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Schools to Pay Millions to Cover Governor's IOU

October 01, 2009 By John Fitzgerald, Education Policy Fellow

School districts statewide stand to lose $58 million in interest and reserve revenue over the next two years to cover Governor Pawlenty's billion dollar IOU. This is money Minnesota's already cash-strapped schools can't afford and didn't account for before the Governor's June shift.  According to calculations, this interest and reserve revenue could amount to $23 million in 2010 and $35 million in 2011, and that's if interest rates stay low.

If today's interest rates go back to traditional levels, 2011's interest costs could jump as high as $79 million, one education finance expert calculated.

In an effort to balance Minnesota's $6 billion deficit without increasing tax revenues, Gov. Pawlenty used an accounting trick known as a tax shift. In it, schools will not receive 100 percent of their state aid, but will receive a percentage at the beginning of the fiscal year and (theoretically) the rest later in the year.

It's not a new idea. Schools have been living with a 90 percent/10 percent shift for several years.  But in a surprise to educators across the state, Pawlenty last June readjusted the shift to 73 percent/27 percent. This change will temporarily save the state approximately $1.07 billion in fiscal year 2010 and $1.17 billion in fiscal year 2011.

While the changes themselves are, on the surface, revenue-neutral, there will be a cost to school districts due to a negative cash flow. Chuck Herdegen, business manager at New Discoveries Montessori Academy in Glencoe and past president of the Minnesota Association of School Business Officials, calculated the tax shift will cost schools millions due to increases in interest payments or reduced interest income earnings on reserves.

"Although the use of payment shifts to balance the state budget is an alternative to reductions in school district funding formulas, school boards, administrators, and the public need to realize that there will be an impact on school district budgets," Herdegen said.

Schools determine finance by counting the number of students in the district, then weighing them by their grade. This is called Adjusted Marginal Cost Pupil Units, or AMCPU. Pawlenty's shift means that on average, schools will see about $1,124 less per AMCPU in fiscal year 2010 and $1,856 in fiscal year 2011. To demonstrate the impact this change will have on school resources, Herdegen calculated that a district of approximately 1,000 AMCPU would receive $1.33 million less from state payments in 2010 and $2.18 million less in 2011.

"While this amount may vary for each school district based on funding formulas, the amounts are an average across the state and can be used by school administrators to calculate the impact that these shifts will have on their district's cash flow," Herdegen said.

To finance this cash flow deficit, districts will have to

  • Use additional cash reserves, which will result in reduced interest income earnings during the school year;
  • Borrow funds to meet cash flow needs; or
  • Use a combination of using resources and borrowing.

If the district has cash reserves, they will lose approximately $9 to $15 each year per AMCPU in interest earnings, assuming a .8 percent interest rate on investments. Statewide, this amounts to $8.5 million in reduced revenues for fiscal year 2010 and $14.3 million in fiscal year 2011, based on current interest rates.

If the district has to borrow money (interest and issuance costs), they will incur $15 to $22 in additional costs per AMCPU each year based on current rates. Statewide this could total $14.3 million in increased costs to schools in fiscal year 2010 and $21 million in fiscal year 2011.

If a combination of drawing on reserves and borrowing funds is used, the impact will be between $9 and $22 per AMCPU based on current interest rates. This will result in decreased revenues available, an increase in expenditures, or a combination of both depending on how the district is able to fund their cash flow needs.

The costs of the shift are lower than expected due to the current low short-term interest rates. This has reduced the cost of borrowing for districts needing to borrow, and it has reduced the amount of interest earnings for districts with cash reserves. If short-term interest rates return to rates that are more typical of recent years, the cost to school districts of the payment shifts will increase proportionately. Costs to school districts could raise to $37 per AMCPU in lost interest earnings ($35.3 million statewide) or $46 per AMCPU for borrowing funds ($43.9 million statewide).

Charter schools have a different problem. These schools cannot access the same low-interest borrowing resources as traditional school districts and must borrow at regular rates. If they are able to secure financing, it is typically at a cost of 6 percent to 8 percent.

The direct losers in this move are Minnesota's students, who will have fewer classroom resources, and taxpayers, who will be picking up a $58 million tab that won't go toward educating our children. Minnesota's economy has and always will depend on a highly educated workforce. We can't afford to continue going down this road.

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