to sending-district finances,
Massachusetts provides a partial tuition reimbursement for up to six
years after the district starts paying charter school tuition. When a
district incurs new tuition costs, the state reimburses the district for
100 percent of the cost in the first year and 25 percent of the tuition
cost for the next five years. Thus, the state essentially provides
districts with 225 percent of a year's tuition for each full-time
equivalent student lost!
These allocations could create a disincentive to improve services
in an effort to retain more students. When students leave a district to
attend a charter school, the district may see an increase in per-student
revenues.
Subsidies for Small Districts
Although some small districts may have lower salaries and
transportation costs than larger districts, and opportunities for
creative and cost-effective service delivery certainly exist, it is
often assumed that larger districts necessarily enjoy economies of scale
from which small districts cannot benefit. The result is that smaller
districts in many states receive more funds per pupil than do their
larger counterparts.
According to a 2010 Education Week report, 29 states have an
explicit "weight" in their state allocation formula to account
for district size. Others fund some items (e.g., staff or programs) in
"one per district" amounts such that when the costs of those
items are divided by the lower enrollment of smaller districts,
per-pupil price tags are quite high.
These small-district subsidies add up. In Washington State and New
Mexico, districts with student enrollments between 100 and 1,200 spend
$104 million and $69 million more, respectively, in total public funds
than if they were spending the statewide average per pupil in these
districts. In Maine, the largest districts spend, on average, $8,033 per
pupil compared to $11,027 for the smallest districts. This subsidy
amounts to $9 million in total, enough to educate almost 40 percent more
students than the small districts serve. In California, districts with
fewer than 100 students receive, on average, more than $18,000 per
enrolled student, or more than twice as much as districts that enroll at
least 1,000 students.
Not all states have bought into the need for small-district
subsidies. As Figure 1 indicates, the extent to which small districts
(here defined as having 200 to 1,200 students) receive extra funds
varies enormously. In states like California and Georgia, smaller
districts receive a subsidy of 15 percent or more of the average
per-pupil spending levels in their larger-district peers. Minnesota and
Wisconsin, in contrast, have small districts that operate at funding
levels on par with their larger peers.
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Even if large districts do enjoy important economies of scale,
small-district subsidies discourage merging or sharing services across
districts, both potential means for gaining such economies. Charter
schools (essentially single-school districts) have learned this lesson
and often share purchasing, specialized services, or back-office
functions. Even larger districts often share services across areas such
as special education provision or vocational education.
Small-district subsidies also reinforce the assumption that there
is one best method to deliver schooling: a traditional school building
with a principal, a nurse, on-site teachers in all subjects including
specialty courses, and so forth. This mind-set has prompted advocacy
groups like the Rural School and Community Trust to seek both
small-district subsidies and protection against loss of enrollment to
charters. In contrast, some small and geographically isolated districts
have found that with digital learning technology, they are able to
provide students with better course options and at a per-pupil cost that
provides for parity with other districts.
Minimum Allotments for Categorical Allocations
Formula minimums for categorical allocations create a fourth type
of phantom funding. Forty-nine states target funds to specific programs
or types of students, including bilingual education, nutritional
programs, drug awareness, and dropout prevention. In some cases, the
targeted allocation distributes a fixed-dollar amount for each eligible
student (say, each bilingual education student) and then includes a
minimum allocation for districts with very low numbers of the targeted
population. Under such a policy, a district with only a handful of
bilingual education students might receive a vastly inflated spending
level for each of them.
Formula minimums usually have their origin in politics. Those
proposing legislation for categorical allocations know that before
understanding its justification, many legislators will flip through the
bill to see how much money is at stake for their district: the minimums
are included to entice legislators to vote in approval.
The result can be windfalls for districts that don't have
significant numbers of students who qualify for the funding. In previous
work, one of us found that Washington State's 2004 compensatory
allocation formula ensured that affluent Bellevue School District, in
which only 18 percent of students qualify for free or reduced-price
lunch, receives $1,371 per poor student in state compensatory funds,
while large urban districts received less than half of that for each of
their impoverished students (see Figure 2).
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The Hidden Costs of Phantom Funding
Declining enrollment, increasing competition, and small size all
create financial challenges for school districts. If districts do not
adapt by restructuring service delivery, they could go bankrupt. Perhaps
funding phantom students is a reasonable state policy response.
We see three primary arguments against the funding of phantom
students: First, by continuing to fund phantom students, states ensure
that districts won't restructure expenditures for smaller
enrollments. If the district has a large professional development
department, or too many kindergarten teachers, those positions may stay
on the district payrolls because the extra state monies make it
possible. A 2010 study of declining-enrollment districts by Pacey
Economics Group found that, while districts face real challenges
reducing transportation costs, they do have flexibility on "other
categories such as other supporting operations and maintenance,
instructional salaries and benefits, food service, and
administration." In other words, they can reduce costs when they
have to.
Second, funding phantom students delivers the message that school
districts should continue delivering education the way they have for the
last century. If, indeed, we have found the "one best system,"
this is all to the good. If we have not (which our relative
international performance might suggest), or even if we are not sure,
this system discourages needed experimentation.
Finally, and perhaps most importantly, funding phantom students
diverts public funding from other uses. Proponents of protections from
declining enrollment or small schools rightly note the challenges of
downsizing. In deciding whether to protect declining-enrollment
districts, however, policymakers should consider alternative uses for
that money. Clearly, the funds could be distributed more evenly across
all schools, used for early childhood services or for augmenting
children's health care, or aimed at improving postsecondary options
for students from lower-income families.
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How States Can End Phantom Funding
Ending the funding of phantom students will not be easy politically
or from an organizational standpoint. Even so, there are numerous
actions states can take to prepare districts and the public for thinking
about schooling and education funding differently and effect a fair
transition.
Encourage districts to structure allocations in per-student terms.
Education funding policy should address the misalignment between what
drives revenues and what drives expenditures. On the revenue side, most
funds are tied to student counts. For San Francisco, for example, a
reduction in one student equates to a loss of $5,000 in state money.
The expenditure side is a different story. A loss of one student
doesn't automatically trigger any change in the budget. Districts
have staffed their schools by estimating how many classes they'll
need and made sure each school has a counselor, a nurse, a parent
coordinator, and so on. When a handful of students leave, these same
line items cost more in per-pupil terms. Districts consolidate classes
where they can, but then imagine that their only option is to pull some
staff from the schools and eliminate programs.
Fluctuations in enrollment are inevitable. Knowing this, districts
should create more nimble fiscal systems, in which expenditures (like
revenues) are tied directly to enrollment. This means reconfiguring
budgets so that allocations for schools and services are on a
per-student basis. Each school would receive a specified dollar amount
for each student so that its allocation automatically rises and falls
with enrollment. School districts in Flouston, Denver, and Oakland
already allocate funds to schools in this manner.
Individual programs, too, might be funded in the same way. A
program to create college awareness, for instance, might receive $100
per eligible student each year, instead of an allocation of some fixed
number of staff. This kind of expenditure structure is currently being
implemented for central departments in the Baltimore City Schools.
In this model, total spending on district schools and services
automatically drifts up and down with enrollment, thereby better
matching revenue trends. Within each school, incremental changes can be
made on a yearly basis to reflect trends in the size of the student
body. The more allocations that districts base on enrollment (not only
to schools, but also to departments, services, operations,
administration, and other district functions), the more protected the
district is from sudden deficits stemming from shifts in the student
population.
This kind of allocation model also protects programs from wholesale
elimination with a drop in enrollment. College awareness services, for
example, may need to be redefined when student counts drop, perhaps by
rethinking delivery, or relying on part-time staff, but the program
doesn't go away. For each program or service, as enrollments
decrease (or increase, for that matter), the per-pupil allocations stay
the same. Where middle-school science was a priority, it is still a
priority. Where parent engagement is thought to be important, the need
may be met in a different manner than assigning a full-time staff person
to each school to lead the effort.
It is true that as districts shrink, some district services will
miss out on economies of scale. At this point, the department may need
to provide the service jointly with another district or contract out for
the service on a per-pupil basis. But rather than having district
leaders make those cuts from the top, adjusting to current enrollment
becomes the responsibility of each school and program manager.
That's where adaptation and adoption of innovations can happen.
Leaders of a high-cost speech therapy program, for example, are driven
to explore technologies that enable remote speech therapy and decrease
staffing costs. In this model of budget management, adaptation happens
within each department as it seeks to hold per-pupil costs steady amidst
enrollment changes.
Restructure true fixed costs: unfunded liabilities. In education,
costs are often assumed to be fixed that actually are not. While it is
certainly easier to reduce a teaching position than to merge a school or
restructure administrative operations and services, most operational and
personnel costs of school districts are variable and could be structured
to vary more directly with enrollment and revenues.
Yet there is a critical exception haunting many districts. Lifetime
health benefits and defined-benefit pensions, sometimes guaranteed
decades ago, have created ongoing costs for districts that are
unconnected to revenues and enrollment and cannot be easily reduced. As
of 2009, the Los Angeles Unified School District, a shrinking district,
had an unfunded actuarial accrued liability of $10.3 billion for
employees' future post-employment health-care costs, more than 200
percent of the active payroll. In 2011, the district paid $240 million
in health and medical benefits for retirees and their dependents. Note
that this cost relates only to the number of retirees, not the number of
current students or employees. Thus, as the district shrinks, the
per-student cost will continue to increase.
One answer to this challenge might simply be "Too bad!"
Districts entered agreements to fund these benefits and did not set any
money aside--they made their own bed. This is not quite fair. Those who
entered the agreements generally did so years ago, and the
administrators, voters, and union leaders that allowed this are all long
gone. Indeed, one wonders whether knowing that the payment on these
promises was going to be someone else's problem rendered them
easier to make. Today, in any case, payments are coming due.
A possible way out of this mess is for states to execute a grand
bargain. States could assume existing liabilities from school districts,
effectively spreading the costs across all current providers.
Simultaneously, though, states should adopt strict requirements that,
from this point forward, districts (and other providers) must fully fund
all employee benefits in the year that those benefits are accrued.
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Limit districts' short-term ability to make long-term
commitments. States should also take additional steps to regulate the
ability of districts to make financial commitments they may not be able
to fulfill. Several states require districts to show that they will
remain fiscally solvent for one or a few years, and some require this as
part of collective bargaining agreements. While this is a step in the
right direction, districts are required only to show solvency under one
set of reasonable assumptions. Instead, districts should be required to
consider multiple scenarios and build revenue contingencies into
agreements.
Defined-benefit and pension programs could be replaced with
defined-contribution programs (a change already taking place in some
locales). Tenure systems might be modified to allow for more fiscal
flexibility, perhaps by including provisions for declining enrollment,
or limiting the portion of the staff that can be tenured. However, it is
unlikely that any of this can happen without states providing political
cover.
Limit state restrictions on how certain funds can be used. Some
state funding policies explicitly assume certain school structures: a
specific number of students are expected to be in front of teachers
within schools that have principals within districts that each have a
superintendent. As a result, small schools or districts cannot leverage
distance learning or rethink service delivery to maximize student
learning and minimize cost. The state essentially requires these smaller
schools and districts to have high per-pupil cost structures.
Supporting more adaptive district budgets won't be easy, as
traditional budgeting practices are deeply rooted in district habits and
in local politics. School board members facing reelection may be
encouraged to make promises that wreak fiscal havoc in years to come.
State legislators will be reluctant to make changes that result in fewer
dollars going to their districts. But the benefits of moving to more
nimble expenditure structures with multiyear budgets that plan for
contingencies are real, not only in terms of long-term fiscal stability,
but also in that priorities can be articulated in district spending
patterns. Under these conditions, district leaders will be better able
to seek out and adopt promising solutions to their cost challenges as
scale changes.
Marguerite Roza is director of the Edunomics Lab at Georgetown
University and senior research affiliate at the Center on Reinventing
Public Education at the University of Washington. Jon Fullerton is
executive director of the Center for Education Policy Research at
Harvard University.