The Outlook for Additional State Aid for K-12 Public Education

The Outlook for Additional State Aid for K-12 Public Education Virginia School Board Association Fiscal Analytics, Ltd. January 27, 2015

15.0% Virginia GF Revenue Declined 1.6% in FY 2014 3.1% Growth Projected per Year in 2014-16 10.0% 5.0% 0.0% -5.0% U.S. recessions -10.0% 2

What Happened in FY 2014! Non-withholding final payments were $342 million below the previous fiscal year, despite a 25 percent increase in the stock market in TY 2013. - Taxpayer behavior was altered due to federal tax increases in TY 2013. Income tax withholding (61% of GF revenues/transfers) grew only 2.3%, due to a slowdown in federal spending - particularly defense. Sales and corporate income taxes fell 4.8% and 4.9%. - Adjusted for the accelerated sales tax collection requirement, sales tax receipts grew 0.8 percent. 3

Virginia Payroll Employment YoY % Chg (SA) 4 U.S. Virginia 3 2 1 0-1 -2-3 -4-5 November 2014 US: 2.0% VA: 0.4% -6 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 Source: Bureau of Labor Statistics/Haver Analytics 4

Virginia Industry Growth Percent Change in Employment from a Year Ago, NSA November 2014 U.S. Virginia Total 2.0 0.4 Natural Resources & Mining 5.4-2.0 Construction 3.9 0.2 Manufacturing 1.5 0.6 Trade, Transportation & Utilities 2.0 0.0 Information 0.3-1.4 Financial Activities 1.5 1.5 Professional & Business Services 3.6-1.0 Education & Health Services 2.0 2.3 Leisure & Hospitality 2.6 0.5 Other Services 1.2 1.7 Government 0.4 0.0-4 -2 0 2 4 6 YoY % Chg (NSA) Source: Bureau of Labor Statistics/Haver Analytics 5 5

Despite 5 Years of U.S. Economic Recovery, Federal Cutbacks Are Hurting Virginia s Economy Federal spending ($136 B total; 44% DoD) is approximately 20 percent of $700B VA economy. JLARC June 2014) - VA per capita federal spending ranks #2 total and #1 DoD. From CY 2000-10 federal spending in VA grew 107% versus 60% in total Virginia s gross state product. However, U.S. defense spending has been declining. -7.2% FFY 2013-4.9% FFY 2014 0.6% 1 st Q FFY 2015 DoD spending in Virginia down from $54.8 billion in 2012 to $41.4 billion in 2013. (Source: Chmura Economics) 6

$2.4 Billion GF Budget Reduction Necessary From Original 2014-16 Biennium Forecast $1.55 billion shortfall anticipated in June adopted 2014-16 budget. - Cuts implemented and placed in reserve account without changing revenue forecast in order to legally access Rainy Day Fund. New revenue forecast prepared in September with additional GF revenue reduction of $882 million anticipated ($346 m in FY 15 and $536 m in FY 16). GF growth lowered to 2.9% from 4.5% in FY 15. - Non-withholding revenue forecast capped at 15 percent of total GF revenue collections. 7

Major June Actions Taken to Save $1.55B Assumed Rainy Day Fund withdrawals of $705M over biennium. Removed almost all new funding for K-12 except rebenchmarking adjustments, including originally proposed 2% teacher salary increase and partial restoration of support cost-of-competing. Removed the majority of new funding above the base budget for higher education. Removed hospital and nursing home provider inflation adjustments. Removed increase in HB 599 funding. Reduced Commerce and Trade funding by $39M over biennium, including all new tourism and economic development funding. Captured $31.1 million in unspent balances from a GF appropriation made to transportation in 2007. Delayed AST phase-out for 125 large sales tax dealers. 8

Major Additional Actions Taken to Close Gap in Introduced Budget, Plus New Spending $194 mil. in new revenues including, $114 mil. in proposed tax policy changes - $57 million in reduced tax preferences and $57 mil. from re-instituting accelerated sales tax for some dealers; $34 mil. in an upward revenue forecast; $13 mil. from ABC tax collections; $10 mil. savings from the private school scholarship program; and other miscellaneous revenues. $216 mil. in lower expected Medicaid savings (4.6% and 5.3% growth in Medicaid now expected even with Governor s Healthy VA Plan included). $90 mil. in higher education management savings $65 mil. in K-12 technical adjustments based on updated student enrollments and participation, sales tax forecast changes, and reduced retirement cost calculations. $60 mil. in local government reversions back to the state $50.4 mil. in debt service savings from lower interest rates $40.1 million in additional literary funds for teacher retirement $33.7 mil. in non-general fund supplants and balance sweeps $28.1 mil. in additional lottery revenue to replace general funds $150.6 mil. in various Executive Agency Management Savings 9

$176.6 Mil. in New Introduced Spending Items $31 mil. in offender medical cost increases $21 mil. in additional Governor s Opportunity Funds $12.9 mil. geriatric hospitals $11 mil. for local jail per diem payments $11 mil for additional information technology charges. $6.2 mil. for the Criminal Fund $5.7 mil. for foster care $5.7 mil. for intellectually disabled $4.6 mil. for involuntary mental commitments $70 mil. in miscellaneous. For example, there were small additions proposed in K-12 for central office school improvement specialists, training funds for principals at underperforming schools, SOL retake funding, and a small increase for the school breakfast program. 10

2015 Session Introduced Budget ($Mil.) FY 2015 FY 2016 Introduced Introduced Budget Budget 2014-16 Change from Base Budget FY 2014 Adopted Budget Legislative and Executive Dept's 103.2 109.0 107.4 10.0 Judicial Dept. 425.2 447.2 453.8 50.6 Administration/Comp Board 654.1 687.1 682.4 61.3 Treasury Board GF Debt Service 608.5 672.1 684.0 139.1 Other Finance/Technology 171.9 179.5 180.9 16.6 Rainy Day Fund 339.6 243.2 - (436.0) Car Tax Reimbursement 950.0 950.0 950.0 - Commerce and Trade 183.3 176.8 193.3 3.5 Agriculture / Nat. Resources 144.0 183.4 152.6 48.0 K-12 Education/Central Office 5,292.7 5,402.2 5,545.7 362.5 Higher & Other Education 1,782.1 1,864.1 1,877.5 177.5 DMAS Medicaid 3,519.8 3,697.4 4,112.8 770.6 Other Health & Human Services 1,541.5 1,647.9 1,538.7 103.6 Public Safety & Veterans/HS 1,699.0 1,803.0 1,823.3 228.3 Transportation 42.0 13.2 69.1 (1.7) Central Appropriations 247.2 16.1 3.3 (475.0) Independent Agencies/Capital 1.2 1.4 1.2 0.2 Total GF Appropriations $ 17,705.3 $ 18,093.3 $ 18,376.1 1,058.9 Available Balance to Spend $ 185.0 $ 2.9 GF Revenues $ 16,927.4 $ 17,459.2 Rainy Day Fund $ 470.0 $ 235.0 Transfers 633.5 564.1 Unspent Balance 122.6 (114.9) Unnappropriated balance 7.7 11

There Was An Unexpected $250 mil. Unclaimed Property Windfall to the Literary Fund The Literary Fund can be used for school construction or teacher retirement funding. Mostly from unclaimed stock resulting from demutualized companies such as Blue Cross (Anthem/Wellpoint) and Metlife. Governor proposes (General Assembly may change): $150 mil. for the VRS Teacher Retirement Fund (lowers VRS rate by 0.35% in FY 16 and beyond or $16 mil. per year for localities) $50 mil. for school construction $25 mil. for an interest rate subsidy on construction loans $25 mil. to offset GF for teacher retirement contributions 12

Will GF Revenues Exceed the 3.1% Forecast? FYTD Thru December Official FY 2015 Forecast Withholding 6.2% 2.9% Est. Payments/Tax Dues 19.3% 6.3% Refunds 1.7% 4.1% Net Individual Income 7.9% 3.5% Sales Taxes 3.0% 4.3% Corporate Income 20.8% 0.1% Recordation -0.6% 2.4% Total GF Revenues 6.8% 3.1% Note: 1 st half FY 15 GF Collections = 48.4% of Official GF revenue forecast of $16.93 B 1 st half FY 14 GF Collections = 46.7% of actual GF revenues of $16.41 B 13

Growth Picking Up in Individual Income Tax Withholding 12 Mo. Moving Avg (% Growth) % G r o w t h 8.0 7.0 6.0 5.0 4.0 3.0 2.0 1.0 0.0 (1.0) (2.0) 14

Meaningfully Increasing 2016-18 Biennium State Support for K-12 Will Also Be Difficult Healthy state revenue growth likely depends on whether Virginia s economy begins to transition from reliance on the federal government to new industries with high paying jobs. Hundreds of $millions in one-time budget actions to help solve the 2014-16 biennium shortfall will not be available for future ongoing spending. The FY 16 budget uses $235 million in Rainy Day Fund balances for operating expenses that will not be available in 2016-18 biennium. Also, the current FY 15 revenue forecast triggers an additional deposit of $163 million in FY 17 just for meeting current 3.1% revenue forecast. About half of any additional revenues above forecast will also have to be deposited into rainy day fund. If the Medicaid program continues its long-term trend of growing faster than GF revenues, less funding will be available for other programs and services. 2014-16 VRS teacher rates rose 24 percent from 11.66% to 14.5%. 2016-18 VRS rates will depend on whether VRS investment returns continue to meet or exceed 7% benchmarks. State continues to incur more GF debt service due to lack of a pay-as-you-go capital program. However, lower revenues do impact new debt capacity and authorizations. Additional GF sales tax for transportation still scheduled in FY 16. Accelerated sales tax for large payers still in force and will be a priority to remove. 15

120.0% K-12 Has Had Below Trend Budget Growth Major GF Budget Drivers FY 2006-16 111.3% 100.0% 94.9% 80.0% 60.0% 55.2% 40.0% 20.0% 11.0% 13.1% 15.7% 23.7% All Programs 25.0% 0.0% -20.0% -7.7% Note: Reflects December introduced budget 16

Share of State General Fund Appropriations 40.0% 35.0% 30.0% K-12 Direct Aid 25.0% 20.0% 15.0% DMAS Medicaid 10.0% 5.0% 0.0% 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 17

$5,400 State Per Pupil K-12 Funding Still Well Below FY09 Peak (All State Appropriated Funds) $5,274 $5,200 $5,000 $4,800 $4,868 $4,966 $5,000 $4,809 $4,863 $5,026 $5,036 $4,600 $4,513 $4,546 $4,400 $4,200 $4,000 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 Includes GF, lottery profits, miscellaneous NGF, and state appropriated federal stimulus funds Source: http://www.doe.virginia.gov/school_finance/budget/calc_tools/index.shtml 18

Inflation-Adjusted State Per Pupil K-12 Funding Reveals Even Larger Declines in State Aid (2007 $ - All State Appropriated Funds) $5,200 $5,039 $5,000 $4,800 $4,868 $4,807 $4,720 $4,600 $4,400 $4,342 $4,200 $4,175 $4,083 $4,242 $4,250 $4,240 $4,000 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 Includes GF, lottery profits, miscellaneous NGF, and state appropriated federal stimulus funds adjusted by the CPI 19

1.600 1.500 At-Risk Student Aid Growing Faster Than Overall State K-12 Aid Cumulative Growth Since FY 2007 in Total State K-12 Aid Compared to Major At-Risk Student Education Programs FY 16 Major At-Risk Student Programs - $413 M * 1.400 1.300 1.200 1.100 1.000 0.900 0.800 FY 16 All K-12 State Aid - $6,266 M 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 *Includes state funds for SOQ Prevention, Intervention, Remediation, and Lottery-funded At-Risk, K-3 Class Size, VPI, Algebra Readiness, Early Reading programs 20

State Standards of Quality Funding Do Not Reflect True Costs of K-12 System State does not pay for all Board of Education approved standards; overemphasizes the lower values in the more numerous, smaller/rural school divisions in calculating prevailing costs; does not reflect real-time salary costs in re-benchmarking; and localities often go beyond state mandates to meet SOL and SOA requirements. All localities spent $6.84 billion for school division operations in FY 2013, or $3.55 billion (108%) above RLE. All localities provided 56 percent of state-local funding for K-12. All school divisions exceeded RLE in FY 13. Divisions at or Below 25% 12 Divisions Exceeding 25% to 75% 51 Divisions Exceeding 76% to 100% 31 Divisions Exceeding 100% 42 21

State K-12 Policy Changes Adopted to Reduce Funding Major K-12 Funding Policy Changes Since 2008 Session Session Biennial $ in Mil. Cap Funding for Support Positions 2009 ($754) Eliminate School Construction Grants 2009 ($55) Adjust Health Care Participation Rates 2010 ($269) Eliminate Equipment, Travel, Misc. Expenses From SOQ Calculation 2010 ($244) Include $0 Values in Linear Weighted Avg Calculation 2010 ($79) Eliminate Lottery Support for School Construction 2010 ($67) Drop Lowest Tier From K-3 Class Size Calculation 2010 ($36) Extend School Bus Replacement Cycle From 12 to 15 Yrs 2010 ($19) Eliminate Enrollment Loss Assistance 2010 ($16) Eliminate Non-personal Inflation Update (not originally intended as permanent, partially offset in 2012-14 biennium) 2012 ($109) Eliminate COCA for support positions in NoVa 2012/14 ($50) Use Kindergarten as Proxy for 4-yr-old Pre-K Count 2012 ($27) Total Major Policy Changes Since 2008 ($1,725) 22

Virginia Board of Education Recommended, But Unfunded, Changes to the SOQ Year First Recommended FY 2014 Est. $ Mil A full-time principal for each elementary school 2003 $8.0 A full-time assistant principal for every 400 students in the school 2003 $70.6 One reading specialist for every 1,000 students in K-12 2003 $51.3 One mathematics specialist for every 1,000 students in K-8 2006 $35.0 A data manager-test coordinator for every 1,000 students in K-12 2006 $51.3 Reducing speech-language pathologist caseloads from 68 to 60 2003 $5.3 Total Annual Unfunded BOE Recommended SOQ Changes $221.5 23

State K-12 Administrative Support Capabilities Are Also Stressed Dept. of Education Central Office Budget FY 2006 FY 2016* General Fund ($ Mil.) $61.0 $53.4 NGF/Federal Funds ($ Mil.) $50.7 $42.5 GF Position Cap 168.5 141.0 NGF Position Cap 168.5 178.5 * Reflects 2015 introduced budget amounts which added 5 training positions 24

Virginia Is a Wealthy, Relatively Low Tax State, With Higher Reliance on Locality Taxes State Rank Per capita personal income 10 State and local taxes as a percentage of personal income 46 Per capita state taxes 34 Per capita local taxes 15 Individual income taxes as a percentage of state and local tax revenue 7 Per capita state and local debt outstanding 25 Source: Virginia Compared to Other States, JLARC, 2014 Edition 25

Virginia Spending Rankings Reflect Tax Policies State Rank State Per Pupil Funding Pre-K-12 39 State and Local Per Pupil Funding 25 Average Salary of Public School Teachers 29 Per Capita Medicaid Expenditures 46 In-State Tuition and Fees at Public 4-Year Institutions 13 State Corrections Expenditures per Offender 13 Source: Virginia Compared to Other States, JLARC, 2014 Edition 26

Without Tax Increases, Localities Will Be Hard Pressed for Additional K-12 Funding 16.0% 14.0% 12.0% 10.0% 8.0% Local Revenue Trends 6.0% 4.0% Real Property 2.0% 0.0% -2.0% -4.0% Total Local Revenues Fiscal Year 27

Appendices 28

Better GF Revenues Require Refilling Rainy Day Fund Balances 1400.0 Revenue Stabilization Fund Year-End Balances 1200.0 1189.8 $ 1000.0 1064.7 1014.9 930.7* M i l l i o n s 800.0 600.0 400.0 200.0 715.6 574.6 472.4 482.3 361.5 340.1 247.5 224.3 156.6 575.1 295.2 299.4 303.6 440.0 470.1 238.3 80.1 85.0 0.0 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 * Includes mandatory FY 15 deposit of $243.2 million from FY 13 revenues. RDF withdrawals in FY 15 and 16 of $470m and $235m expected. 29

Rainy Day Fund Deposit Requirement Calculation for FY 2015 General Fund Revenue Sources for Calculation ($000) FY Individual Corporate Sales Total % Change Preceding 6 yr avg Deposit Requirement 2008 10,117,132 807,852 3,302,181 14,227,165 2.05% 2009 9,481,256 648,032 3,116,831 13,246,119-6.90% 2010 9,088,732 806,473 3,264,209 13,159,414-0.65% 2011 9,944,652 822,259 3,190,452 13,957,363 6.06% 2012 10,612,918 859,923 3,314,677 14,787,518 5.95% 2013 11,340,015 796,728 3,419,489 15,556,232 5.20% 2014 11,253,348 757,491 3,400,456 15,411,295-0.93% 2015 $11,645,300 $757,900 $3,545,900 15,949,100 3.49% 1.45% $162,341 * FY 15 revenues represent current official forecast. While normally reserved, deposit is not required until FY 17. 30

$ Millions $800 State GF Debt Service Growing Rapidly $700 $600 $500 $400 $300 $200 $100 $0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 Fiscal Year 31

Growth in Non-General Funds Have Far Exceeded General Fund Growth and Now Make Up 63% of the State Budget Non-general funds represent a variety revenue sources specifically earmarked to fund certain programs or activities. All federal grants and contracts, including the federal medicaid match, transportation, K-12, and higher education grants State transportation revenues, including toll revenue Institutional revenue, such as higher education tuition and fees, patient revenue at medical and mental hospitals, and corrections revenue Unemployment compensation payroll taxes Debt proceeds Alcoholic beverage, lottery and other sales Assessments and receipts for support of special services, such as child support enforcement payments Virginia Health Care Fund revenues Master tobacco settlement agreement funds 32

Should the State Look at Its Tax Preferences? Description of Largest Tax Preferences Largest Virginia Tax Preferences Cost Est. ($mil.) Sales Tax Exemptions See table next page Personal Property Tax Relief Act ("Car Tax") $950.0 Subtraction For Those Aged 65 or older and 62-64 (means tested) $284.9 Social Security and Railroad Retirement Subtraction $244.0 Estate Tax Elimination $140.0 Tax Credit for Families Below the Poverty Level $115.7 Tax Credit for Land Preservation (credits transferable) $100.0 Coalfield Employment and Production Incentive Tax Credits ($3/Ton) $59.4 Tax Credit for Historic Rehabilitation $59.2 Single Sales Factor for Corporate Income Tax $59.0 Child and Dependent Care Deduction $28.4 Coalfield Employment Enhancement Tax Credits ($1-2 per ton) $25.0 Subtraction for Unemployment Benefits $21.8 Virginia Education Savings Trust $17.9 Blind and Aged Personal Exemption $14.7 Deduction/Credit for Long Term Health Care Insurance $8.0 Subtraction for Military Wages -- Up to $15,000 $7.8 Tax Credit for Motion Pictures and Media Equipment $7.5 Neighborhood Assistance Tax Credit $6.2 Subtraction of Disability Income $5.8 Major Business Facility Job Tax Credit $4.3 Tax Credit for Equity and Subordinated Debt Investments $2.1 33

Largest Sales Tax Exemptions Cost Est. ($mil.) Services Exemptions $ Varies by Service Prescription Drugs $378.8 Partial Food for Home Consumption $346.2 Non-Profit Organizations (largely non-profit hospitals/medical) $208.4 Advertising $84.8 Transportation Services $83.8 Residential Heating Fuels $41.9 Research & Development $28.9 NonPrescription Drugs $26.7 Railroad Common Carriers $20.1 School Lunches $12.0 Airline Common Carrier $10.1 Movie Theatre and Broadcaster Purchases $7.5 Churches $6.0 Donations of Tangible Goods to Non-Profits $5.5 Media Provider Equipment $5.2 Printed Materials for Out-of-State Distribution $5.0 School Supplies Holiday $4.1 Forestry Equipment $3.8 Pollution Control Equipment $3.8 Ships and Vessels $2.8 Durable medical Equipment $2.3 Hurricane Preparedness Sales Tax Holiday $2.2 34

YoY % Chg 3-month average 60 Virginia Building Permits Single-Family Homes U.S. Virginia 40 20 0-20 -40 November 2014 US: 3.1% VA: -3.4% -60 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 Source: US Census Bureau/Haver Analytics 35

Virginia House Price Index FHFA YoY % Chg 24 21 U.S. Virginia 18 15 3Q: 2014 US: 5.7% VA: 3.1% 12 9 6 3 0-3 -6-9 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 Source: Federal Housing Finance Agency/Haver Analytics 36

Virginia House Price Index FHFA YoY % Chg 24 21 U.S. Virginia 18 15 3Q: 2014 US: 5.7% VA: 3.1% 12 9 6 3 0-3 -6-9 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 Source: Federal Housing Finance Agency/Haver Analytics 37