We Fixed the Formula … Now How Do We Fund it?

By PrinciPal Connection posted 10 days ago

The following blog originally appeared in IASBO Update magazine. You can view the original article here.

Reaching the goal of fully funding the Evidence-Based Formula and creating educational success and equity for all students cannot happen without addressing the structural problems behind Illinois’ poor fiscal condition.

Article written by:

Ralph Martire Daniel Hertz

A Historic Turn of Events

When August 31, 2017 dawned, Illinois had one of the worst school funding formulas in the country. By nightfall, that changed 180 degrees and Illinois had the best school funding formula in the country — one designed to ensure that public education not only had an adequate level of resources to meet the needs of all students, but that those educational resources would be distributed equitably.

The reason for this historic turn of events? Governor Bruce Rauner signed the Evidence-Based Funding for Student Success Act (Public Act 100-0465) into law. Known as the Evidence-Based Formula (EBF), it created a system that ties school funding to the cost of implementing best practices that research indicates have a statistically meaningful correlation with enhancing student academic achievement. This ensures that, when the EBF is fully funded, public education will have adequate resources to meet the needs of all students statewide. The EBF identifies a unique funding target for each school district based on the costs of implementing these best practices and that district’s unique demographic makeup. Then, it directs all additional funding above prior levels to those districts with the greatest gap between funding target and actual funding. The bottom line: The EBF aligns resources with evidence-based needs. Contrast that to Illinois’ prior K-12 education funding formula, which was not based on any evidence of what leads to student success, but also was not based on any actual costs of educational needs of different students. On the one hand, it led to a system that provided an inadequate level of funding to schools statewide. On the other, it resulted in a highly inequitable distribution of those inadequate amounts of funding.

The result? In fiscal year 2017, the Foundation Level was just $6,119 per student — an amount that had not increased for seven years, and which research suggested was woefully inadequate to educate Illinois’ children, particularly in districts with large low-income and English language learner populations. Additional funding, in the form of a “Low-Income Grant” and “categorical” grants for specific programs like transportation and special education, did little to solve this problem.

The good news is that Illinois has taken a quantum leap forward in its approach to funding public education. The bad news is, the EBF cannot be the agent for educational success and equity it has the potential to be unless it is fully funded. That is quite a challenge, given that the Illinois State Board of Education (ISBE) shows current funding levels for K-12 statewide are some $7.4 billion less than what the evidence indicates is needed.

The Real Problems Behind the Structural Deficit

Of course, that gap will not be closed overnight. Especially when Illinois’ poor fiscal condition is taken into account. Indeed, current projections are that Illinois’ General Fund will have an accumulated deficit of $9.9 billion by the end of FY2019. This means 38 percent of state spending on current services this year will be deficit spending. That is troubling, since $9 out of every $10 Illinois spends on General Fund services go to the core areas of education, healthcare, human services and public safety. All of which means if the education community wants to realize the promise of an adequate and equitably funded public school system in Illinois, it has to become fully engaged in the fight to get the state’s fiscal house in order.

This, in turn, means getting decision makers to take the actions needed to eliminate Illinois’ serious and longstanding structural deficit. A structural deficit exists when, over time, revenue growth is insufficient to maintain the same level of services, adjusting solely for changes in inflation and population. And despite frequent claims to the contrary, Illinois’ structural deficit is not about overspending on current services. Indeed, accounting for inflation and population growth, Illinois’ General Fund service spending has fallen by some 24 percent in real terms since FY2000, including a 29 percent real cut in human services and a stunning 52 percent cut to higher education.

If it is not spending, what is the real problem? The data clearly show Illinois’ structural deficit is driven by two things: first, a revenue system that is not designed to keep up with the modern economy and second, an unsustainable, back-loaded pension debt repayment plan. This plan was created under Governor Jim Edgar back in 1994 and is known as the “Pension Ramp.” And while reforming Illinois’ tax policy is crucial, the biggest fiscal problem Illinois faces today is created by this Pension Ramp. 

The Pension Ramp: Digging a Hole By Design

When passed, the Ramp was sold as a responsible way to pay back the unfunded liability owed to Illinois’ five state public pension systems, which then stood at around $17 billion. However, rather than being a responsible repayment plan, the Pension Ramp by design dug the hole much deeper. It in fact legislatively continued the practice of intentionally underfunding the state’s pension systems through 2010–growing the principal of the unfunded liability by over $46 billion. Making matters much worse, the Pension Ramp also created a back-loaded repayment plan which requires rapidly escalating annual payments to reach a 90 percent funded ratio by 2045. Today, the state faces the largest unfunded pension liability in the country, with annual contributions that will take up more than 27 percent of General Fund revenues by 2045. 

It is crucial to understand that this growth and Illinois’ pension crisis in general, is entirely a result of pension debt, rather than pension benefits. Indeed, the Commission on Government Forecasting and Accountability used actuarial data to show that less than two percent of the growth in the unfunded liability since 1995 was a result of growing salaries and benefits. Meanwhile, over 41 percent was the direct result of underfunding, with lower-than-expected investment returns (largely from the 2008 Great Recession) and flawed actuarial assumptions comprising the lion’s share of the rest.

In fact, the cost of newly earned pension benefits will be just $1.9 billion in FY2019, compared to the $5.6 billion payment on pension debt required in that year under the Pension Ramp. Looking ahead, the cost of newly earned pension benefits is expected to fall, even as the cost of repaying the debt Illinois owes to its pension systems rises dramatically. It is that growth that pushes the state’s annual pension contribution to a scheduled $20.2 billion by FY2045.

“Simple” Solutions: Reamortization and Bond Issuance

Fortunately, solving the Pension Ramp quandary is actually somewhat simple in concept: replace the highly back-loaded repayment plan of the Ramp with a level-dollar reamortization of Illinois’ pension debt. This means, rather than a back-loaded ramp that substantially increases the state’s required pension payments annually, Illinois would make the same nominal dollar debt payment to its pension systems each year.

To work, this level dollar payment has to be sufficient to increase the funded ratio annually and bring the systems to health, while covering all cash-flow obligations to pay pension benefits to current and future retirees. That means the level dollar amortization schedule requires somewhat higher payments in the first several years than under the Pension Ramp. But the magic of compounding interest means those somewhat higher payments allow for dramatically lower payments in outlying years. Better yet, the fact that payments remain the same in nominal dollars over time means that in real dollars, accounting for inflation, the state’s payments would gradually shrink over time, demanding a smaller and smaller share of General Fund spending and freeing up significant revenue to invest in other priorities, such as the EBF.

Of course, Illinois’ current fiscal system cannot accommodate increasing up-front payments to the pension systems (by our calculations, some $2.4 billion in the first year of the plan) without a tax increase, as every additional General Fund dollar that pays for pension debt is a dollar not available to pay for core service programs including education. For that reason, we propose that the additional payments required above the current Pension Ramp (some $11.2 billion over the next eight years) be financed with pension obligation bonds.

Bonding out these payments does not generate new debt — it simply replaces existing pension debt with bond debt. And that creates two major benefits. One, it allows Illinois to make its payments to the pension funds without reducing spending on current services. Second, it refinances highinterest pension debt with lower-interest bond debt, saving taxpayers money in the short and long-term.

Even accounting for the debt service payments on the pension obligation bonds, we estimate that this reamortization plan saves the state some $67 billion through 2045 when compared to the Pension Ramp — while getting the systems over 70 percent funded, a major improvement over the current 39 percent funded ratio. It also means budgetary room to invest more in core services that Illinois residents depend on, and which drive the modern economy — like fully funding every public school district in the state through the EBF.

Bottom line: the Pension Ramp is fiscally unsustainable and makes it impossible to fund K-12 education adequately under the EBF.