Ep. 398: How States Protect Funding for K-12 Public Schools

November 29, 2023

In this episode of EdChoice Chats host Marty Lueken digs into his new report which explores hold harmless funding; declining enrollment protections and funding guarantees. Guests James Shuls and Aaron Smith join.

Marty Lueken: Hey everyone, and welcome back to another episode of EdChoice Chats. Thanks for spending some of your time with us today. This is Marty Lueken, the director of the Fiscal Research and Education Center here at EdChoice, and we have a special podcast today, particularly for those of you who are fascinated by the world of school finance. Today, I’m joined by Dr. James Shuls and Aaron Smith. James is an associate professor and the graduate program director of Educational Leadership and Policy Studies at the University of Missouri-St. Louis, and he’s also one of our fellows here at EdChoice. Aaron is the director of education policy at the Reason Foundation. Aaron and James have both done extensive work in the area of education finance, so they are truly experts in their own right. It’s a pleasure to have both of you on the program today.

James Shuls: Hey, it’s great to be with you, Marty.

Aaron Smith: Thanks for having me.

Marty Lueken: Yeah. The topic of this episode is funding protections for public schools. Now, EdChoice released a couple of reports recently about funding protections. The first report is one that I coauthored with you, James. It’s basically a primer on these policies and it discusses their trade-offs. Then the second paper is a policy scan which summarizes funding protections across all the states. First, let me just start off by setting the table here by just describing for our listeners what we mean by funding protections. All of this applies to public schools, and some of these laws, they also include charter schools, but usually they do not. What we mean by funding protections are that these are provisions and state funding systems that are aimed at softening the impact of funding reductions that usually occur from declines in student enrollment. There are usually two main types of funding protections that nerds like us talk about. One is declining enrollment protections, and the other is funding guarantees, which are sometimes referred to as hold harmless provisions by some people.

Now, just a note on the parlance here. To be clear, some folks use the term hold harmless to refer to all forms of funding protections, but James, in our paper, we use the term to refer to a specific form of funding protection, namely funding guarantees. Now, the two types. Declining enrollment protections are meant to help districts cope with enrollment reductions by basically softening the impact on the district’s budget. For example, a state might base funding on enrollment during say, the previous three years or the current year, and the district would use the count that generates the greater amount of revenue for them. Then funding guarantees, they guarantee that a district is going to receive some minimal level of funding. For example, a state might guarantee that funding won’t go below the level of funding the districts receive in some prior year. Sometimes that might be a year when say, the state enacted a new funding law. Now that the table is set, gentlemen, why should we care about these policies in the first place and who should care about them?

James Shuls: I’m actually going to start from the conclusion of our paper. We quote some wise authors. It’s actually we quote a paper that you and I wrote before, where we say, “Equity efficiency and educational opportunity are three guiding principles that state lawmakers should consider as they develop or change state funding systems in order to pursue ideal education finance systems.” We’re saying equity, efficiency, educational opportunity, these are things state policymakers should be concerned with. And hold harmless provisions and these funding protections that we’re talking about here run afoul on all three grounds, and we can talk about them more, but they’re contrary to equity, they’re contrary to efficiency, they’re contrary to ensuring educational opportunity and school choice for every student, and so who should care about these? I mean, taxpayers should care about these, state lawmakers should care about these, but also individuals who are concerned or interested in advancing educational opportunity should be concerned about how their state is funding schools and how many of these different sort of provisions are in their state funding formulas.

Marty Lueken: Well, those are all great points and really good insights. Aaron, you’ve done some work in this area as well. Who should care about these policies, do you think?

Aaron Smith: Yeah, well, James mentioned a couple, so obviously taxpayers should care. Hold harmless provisions in many instances, are costly and they result in students being double funded and oftentimes, districts that are already high-spending, higher wealth get money from these provisions, and that tends to work against the entire purpose of state funding formulas, which seek to equalize local education dollars. In a sense, they not only counteract the purpose of state funding formulas, but they also waste taxpayer dollars. School choice advocates should also care, so when dollars don’t follow students, this could have a couple of effects. The first, it could decrease the share of funds that follow students to their school choice programs such as ESAs. And as I mentioned before, it could make a school of choice costly or if you’re double counting students and you’re double funding students, you have a school choice program that could increase the bill for it.

Lastly, certainly not least, kids and teachers should care about hold harmless provisions. Right? The effects of these provisions are not always seen. There’s not always a lot of transparency around them, but the result is that dollars aren’t allocated to public schools in a fair and efficient manner, and the effect is that you don’t have as many dollars to actually put into your funding formula to allocate based on student needs or to just put into a base alignment that all districts can benefit from. Along these lines, when you have hold harmless provisions, specifically declining enrollment provisions, schools don’t really have much of an incentive to improve, so the competitive effects of losing students, losing funding are diminished and they have no reason to innovate.

Marty Lueken: That’s great. This eventually all comes back to students. These are things that affect students and some might view adverse ways. But I want to get to also at why states have these policies in the first place, or if there are any reasons why they should have them or would have them. James, in the primer report, which to our listeners, you can find these two reports on our website at edchoice.org. We don’t see these kinds of arrangements elsewhere in the economy. We don’t see them in a higher education, I don’t think, or with hospitals and clinics or law firms where these entities and firms are getting dollars for customers that they may no longer serve, right? Or what have you. But why do we see these in public K-12? I mean, what are the upsides, if any, here?

James Shuls: Well, I can’t speak to all those other areas because I don’t know for sure. I haven’t studied those, but I could tell you what’s going on in education, and you have to separate out these two types of provisions, as you did in the intro, to sort of understand why they’re there. The declining enrollment provision is based on the idea that we want to protect the local school districts when they have this sort of a downturn. There are fixed costs in education. There are some things that we can’t cut immediately if the school district receives less funds, and so by creating a declining enrollment provision, we allow some stability and they don’t have to respond right away when the reduction in students happens, it can come down the road, so they need to release staff or lay off teachers, decrease their teacher workforce, whatever it is. It allows for a longer time period for that to happen, so it’s just a mechanism that provides stability for the school district. Those are the reasons which you might do it.

Of course, what we highlight is that that also leads you to the case where you’re decreasing market pressure on school districts. The school districts don’t feel the need to respond quite the same, and it also leads to this idea of funding go students, right? Once a student has gone somewhere else, we’re paying for them there, but we’re also paying for them in their previous district, so that’s the declining enrollment provision.

Now, hold harmless, the traditional sort of hold harmless or funding guarantees is slightly different. The reason that we have those provisions in my estimation is a more of a political calculation. It’s funding formulas are determined by state legislatures and there’s horse trading going on, and you have state policymakers who are trying to watch out for the interests of their local school districts, and so when they put in place a new funding formula and that funding formula may reduce funds at their local school district, these policymakers, they argue for a hold harmless provision so that their schools aren’t affected, so that they’re not impacted by the new funding formula. That’s when these things are oftentimes put in place. It’s really to try to sell the new funding formula to state policymakers.

The problem is these things typically become permanent. They don’t go away. They put them in place and they could be for a transition period, but they’re often not, and so we have a situation where school districts are essentially held harmless in perpetuity. They could be guaranteed to receive the same dollar amount per pupil, or they could be guaranteed to receive the same total dollar amount from the state. States structure this in different ways, and that could be quite harmful when you do it that way, especially in terms of equity and in terms of the allocation of state dollars, so there are reasons that we put these things into place, but oftentimes, we see that they become permanent and they distort the school finance system.

Marty Lueken: That’s a great explanation, thanks. And Aaron, you mentioned a few of the trade-offs of the downsides to having these, for example, these policy [inaudible 00:10:50] incentives for districts to improve because they continue to receive funding. The dollars are not following the students, they’re not experiencing a loss or as big of a loss as in a world without these policies. You mentioned the impact on taxpayers, and this makes sense because states, they have budget constraints and with budget constraints, trade-offs are inherent in policymaking. But are there any other downsides to these funding protection policies? You also mentioned, James, in the beginning, some issues with equity as well. How’s that mechanized and how’s that work out?

Aaron Smith: Yeah, so I think we hit on the big ones, and I think the biggest is there’s just a large opportunity cost with these hold harmless provisions, especially now in a post-COVID-19 world where school districts have lost a lot of students and they haven’t been forced to adapt. These dollars are being diverted to school districts that aren’t serving as many students, and those dollars could be following students to their actual school, so I think that’s the biggest one, and it’s just the opportunity cost of these provisions. But what I haven’t mentioned yet is that they’re also opaque, so it’s often unclear how much they cost. It’s unclear how these dollars are distributed and who benefits and who doesn’t benefit. As a result, state policymakers can easily assess their effectiveness or whether these resources could actually be put to better use, and this is true across states. If you ask most state lawmakers and states with a declining enrollment provision, how much schools would be receiving if they used current year counts instead of prior year counts, I’m willing to bet that most would not have an answer to that question. In fact, most policy wonks don’t know.

But the other thing I’d mention is, is that I think all of the benefits, the advantages that James pointed out, those are good arguments. But what we also see across states is that there are many states that already use current year counts. Texas stands out as a state that funds school districts based on who’s currently enrolled in their buildings. They have 1,100 school districts statewide and many rural school districts, and those districts are doing just fine with their budgets and with their planning in that current system. There’s also a bit of a hypocrisy to it too, right?

You look to California, which has a very generous declining enrollment provision. It’s essentially a three-year provision, a three-year lookback that funds districts based on prior enrollment counts if they’re higher. The thing here is that charter schools aren’t actually eligible for this declining enrollment provision. While school districts are funded based on their high water level mark in the past couple few years, charters are receiving funding based on their current year student counts. If charters can do it, if 1,100 plus school districts in Texas can do it, then I’m confident that every school district in America can do this as well.

Marty Lueken: Now, these are all really good considerations for our listeners and our audience and for policymakers as well to be aware about these funding protections. Now, let’s take a look at some of the specific policies. The second report that we released is kind of a state policy scan of funding protections across all 50 states. For those who really want to dig into the weeds and nerd out, we have a companion state profile appendix, which plays out all the details for each state. But overall, we found that there are 34 states providing districts with declining enrollment protections, with funding guarantees or with both. Also, there have been 27 states that actually enacted additional protections, temporary provisions during the COVID pandemic, which was aimed at mitigating funding losses that were largely occurring from enrollment decline from the pandemic. Let me just highlight how a few states protect funding for public schools for our listeners.

Ohio, which recently expanded its choice programs to be universal, Ohio has a declining enrollment provision where it bases funding on greater of I think the previous fiscal year or the average student count from the three previous years. This type of structure is one of the more common policies that we see among the states that have declining enrollment provisions. Now, Colorado has an interesting provision for declining enrollment, where it bases funding on the current year of enrollment or the greater of the average enrollment from the prior two years, the prior three three-year average, four-year average or five-year average.

Iowa, which is another state that introduced universal ESA program, they have a funding guarantee where districts that experience any kind of enrollment decline, they may receive a 101% of the funding that they received during the previous year. The state basically is giving districts one year to adjust plus some extra funding and additional 1% of funding to help them adjust. In other words, this policy is kind of postponing the effects of the declining enrollment on the district’s budget for just one year so unlike many others, it’s not perpetual. But an example of a state that does have perpetual hold harmless is Pennsylvania. Districts there are guaranteed the same amount of state funds that they received in 2014, regardless of what their enrollment is now.

James and Aaron, I just want to see what your thoughts are about these flavors of funding protections. Also, I mentioned a few of these states, they have Choice programs, and we touched on it earlier before, but in the context of a school choice environment, particularly a rich school choice environment where we’re starting to see more and more states pass universal or very broad eligibility programs. In the context of school choice, where states allow the public funds to follow the child to whatever educational setting that their families are choosing, what implications do these policies have on taxpayers and school districts or for students? What implications do they have for passing or expanding choice policies in states that don’t have them or might have them or want to expand them?

James Shuls: I was thinking about this as you were talking in terms of the political divide, the Democrats versus Republicans or conservative versus liberal or who would be interested in this sort of policy? Who would be interested in hold harmless provisions? Really as you were describing those circumstances and the policies in different states, I was thinking to myself, everyone should. Everyone should care for one reason or another. We’ve used the word in this conversation, distort, that the sorts of provisions distort the school funding system. What we mean by that is that they put dollars in one place when they should be or could be used in another place. They allow for a school district to get dollars for students they’re not educating. Those dollars, if you’re on the conservative side, well, maybe we could save those dollars, they could be returned to the taxpayers. Or if you’re more on the progressive side, maybe those could be used in a more progressive manner in the formula somewhere else, so we’re using dollars, we’re giving money to schools for students they’re not educating. Or especially in the case of the traditional hold harmless provisions, we’re giving dollars to schools that may be more affluent and wouldn’t deserve those dollars based on the funding formula, but we’ve guaranteed them those dollars.

What we’re talking about is you’re putting money into the system in a way that basically no one would want, except for the local school district administrators. The local school district administrators who benefit from these, of course, would absolutely want these. But what we’re not saying is this is just a way to get more money and we want to cut funding. That’s not at all what we’re saying. What we’re saying is the way that we’re choosing to spend these dollars is distortionary, and we could find better ways to do it. We could find ways that would follow the student and would allow more market pressure. We could do it in ways that would be more equitable, right? There are all sorts of ways we could do this better, but the ways that we’re doing it when we have these sorts of systems basically benefits places that don’t necessarily need those dollars.

Aaron Smith: Yeah. Those are all really great points, James. I completely agree, and as I mentioned before, there’s a big opportunity cost with these hold harmless provisions, and realistically, no one’s going to cut funding. These dollars aren’t going to disappear, but the whole point is to put them back into the funding formula and allow lawmakers to use their funding formulas in a strategic way that benefits students, that targets dollars to students based upon their needs and based upon where they’re actually going to school or their education service provider.

I’ll say, to be straight, I’m generally against hold harmless provisions. You can call me a hold harmless hawk, if you will, but yeah, that doesn’t mean they can never be used effectively. Right? As James was and you, Marty, were going through the benefits and how states use them to enact funding formula changes, I would never say not to use them if you have the opportunity to remake your funding formula and to enact a pretty big reform that’s going to benefit students in your education system, because realistically they do help to grease the wheels of reform, and if you’re going to get a big payoff in the terms of a better funding formula or more school choice, then in my estimation, the payoff is generally worth it. I’m very pragmatic in that sense. But at the same time, you have to make sure that that hold harmless provision disappears.

We look at a lot of states, James, your home state of Missouri. Marty, I think you might’ve lived in Missouri at some point too. You look at their funding system and districts are still receiving dollars based on what they’ve got in 2006, right? We’re pushing on two decades now, and there’s a bunch of school districts receiving funding based on their 2006 levels, and that’s just ridiculous. Right? I think any reasonable person can agree that that shouldn’t be the case.

I think the problem is, is that these provisions are sticky. There’s not much political benefit for a legislator to attack them or to take these dollars away, and sometimes you have to wait until you get more funding in order to take them away. Texas is a good example of that, right? They had something called the Cost of Education Index for many years, for 20 or 30 years, and this wasn’t initially a hold harmless, but it turned into one based upon how it functioned. Long story short, it funded school districts based upon their demographic data from 1989. In 2015, in 2016, a billion dollars was being allocated based on data from the ’80s. But in order to get rid of that, the state had to dump a lot of money into their system, and as part of their big overhaul in 2019, they managed to get rid of it. All districts were made whole, they got more money and they were able to eliminate that provision. But that just illustrates just how sticky these things are. Once you have them in law, no matter how noble it was or how good it was, they’re very difficult to get rid of.

James Shuls: I was thinking too, Aaron, about the interplay between districts that it causes within a state when some get the additional dollars based on the hold harmless provision and others don’t. It creates this sort of system where the school districts’ interests aren’t aligned in terms of thinking about reform, and especially when you have a hold harmless provision like you talked about Missouri, where it is often the case that more affluent school districts tend to benefit from the hold harmless provision. If you’re starting to talk about reforming the system, you then have some districts who think of themselves as haves versus have-nots and benefit differently from reforming the system, and so the longer those things are left in place, the more harmful those divisions can be, and the tougher it can be to make those sort of changes that you were just talking about.

Aaron Smith: Right, and I mentioned how hold harmless provisions tend to be opaque. But I’ll tell you, if you’re going to go after them, districts will know exactly how much money they stand to lose if legislators vote in favor of eliminating those hold harmless provisions.

Marty Lueken: Absolutely. No, thanks. These are really fantastic thoughts and insights. Aaron, thanks for bringing in Missouri. I grew up there, so yeah, I’ve been there a few times. But before we wrap up, I do want to tease something that Aaron, that you and your team and mine has been working on together, and that is that we’ll soon be releasing a fiscal effects calculator. For our listeners, this is basically a tool that will allow you to design an ESA program for your state or for any other state that you might be interested in.

What it does is that it’ll display the overall fiscal effect for taxpayers in that state. This tool will basically allow users to toggle various program parameters and assumptions about funding and participation, so just want everyone to be on the lookout for that. That’s something I think is exciting, that’s on the horizon. James and Aaron, I really appreciate our partnership that EdChoice has with each of you, and Aaron with Reason. Aaron, you and I, we have also talked before about some of the work that your team is doing on funding protections. I just want to make sure that you get an opportunity to tell our listeners about what you’re doing, what you’re working on because I think they’ll be interested to learn about it.

Aaron Smith: Yeah. Thanks, Marty. Yeah, so we’re publishing a paper early next year that puts hold harmless policies in context, and so we evaluate the extent to which they use education dollars effectively across three states, so California, Missouri, and Oklahoma, and a couple key takeaways. One is that declining enrollment provisions can be quite costly, but obviously policy design and state context is pretty important. What stood out there is that California in 2023 had about 400,000 students. These are students who weren’t enrolled in public schools, that public schools were still receiving money for and that cost the state roughly $4 billion. For context, that’s about 7% or 8% of total state formula aid, so definitely not a small chunk of change. A lot of dollars are being distributed outside of the state’s local Control Funding Formula. For Missouri, that was, we estimate that their declining enrollment provision costs them just under $200 million in 2022. And depending upon what you use as the denominator, that’s roughly 5% of the state’s formula aid.

But the other big takeaway is that there really wasn’t a strong relationship between hold harmless funding, so declining enrollment funding and student poverty. One argument might be, well, a lot of these districts that are losing students have high concentrations of student poverty, and in many instances, that’s true, right? You look at LA Unified, they’re losing a ton of students, they receive a lot of declining enrollment funding. But when you step back in the aggregate and you look at the data, there isn’t a strong connection. As we mentioned before, there are many examples of low poverty districts, low need districts that are receiving large amounts of declining enrollment funding or large amounts of funding guarantees that they otherwise wouldn’t receive.

Marty Lueken: That’s great. Really excited to see your report when it comes out. Well, gentlemen, thank you again for being on our podcast today. Really appreciate it and always great to chat with you.

James Shuls: Thank you, Marty.

Marty Lueken: Everyone who is listening, you can go to edchoice.org to access the funding protections reports that EdChoice has released, and if you have feedback on any of our work, always feel free to reach out. But just want to thank everyone for listening, and we’ll see you again next time on the next edition of EdChoice Chats.