Mounting debt: the long economic boom enabled school districts nationwide to fund expensive reforms and hefty pay raises. Now, however, they are finding it nearly impossible to cut costs and balance their budgets. What makes it so tough for districts to downsize? - forum

Education Next, Winter, 2004 by Jon Fullerton

In April 2003,Joseph Olchefske, a nationally recognized reformer, announced his intention to resign as superintendent of the Seattle Public Schools. Surprisingly, given his background in investment banking and his previous experience as the school district's chief financial officer, Olchefske was felled by a financial crisis. In the fall of 2002, the school district had discovered an unexpected $23 million deficit for the previous fiscal year. The district was on track to ledger another $12 million deficit for the 2002-03 fiscal year.

About a month later, Dennis Chaconas was fired as superintendent of the Oakland, California, public schools. New software, installed so that the school district could better understand its finances, had uncovered a $40 million deficit from the previous year. The deficit for the current year was expected to be equally large. To keep the district solvent, the state of California provided a $100 million line of credit and took over the district's operations, stripping the school board of all but advisory powers and appointing an administrator to replace Chaconas. Although Oakland had long been known as a troubled school district, it had appeared to be moving in the right direction under Chaconas. Teacher turnover was down and test scores were up.

Unlike the financial chicanery that doomed corporate titans like Enron and WorldCom (now MCI), intentional corruption does not seem to have been behind either of these crises. Deliberate malfeasance has played a role in many a school district's financial distress (as in Compton, California), but Seattle and Oakland fell into difficulty while they seemed to be on the upswing. Why can even school districts that are apparently healthy suddenly find themselves on the verge of insolvency? This question will become increasingly urgent in the coming months, given the grim budget outlook that most states are facing. The problem is particularly acute in California (the primary focus of this article), where the state government, which largely dictates K-12 spending, is in the midst of a financial crisis.

The specific path to financial distress is, of course, unique in each case. Any number of factors, from excessively generous concessions at the bargaining table to a fiscal crisis at the state level, can throw a district into financial turmoil. The common way of dealing with these crises is to focus on the immediate causes of financial distress and to treat them as a straight-forward management problem. However, such crises are more properly understood as the result of underlying political and legal realities that prevent districts from managing their finances properly.

Four general factors can interact to create financial instability. First, the dynamics of public funding and the budgeting process encourage school districts to spend their entire funding allocation, creating a cost structure that is difficult to adjust down when revenue drops or fails to grow at an expected rate. Second, districts are constrained in how they can spend money and in the financial engineering options open to them. Third, the lack of attention afforded to the nuts and bolts of financial management in K-12 public education can result in naive oversight and inadequate management-information systems that can delay appropriate responses to emerging financial crises. Finally, school district finances are lodged within a larger political environment. Politicians and state officials may find ways to help push districts over the financial edge in order to accomplish their own purposes.

The Downsides of Incrementalism

Given that school districts largely do not have to face the vagaries of "selling" their services to fickle consumers, one might think that balancing the budget would be fairly straight-forward. Not so. The typical district has a budgeting process that results in its permanently "living on the edge," with revenues just matching costs. When hard times arrive, it is difficult for districts to adjust for a variety of reasons.

The first reason is the use of incremental budgeting. That is, school districts generally determine their current year's budget by taking the previous year's budget and adding or subtracting incremental spending to each major item. By contrast, zero-based budgeting asks managers to examine the services they are required to deliver and then build up their cost structure from scratch. Another strategy, activity-based costing and its derivatives, separates the costs of various activities within a business. Then, by looking at external benchmarks and generating ideas internally, managers search for ways to reduce the costs of these activities while delivering the same level of service (if such a level of service is even needed). The goal of using these budgeting methods is to ensure that the organization aligns its costs with its strategy and most valuable activities.

The downsides of the incremental approach are obvious when they are compared with methods that are more tightly focused on value. Making piecemeal changes to district priorities through a fragmented series of increments based on last year's budget will not ensure that the organization is carrying out the strategically correct activities or that it is executing them in a cost-effective manner. Thus when cuts need to be made, in the name of "fairness" they are often imposed as flat percentage cuts to each department across the board, ignoring both the relative efficiency and the relative importance of various departments. This method in fact provides an incentive for inefficiency: the fatter a department gets, the better it can survive the inevitable budget cycles.