Arizona School Funding Formulas Do Not Take Recessions Into Account

It is high time for school districts to wake up and smell the coffee

Back in March Governor Ducey signed a budget with the intention of bringing the General Fund into balance in three years. The path to balance is going to be paved with spending restraint and economic growth.

Overall, this was a good strategy, much in line with the general philosophy governing the state in the past few decades. It also works well in challenging economic times, when tax increases can derail moderate recoveries and deepen recessions.

The problem is that this general philosophy has not translated into an overarching model for funding and prioritizing state spending. A good example is the Cave Creek v. DeWit lawsuit over K-12 school funding.

In Arizona, like in most other states, K-12 appropriations are based on independent formulas. Those formulas are intended to “guarantee” a certain stability and quality in the education our kids get through the public school system. Some of those formulas come from Washington, attached to federal funds; others are constructed locally or by the state in order to “guarantee” funding stability.

The problem is that these formulas do not take into account the fact that there are both short-term and long-term trends in tax revenue, trends that are largely beyond control of the state government. Over the short term we have recessions, and in recessions tax revenue falls while the cost of government does not. This makes it practically impossible to maintain government spending, including but not limited to K-12 education.

You do not counter a recession and its tax revenue shortfall with higher taxes. It does not take a Keynesian economist to realize that higher taxes on an already depressed economy is like praying for a deeper, more serious recession.

Apparently, Arizona school funding formulas do not take recessions into account. They appear to be written on the premise that schools are elevated above macroeconomic reality.

This is, by the way, not just the case in Arizona. In March, seven school districts in Tennessee decided to sue for more money, again based on a preconceived notion of independent funding.

However, it is high time for school districts to wake up and smell the coffee. Arizona’s state government may have $13+ billion in tax revenue to toss around, but that does not mean the state can toss money around like a lottery winner. About 85 percent of that money comes directly or indirectly out of personal income, in other words the money that individuals and families in Arizona make every week. The direct part, of course, is personal income tax (26 percent of state tax revenue) while the indirect part is from sales and general receipts taxes (59 percent).

In recessions personal income drops, but it also recovers as the economy gets better. However, as mentioned earlier there is a long-term problem with the state’s tax base: its growth rate is slowly tapering off. Figure 1 has the story:

Figure 1

arizona-personal-income-growth

Source: Bureau of Economic Analysis. Current-price growth. The number for 2010s is based on 22 quarters through Q2 2015.

For the fourth decade in a row, now, the growth rate in total personal income in Arizona has been declining. Even though we are just a bit over halfway through the 2010s, we can already now see that it is entirely unrealistic to expect any rebound from the downward trend. On the contrary, it is more likely that the 2020s will see even weaker growth.

What does this mean? Plain and simple, the growth rate behind 85 cents of every tax dollar that the state takes in, will continue to weaken. In the meantime, school districts and others benefiting from government funding will continue to enforce appropriations formulas written without attention to macroeconomic reality.

As the Arizona Daily Independent reported on October 30, the state settled the Cave Creek v. DeWit lawsuit by promising a $2.2-billion increase in school funding over the next five years. That may have been what the lawyers advised them to do. But no lawyer in the country can litigate away the stagnating tax base of the real world.

It is time for Arizona’s legislators to start looking for long-term structural reforms to their entitlement programs. This includes K-12 funding. If not, lawsuits in the future are going to be even more desperate – and frankly comical. Just as you cannot give a bald man a haircut, you cannot give a school district money that does not exist.

About Sven Larson, Ph.D., Economist 15 Articles
Sven Larson, Ph.D., is an economist and Member of the Council of Scholars of Compact for America. He is the author of Industrial Poverty (Gower Publishing) about the debt crisis in Europe. Find his daily blog articles at America’s Fiscal Future.