Plunging state revenues –down in May and June by as much as $1.8 billion below official expectations -- could wind up costing public schools as much as $8 billion in money they say is owed to them by the state.

The state’s worsening fiscal picture sets the stage for the latest chapter in the tempestuous, love-hate relationship between education groups and the Schwarzenegger administration that has marked the governor’s six years in office.

Some education advocates, most notably the California Teachers Association, entered an uneasy truce with the governor through the May 19 special election. But that truce now appears to be over as CTA takes to the airwaves to blast the governor, and Schwarzenegger talks about the need to suspend the Constitution to cut payments to schools.

While a major political fight is brewing over whether to suspend the Proposition 98 constitutional guarantee to public schools for the new 2009-10 fiscal year, the bigger financial question is over the revenues for the 2008-09 fiscal year that just ended, and whether falling revenues could alter the money owed to schools over the next several years.

It is a battle that the Schwarzenegger administration and the CTA sought to avoid by asking voters to approve Proposition 1B on the May 19 ballot. That measure would have guaranteed that the state must give the schools billions in back payments over the next several years.

But now that Proposition 1B was resoundingly rejected by voters, CTA and the Schwarzenegger administration appear to be on different sides of that issue, and may be headed for a legislative and legal showdown over how much money is owed to the schools.
At issue is which of the three “tests” under Proposition 98 should be used to calculate the 2008-09 school funding guarantee. Sources in the legislative analyst’s office say the plummeting May and June revenues – which are off by as much as $1.8 billion in their estimates – have moved the state into a Test 1 year instead of Test 3. Schwarzenegger spokesman Aaron McLear said the governor “believes education should get the money back. We just have to find a way to pay for it.”

The CTA is expected to start a statewide ad campaign blasting Schwarzenegger for proposing a suspension of Proposition 98 in the new fiscal year. CTA sources indicated the campaign will consist of statewide television commercials, with an ad buy of more than $1 million.  But the wrangling over the year that just passed is far more technical, and at least as important.

Education advocates say the original intent of the state’s Constitutional education guarantee was to allow the state to defer money owed to schools, as long as it was paid back when the state’s fiscal circumstances improved. They say the rapid drop in personal income and sales taxes have exposed an unanticipated quirk in the formula that leaves some technical ambiguity over whether the state must pay that money back.

“It’s part of an ongoing discussion,” said CTA spokeswoman Becky Zogleman. “Everybody is trying to figure out where the (revenue) numbers are, and what they mean for state school funding.”

In 1988, voters approved Proposition 98, which set minimums for how much the state was required to spend on education. The initiative set up a number of formulas - called “tests”  - to determine the amount of money schools would receive.

The first formula, known as Test 1, ensures that public schools and community colleges receive about 40 percent of all money in the state’s general fund. That money was intended to be a bare minimum. Indeed, in all the 20 years since Proposition 98’s passage, the funding for schools has exceeded 40 percent of the state’s general fund revenues.

In years of general fund growth, the formula known as Test 2 is used to come up with the schools’ dollar figure. Test 2 links increases in school funding to growth in the state’s per capita income.

In years of slower growth, Test 3 typically applies. Test 3 was not actually part of Proposition 98. It was adopted in 1990 as Proposition 111 as a way to lower demands on the general fund in times of slow budget growth. Test 3 is typically used when general fund revenues drop. In those years, the state can defer payments to schools for up to five years.

The money owed to schools by the general fund is known as the “maintenance factor,” a fancy term for a debt. The current maintenance factor is about $1.4 billion. That is money that was owed schools and has not yet been repaid, dating back to 2005.
If Test 1 is applied retroactively to the 2008-09 year to determine the Proposition 98 guarantee, it would be the first time in 20 years that schools are simply guaranteed the 40 percent minimum of the state’s general fund.

The LAO has indicated declining state revenues now make it “95 percent likely” that Test 1 will be the operative formula for the 2008-09 budget year. But Department of Finance spokesman H.D. Palmer said Finance and the analysts’ office are still working to make that determination.

If it does become a “Test 1 year,” the core issue becomes: Does the state still owe the “maintenance factor” money to schools in Test 1 years? The Legislature and Gov. Schwarzenegger have tangled over that $8 billion question.

“We would still maintain that we are in a maintenance factor. As far as we’re concerned, that’s the intent of the law,” said Zogleman.
The California Federation of Teachers has already filed a lawsuit claiming there should be a maintenance factor in Test 1 years. When the suit was filed, CTA had said it was “premature” while voters had yet to weigh in on Proposition 1B, which would have rendered the lawsuit moot. But Zogleman said CTA was exploring its own legal options if the administration does not make the repayment to schools.