Ohio’s budget bill—House Bill 96—has garnered a lot of attention because the legislation will determine the level and distribution of school funding over the next two years. One of the especially controversial elements of the bill would restrict how much money districts hold in reserve (how large their “fund balances” can be), with any “excess” funds returned to taxpayers in the form of lower taxes.
The goal is commendable, but the legislation’s proposed solution is flawed. House Bill 96 would in fact incentivize more wasteful spending and impede districts’ ability to manage their finances responsibly. My own research clearly documents just how costly this lack of financial flexibility has been in the past. There are better ways to ensure that Ohio taxpayers get their money’s worth.
Three problems with House Bill 96’s “excess carry-over balance” provisions
The bill in its current form states that a school district’s general fund balance—the discretionary funds that districts have on hand—can be no greater than 30 percent of their annual operating budgets. Every summer, a county budget commission would determine whether a district exceeds this threshold and by what margin. Districts with “excess carry-over” would have their local tax receipts reduced during the following year through a reduction in the local taxes that residents pay. The aggregate tax reduction would match the excess amount in the general fund.
There are at least three problems with this proposed solution to districts hoarding tax dollars: more bureaucracy, perverse incentives, and costly financial vulnerability.
1. Yet more cumbersome government bureaucracy
The law would impose yet another bureaucratic obstacle that local governments need to overcome as they try to deliver education services to their residents. The burden includes the added time and effort districts must expend to stay under the 30 percent limit, the work of a commission that must determine how much to reduce tax rates, as well as the implementation of this reduced tax rate, including communications with residents. These requirements may seem minimal, but government bureaucracy is dysfunctional in part because we’ve added such rules and procedures annually for decades. Unless there is clear evidence that a regulation would improve outcomes, lawmakers should think twice before imposing it.
2. Perverse incentives to waste taxpayer money
One of the most problematic (and lamented) features of public bureaucracy is the incentive among civil servants to spend as much money as possible. Once a public agency has been created—in this case, a school district—there are incentives for those in the organization to bring in and spend as much money as they can, even if that spending is questionable or outright wasteful. There are some rules governments impose that should limit this tendency, such as Ohio’s requirements that district budgets be publicly available and that residents vote directly on proposed tax increases. But there are some rules that might exacerbate the tendency to maximize wasteful spending. Rules that require agencies to return unspent funds are a prime example.
Such requirements are colloquially referred to as “use it or lose it” budget rules. They create incentives to spend every last dollar, regardless of the returns on that spending. For example, research on federal procurement shows that federal agencies increase spending dramatically just before the end of the fiscal year, and that the contracts they enter into in those final weeks are of substantially lower quality than those entered into earlier in the year. Creating incentives to spend down funds at the end of the fiscal year literally leads to wasteful spending.
The “excess carry-over” provision in House Bill 96 would create a strong incentive for impacted districts to spend down their fund balances to just below the 30 percent threshold, regardless of the circumstances leading to the “excess” fund balance. The incentive is for these districts to burn money rather than exceed the threshold, as doing so would trigger extra work for them, and require them to give money back to taxpayers via tax breaks.
3. Financial vulnerability that can lead to increased costs and lower educational quality
A fundamental problem with the “excess carry-over” rule is the underlying assumption that money districts haven’t spent is money that districts don’t need—that these fund balances are indeed excessive. Districts need reserves to take advantage of opportunities (e.g., launching a new program to address an unanticipated need) and to absorb financial shocks without disrupting operations. Building sufficient reserves is just good management, which is why credit agencies consider fund balances when determining school districts’ bond ratings. That has a direct bearing on how much interest district residents must pay when borrowing for capital projects, for example.
Whether a fund balance above 30 percent is “excessive” will depend on the district, including its risk tolerance and its financial situation. For example, a low-wealth district that is heavily reliant on state funds and that projects future enrollment declines arguably could use more than 30 percent in reserves. Indeed, I argued previously that districts fitting this profile should be far more financially prudent to absorb the hit from expiring federal stimulus funds.
My research indicates that during the Great Recession, Ohio districts with relatively low fund balances (below the median of 22 percent at the time) experienced large declines in student learning simply because of the unanticipated fiscal shortfalls. Not because they subsequently had to spend less, but because they hadn’t anticipated having to spend less. The sudden realization that they faced a deficit required them to make sudden cuts in spending—such as immediately laying off untenured teachers, perhaps without regard to quality—as opposed to making smaller, less harmful cost-reductions over a longer period of time. It also required them to hold new tax referenda, which also disrupt operations by drawing the attention of district staff away from their core function.
Thus, due to a lack of reserves, districts experienced sudden disruptions and delivered an inferior education without saving taxpayers a dime. Only districts in the top third (those with fund balances greater than 29 percent) experienced negligible achievement disruptions. By 2016, the median fund balance among Ohio districts had increased to approximately 30 percent, such that half of Ohio’s districts deemed it prudent to have even larger fund balances.
Increase transparency and let voters decide
One alternative to the proposed legislation is to use budget transparency and tax referenda as mechanisms to hold districts accountable. Voters turn out at higher rates when tax increases are on the ballot than they do merely for school board elections. They notice when school districts try to increase their tax rates. If lawmakers want to make it easier for voters to hold districts accountable for large fund balances, then one option is to make the issue more salient. For example, whenever districts put a proposed tax hike on the ballot, the ballot language could tell voters whether a district’s reserves are above or below some recommended amount. Indeed, one could use the 30 percent threshold to make this determination.
This option would enable Ohio to better meet the preferences of Ohioans while lessening the bureaucracy and perverse incentives that House Bill 96’s “excess carry-over” provisions would introduce. Some voters might consider large district fund balances to be a positive indicator—an example of good fiscal stewardship that makes them more inclined to vote in favor of school funding measures. Others might be more concerned about their own finances and vote down the tax measure if the ballot indicates that the district has reserves in excess of 30 percent. If districts experience opposition, then it’s on them to make their case to voters that they need to carry those balances.
Let’s get out of the way and let those who know best—local voters and school officials—hash it out.
