Financial projections presented at the Feb. 3 meeting of District 65’s Finance Committee sparked a discussion about the need to rein in expenses and to develop a plan, with community input, to address the District’s structural deficits before it becomes an “emergency” to do so. The projections show that operating deficits will surface in the 2021-2022 (FY’22) school year and rapidly increase in subsequent years.
While the District is projected to have enough Referendum Reserve funds set aside to cover the deficits up through FY’ 25, the reserves are expected to run out in FY’26, when operating deficits could be $13 million a year and growing if nothing is done.
The projections also show that the five-year contracts entered into last summer with the teachers’ union and the teachers assistant association do not address the structural deficit that the District has faced for many years.
The Referendum Plan
The projections should be considered in the context of the Referendum approved by voters in April 2017. In the referendum, voters approved an additional $14.5 million in funding for operations each calendar year. Under the Referendum Plan, District officials said they would set aside surpluses generated in FY’18 through FY’21 in a Referendum reserve, and then use the amounts set aside to balance projected operating deficits in FY’22 to FY’25. The commitment made during the months preceding the Referendum was to balance the District’s budgets for eight years, through FY’25.
The District also committed that it would allocate $1 million each year to build up the District’s fund balance.
The District has already set aside or is projecting that it will set aside the following amounts in the Referendum Reserve for the years indicated: $18.5 million in FY’18; $6.4 million in FY’19; $4.2 million in FY’20; and $1.0 million in FY’21, for a total of $30.1 million.
The District plans to use the amounts held in the Referendum Reserve to balance projected operating deficits of $804,504 in FY’22; $4.2 million in FY’23; $ 6.9 million in FY’24; and $10 million in FY’25, or a total of about $21.9 million.
At the end of FY’25, there will be about $8.2 million available in the Referendum Reserve to cover a possible operating deficit in FY’26.
The District has not yet issued projections for FY’26, but if the trend continues, the operating deficit in FY’26 would be about $13 million, and there would be about $8.2 million left in the Referendum Reserve to apply toward balancing that deficit. There would be nothing left to cover operating deficits in subsequent years.
Kathy Zalewski, Business Manager for District 65, said the District is on track to balance its operating budget through FY’25 as promised as part of the Referendum.
But the issue is what happens after that.
The chart below shows the deficits projected by the District for FY’22 through FY’25, and it shows a potential deficit of $13 million for FY’26 based on the trend. The chart also shows the projected applications of the Referendum Reserve to balance the budgets, which may run out in FY’26 if no action is taken.
The Structural Deficit
The District has been facing a structural deficit for many years, where expenses increase at a faster rate than revenues. This has generally been due to salaries increasing at a rate faster than the increases permitted under property tax caps, which is the lesser of the Consumer Price Index (CPI) or 5%.
Ms. Zalewski said in a Jan. 30 memo, “The District has not been able to resolve the problem of the structural deficit, which occurs when expenditures outpace revenues on an ongoing basis.”
The problem is difficult because salaries and benefits account for about 80% of the District’s operating expenses, and the Board just approved five-year contracts with the teachers and teacher assistants union. The contracts lock in compensation for the next five years.
On the other side of the equation, property taxes account for about 80% of the District’s operating revenues, and increases are limited by property tax caps to the lesser of the Consumer Price Index (CPI) or 5%. The CPI for 2019 was 2.3%, and the District assumes it will be 1.5% in subsequent years.
The structural deficit is illustrated by comparing the projected rates of growth of operating revenues with that of operating expenses. The table below shows the percentages at which the District’ operating revenues and expenses are projected to increase for the years listed.
Over time, the operating deficit is projected to grow to $10 million in FY’25, and if the trend continues to $13 million inFY’26. The Referendum reserve would be used up in FY’26.
Since FY’17, District 65’s student enrollment has declined by about 150 students, and the District is projecting that enrollment will decline by almost 400 more students between now and FY’25.
Ms. Zalewski told members of the Finance Committee, “We feel very strongly we need to look at current resources before we hire additional staff. If you look at student projections, which are projected to be flat and declining, we continue to hire additional staff. If you look at the last year and the year before, it’s usually net 20, 30 positions every year and this is unsustainable.”
Ms. Zalewski’s memo says, “With flat/decreasing student enrollment, the District will have to make every effort to control the size of its workforce.”
Raphael Obafemi, Chief Financial Officer, said, “We can’t overstate the fact that at the end of the day, we have limited control over revenues because the majority of our revenues is from property tax, which is capped by PTELL [the Property Tax Extension Law Limit]. We have absolute control over expenditures. And the largest driver of expenditures are people; 80% of our expenditures are people. So that’s really where the savings are. I think it’s important for us to be very thoughtful about hiring additional people and the associated benefits that go with that.”
Ms. Zalewski added that the District will continue to use zero-based budgeting for non-personnel expenditures, continue to renegotiate contracts with suppliers, use a priority/equity budgeting model, work with the new Superintendent to develop a matrix for evaluating programs that are less than effective for restructuring or elimination, and offer retirement incentives and hire replacements at lower costs.
Threats from Springfield
Ms. Zalewski said there is also a possibility that State legislators could pass legislation that could impact the District’s financial position.
First, she said the State could shift the cost of funding teacher pensions to school districts. The District’s projections take this into account by building in an expense of $300,000 in FY’21, growing to $1.2 million in the next four years. If there is in fact a pension cost shift, it is possible that it would be much larger.
In addition, Ms. Zalewski said that legislation that would freeze property taxes is not dead and that it may be coupled with the proposal to implement a graduated income tax in the State.
Mr. Obafemi said, “From what we’re hearing, there is going to be some kind of tax freeze. It’s a matter of whether it’s temporary or long-term. But the politicians in Springfield are saying in order to sell the progressive income tax, there needs to be some form of property tax freeze to make it saleable. It’s going to impact our revenues one way or the other.”
Ms. Zalewski said an analysis done by the District several years ago showed that if property taxes were frozen, the impact would be in the millions.
While politicians have argued that an increase in State income taxes would allow the State to put more money toward education, the chances of District 65 receiving an increase in State funding is virtually nil under recent legislation that revamped how the State allocates funds to school districts.
Board Members’ Discussion
Finance Committee Chair Joey Hailpern said he thought the Board needed to be educated in order to make decisions on how to proceed. He added, “But I think we as a group need to talk about Board values and what are our financial goals and responsibilities to the District in order to have sustainability going forward.”
Board Vice President Anya Tanyavutti said the Board had been talking about how to get the community involved. “I think we need to have a community conversation about the difficult decisions we need to make, because it’s clear we can’t just trim around the edges here in order to get to solvency.”
Board President Suni Kartha said, “I absolutely agree with that. This conversation can’t wait.” She said as the budget for FY’21 is being prepared, perhaps some reductions could be made, such as with negotiating the cost for bus transportation. By next fall, she said, the Board needed to decide whether to hold town halls to inform the community about the where the District is and what type of analyses the District is doing.
Board member Candance Chow said, “What we have not done is rein in expenses so we’re not worsening the problem.”
“I was thrown by our current projections,” which she acknowledged may be adjusted to take into account a reduction in the cost for bus transportation. She said revenues in FY’21 were projected to increase by 1.47% but expenses were projected to increase by 3.93%. “That’s almost three times versus this past year [FY’20],” she said. In FY’ 20, revenues went up 4.25% and expenses went up 6.19%.
Ms. Chow said she thought the Board’s responsibility was to set “a parameter around what is our guidepost in terms of this gap – how we’re certainly not going to worsen it.” She said the District should not increase the gap from what it was in FY’20.
“We can’t keep spending more while we’re waiting to fix the problem.”
Ms. Chow added, “We have a reduction in students and haven’t seen a commensurate reduction in our staffing plan.”
She said the Board needed to develop a broader plan to address the budget.
Ms. Tanyavutti said she agreed the Board had a duty to set some guideposts now. She said, though, the Board also had to consider the experiences that children are having in the District and a responsibility to improve the experience of marginalized students.
Ms. Chow said she agreed with the investments made by the Board to help marginalized children, and that that was a priority. But she said, “We need to make other choices about where do we need to pull back or restructure. We can’t have everything.”
Ms. Chow said the Board needed “to put a stake in the ground that our expectation is that we’re not going to be broadening this … “
Ms. Kartha asked administrators to present a plan at the next Finance Committee meeting that would limit the percent of the gap between revenues and expenses in FY’21 to the percent of the gap that existed in FY’20, and to show how the reductions would be made.
Mr. Obafemi said, “Let’s be clear, it’s going to involve a reduction in people.”
“I think we all understand that,” said Mr. Hailpern.
He added, “The referendum dollars are giving us this window to have this conversation in a way that’s not a drastic, emergency conversation – which will become an emergency if we wait.”
“Absolutely,” said Mr. Obafemi.
Ms. Kartha said she would like to see a plan at the next Finance Committee meeting, and said the reductions could be in traveling for professional development and the amount spent on consultants.
Meg Krulee, President of the District Educators Council (DEC, the teachers union), said she would like to see something “across the board” that did not target one type of expenditure. She added that all members of the community that are affected should be consulted.
“This is the same thing that we would like to do,” said Mr. Obafemi. “Because the way we look at our charge here is to make sure whatever we do, it doesn’t hurt kids. We’re in the student business. We’re not in the business of just deficit reduction, finances, projections. We want to make sure that long-term, students get the resources they need to be able to reach their fullest potential long-term.”
Mr. Hailpern asked administrators to assess whether the manner in which the District had analyzed programs and potential cuts before the Referendum was an approach to use again or whether a different approach would be preferable. He said he would like to establish a timeline for the Board to better understand programs, alignment, and efficiencies. He said the conversation might also include conversations around school boundaries and revamping transportation.
Some Key Assumptions Used in the Projections
There are several key assumptions that shape the District’s financial projections. On the revenue side, the CPI limits the amount the District may increase property taxes, which account for 79% of the District’s revenues. The CPI came in at 2.3% for 2019 which impacts the District’s property tax revenues in FY’22. While this is higher than the 1.5% used in prior projections, the higher CPI will also increase the base salary due to teachers in FY’22 under the new five-year contract, said Ms. Zalewski. For FY’23 and subsequent years, the District is assuming the CPI will be 1.5%. She said the CPI has averaged 1.75 in the last 10 years, and they were being conservative in light of uncertainty in the economy.
Ms. Zalewski added, that local revenues are projected to decrease by $400,000 in FY’21 because interest rates on investments have declined.
On the expense side, the projections are based on the salary structure agreed upon with the teachers union and the teacher Assistants Association for the next five years (i.e., through FY’24), and they assume that salaries will increase at the rate of 3% in FY’25.
While a new five-year contract is in place, there are still some unknowns that may impact the total expense for teacher salaries. In the last three years of the contract, the increase in base salary may be impacted, with some limits, depending on the CPI. Salaries increases also depend on step and track increases. In general terms, if the overall workforce has a higher number of teachers in higher steps and tracks than in the prior year, it would increase total salary costs. Conversely, if there were more teachers in lower steps and tracks than in a prior year, it would pull down total salary costs.
Another expense item that is taking on increased significance is employee benefits (including health care costs), which account for 11% of total operating expenses in FY’20. Medical premiums are projected to increase by 8% in FY’21, and then 5% in subsequent years. Ms. Zalewski added that the District is encouraging employees to participate in Teladoc and Wellness programs, which may help reduce medical insurance costs. The remaining benefits are projected to increase by 3%. The projections assume that benefits will increase to 13% of total operating expenses by FY’25.
At the Finance Committee meeting, Ms. Zalewski said the projections built in an increase of 30% rise, or a $1 million increase, for bus transportation. She said the company that currently provides busing service to the District submitted a bid with the 30% increase; and no other company provided a bid.
Mr. Obafemi said he has been conducting post-bid negotiations with the company, and they reduced the increase to 19% in a subsequent proposal. Mr. Obafemi said he responded that a 10-12% increase would be reasonable, with an increase in subsequent years at 2.3% to 3.0%. He said he is considering other options, including changing the start time of certain schools, which would enable more buses to make two runs each morning and afternoon.
Since the projections are based on a $1 million increase for bus transportation, the projected expenses will likely decrease once that issue is resolved.
As noted above, the projections may also be impacted by legislation regarding pension cost shifts or property tax freezes.