The School Budget Explained
This article is one of a series to help explain to residents some of the more arcane and complicated aspects of school budgets.
School officials are often asked about fund balances, an aspect of fiscal management which is unique to public entities like school districts. Because a fund balance is often mistaken for a "surplus", it may seem unnecessary to have it in the budget. The concept is fairly complicated, so we offer the following (relatively) simple explanation of how fund balances, when properly managed, can be an effective budgeting tool and beneficial to taxpayers.
A school district has an annual budget of $40 million. It levies $40 million in property taxes. At the end of the school year, it finds that it has only spent $39 million. The $1 million that was not spent is called a "fund balance" because it's the balance that's left in the general fund at the end of the fiscal year.
What can the district do with the $1 million that's left over? Its options under the law are these:
1) Put the money in a "reserve account", which is like a savings account except that it has a specified purpose (e.g., capital improvements, emergency repairs, workers' compensation, employee retirement obligations). A district may not put this money in a regular bank account and just leave it there.
ADVANTAGE: A lump sum like this may not come again.
DISADVANTAGE: Once reserved, the money cannot be used for any other purpose.
2) Apply the money to the following year's budget. In other words, use the leftover $1 million as a revenue source that reduces the amount of money the district has to raise in taxes in the following year.
ADVANTAGE: Lowers the tax liability for one year.
DISADVANTAGE: After the first year, the tax benefit will turn into a liability unless it is repeated annually.
HOW COULD NOT HAVING A FUND BALANCE BE A LIABILITY?
Let's follow the scenario:
The school board doesn't like the idea of having any money left over at the end of the year. So in year two, with a $1 million increase in costs, the budget is kept to $40 million (remember, only $39 million was spent in year one). The "leftover" money from year one is used to reduce the tax levy from $40 million to $39 million — in other words, even though spending goes up, taxes decrease by 2.5 percent. Everybody's happy.
But keep this is mind: The district projects $40 million in expenditures; levies only $39 million in taxes; uses the $1 million “leftover” from the previous year; and plans to have no fund balance at the end of year two.
At the end of year two, the district finds that it has spent precisely $40 million, with nothing left over. Exactly as planned.
In year three, rising costs push the budget up another million to $41 million. Without a fund balance to apply as revenue, the tax levy jumps from $39 million to $41 million: an increase of more than 5 percent. The board has a difficult time explaining why there is a greater than 5 percent increase in taxes when spending only increased by 2.5 percent. The budget is defeated.
HOW COULD THIS HAVE BEEN AVOIDED?
If the district had planned for a $1 million fund balance at the end of year two, the budget would have been $41 million and the tax levy would have been $40 million (instead of $39 million), about a 2.5 percent increase. In year three, with another increase of $1 million, again about 2.5 percent, the tax levy would have kept rising at a steady rate, in parallel with spending increases, instead of jumping 5 percent in one year.
BUT ONCE THE FUND BALANCE IS ELIMINATED, AREN'T WE BETTER OFF?
Eliminating the fund balance is a good thing only if the district spends exactly the amount that is in the budget every year. However, in the real world, this does not happen: good budget management will always leave at least a small amount left over. In addition, by cutting it too close, there is always a risk of going over budget. By law, districts cannot borrow money to cover a budget deficit. In an emergency, unless the district had set aside money in a reserve fund that could be used for that particular kind of emergency (as described above), the district would have to make immediate cuts (personnel? programs? transportation?) in order to meet its obligations and balance the budget.
Fund balances help school districts to keep their finances steady from year to year without running the risk that unforeseen events will disrupt the delivery of educational services to children.