The new state budget agreement will include up to $11.1 billion in K-12 payment "deferrals." But what exactly are deferrals? How do they help the state balance its budget? And what are the implications for local school districts?
In this special “explainer” episode, guest Matt Phillips, director of management consulting services at School Services of California, is back to describe everything you need to know about this highly significant but seldom understood fiscal mechanism.
Matt provides clear examples that will help finance-minded and non-finance-minded folks alike gain a solid grasp of the ins and outs of payment deferrals, including how they differ from budget cuts. Deferrals, Matt says, are the "lesser of two evils," but they pose their own significant complications for school districts.
Given the pending adoption of a new California State Budget, this is an episode you won’t want to postpone listening to.
In this episode, you'll learn:
Latest state budget information:
About Our Guest
Matt Phillips, CPA, serves as Director of Management Consulting Services at School Services. In this role, he provides support to school districts for fiscal-related matters including budget reviews, salary schedule analyses, organizational reviews, and negotiations. He also presents workshops across the state on a variety of topics including the Local Control and Accountability Plan, collective bargaining, district budgeting, and auditing. His background as a Certified Public Accountant, experience working in a school district, and completion of the Fiscal Crisis & Management Assistance Team Chief Business Official (CBO) Mentor Program that resulted in the CASBO CBO certificate provide the foundation for these areas. Matt graduated from California State University, Chico, with a degree in business administration with emphasis in accounting.
About CASBO
The California Association of School Business Officials (CASBO) is the premier resource for professional development and business best practices for California's school business leaders. Follow at @CASBO and @CASBOGR
About your series guide
Paul Richman is a public education advocate and consultant. Contact him at edfundingca@gmail.com. We value your feedback! Follow him at @pjr100
The new state budget agreement will include up to $11.1 billion in K-12 payment "deferrals." But what exactly are deferrals? How do they help the state balance its budget? And what are the implications for local school districts?
In this special “explainer” episode, guest Matt Phillips, director of management consulting services at School Services of California, is back to describe everything you need to know about this highly significant but seldom understood fiscal mechanism.
Matt provides clear examples that will help finance-minded and non-finance-minded folks alike gain a solid grasp of the ins and outs of payment deferrals, including how they differ from budget cuts. Deferrals, Matt says, are the "lesser of two evils," but they pose their own significant complications for school districts.
Given the pending adoption of a new California State Budget, this is an episode you won’t want to postpone listening to.
In this episode, you'll learn:
Latest state budget information:
About Our Guest
Matt Phillips, CPA, serves as Director of Management Consulting Services at School Services. In this role, he provides support to school districts for fiscal-related matters including budget reviews, salary schedule analyses, organizational reviews, and negotiations. He also presents workshops across the state on a variety of topics including the Local Control and Accountability Plan, collective bargaining, district budgeting, and auditing. His background as a Certified Public Accountant, experience working in a school district, and completion of the Fiscal Crisis & Management Assistance Team Chief Business Official (CBO) Mentor Program that resulted in the CASBO CBO certificate provide the foundation for these areas. Matt graduated from California State University, Chico, with a degree in business administration with emphasis in accounting.
About CASBO
The California Association of School Business Officials (CASBO) is the premier resource for professional development and business best practices for California's school business leaders. Follow at @CASBO and @CASBOGR
About your series guide
Paul Richman is a public education advocate and consultant. Contact him at edfundingca@gmail.com. We value your feedback! Follow him at @pjr100
Everything You Need To Know About California Budget Deferrals – And Don't Want To Postpone Asking
A Special Explainer About California School Funding
Opening quote:
Matt Phillips, Director of Management Consulting for School Services of California:
For me, to make it very simple, I'm just going to go straight to the dictionary and the Oxford Dictionary defines a deferral as a postponement of an action or an event.
Series Intro Music starts.
Paul Richman, host:
Welcome to this special “explainer” edition of Adventures in Ed Funding, the series presented by CASBO – the California Association of School Business Officials. My name’s Paul Richman and I am extremely grateful to be joined once again by our friend and explainer extraordinaire Matt Phillips. Matt’s the Director of Management Consulting for School Services of California, a firm that provides guidance and analysis to school districts throughout the state.
Prior to joining School Services, Matt worked in school districts as a director of fiscal services and as an auditor. In this episode, Matt will help shed light on one of the most important though least understood elements that will be included in this year’s state budget for education: the deferral….Stick with us and you’ll learn everything you need to know about deferrals – and didn’t want to postpone asking.
Music ends.
Paul:
Thanks Matt, for joining us again on the podcast.
Matt:
My pleasure. I'm happy to be back.
Paul:
As I think many people know, the state budget deal that will be finalized soon is going to include something that has come to be known in budget-speak as “deferrals.” The total amount of these deferrals is likely to be in the billions of dollars. So Matt, we want to talk about what exactly deferrals are and how they impact both the state budget and local school district budgets. First, as it relates to the state, help us better understand what it means when the budget agreement includes a deferral of payments to schools?
Matt:
Absolutely. So, within the context of the definition of a deferral, recognizing that it's a postponement -- the state uses the word deferral with respect to cash as a postponement of the payments of the cash to school districts. The state uses it for a couple of different reasons. One could be solving a budget problem, and two, it could be solving a cash problem at the state level. And what we're looking at here is a little bit of both.
Paul:
How does postponing payments to schools help with balancing the state’s budget?
Matt:
Some may call it funny accounting, um, and without getting into the weeds, there are some accounting components there that folks could look at and scratch their heads. But the practical application of a cash deferral from the state's perspective is the state is promising to pay school districts X amount of dollars -- and rather than paying that full amount in a current year, if the state defers some of that cash to a subsequent year, it only takes credit for the cash that was paid to the school district in the current year. So, let's assume for a common school district, that school district is slated to receive a thousand dollars from the State of California. (We'll use small numbers for the purposes of this illustration.) And so the state adopts its budget and for this particular school district, the state would otherwise pay the school district a thousand dollars in the current year. So the state would on its side recognize a thousand dollars of expenses. Well, if the state only pays $800 to the school district, thereby deferring or postponing $200 to a subsequent fiscal year, the state has effectively reduced its expenses in the current year by $200. On the state's financials, they're only showing $800 of expenses in the current year, and $200 is deferred to the next year. That's important. When you think about the state's requirement to pass a budget, the legislature providing that budget to the governor by June 15, and then the governor acting on it within 12 days, so that there is a balanced budget in place by June 30th. This is a mechanism that is currently being contemplated in both the Governor's proposal and in the legislature's proposal to varying degrees. And it's also something that we've seen before. It was a pretty significant mechanism that was used by the legislature and the governor in the previous recession.
Paul:
And when we saw it before, did, um, the education community, did we like it before, or we tolerated it?
Matt:
You know, that's a great question. Um, tolerate is a good word to use for that. It's almost a lesser of two evils, because when you think about a deferral, uh, the alternative to a deferral is just a straight cut. So if we go back to the example that we used where the state owes a school district a thousand dollars, you know, the state can go one of two ways. The state can say, ah, we're going to defer part of that thousand dollars to the next year, which means that the district will ultimately receive the money, it just won't be in the current year. Or the state can get to the same position by saying, well, we'll just cut what we're going to give you. And rather than promise to give you a thousand dollars, we'll just promise to give you $800. And it's a six of one, half dozen of another from the state's perspective, but a very different practical application and impact to a local school district. When you tell them [the district] that rather than, you know, the promise of a thousand dollars split over two years, now you're just going to get $800, um, that's a pretty significant hit.
Paul:
And we're going to dive into that a little bit more in just a second about the, the impact on the school district side, but I also wanted to ask at the state level, so what happens in future years if the economy is still struggling and it's hard to balance the budget, Do these deferrals keep piling up?
Matt:
Yeah, so the, the deferrals can expand and contract as needed. What we're looking at right now in the governor's proposal, in his 2021 budget, is proposing to defer payments that school districts would have otherwise received in the months of April, May and June of 2021 into the subsequent fiscal year, into 2021-2022. Let's say, hypothetically speaking, that the economy takes a nosedive from where we're at over the next few months and the fiscal outlook for 2021 gets worse. The state could expand those cash deferrals further into the year. So, if we are only right now looking at April, May and June, they could push those deferrals back to the March payment, the February payment, the January payment, and so on, to grow the deferral to the necessary level to balance the state's budget. Now, conversely, if the economy gets better and the state recognizes that the economy is getting better, they could shrink the deferrals, so rather than deferring April, May and June, they could differ only May and June. They could defer only June or even a part of June. So it goes both directions. But it's certainly a mechanism, as I mentioned before, that has been used by the state.
Paul:
At least the last time that we used it, I know under Governor Brown, a substantial amount, billions and billions of dollars that had been deferred, were repaid over time. Is that right?
Matt:
That's correct, yeah. Governor Brown called it his “Wall of Debt.” And that was one of his commitments when he took office back in uh, 2012 for his second term. He was facing this, this very large, uh, multibillion dollar wall of debt, which included these cash deferrals that had been piling up through really four years of the Great Recession. And so when governor Brown took office, school districts were facing both cuts and deferrals. School districts were receiving only 78 cents of every dollar that was otherwise promised to them, and of that 78 cents of every dollar, 40% of that was being deferred into the “out” year. So, it was a double whammy where both of those mechanisms were being used by the legislature to get through the Great Recession over the first few years of Governor Brown's tenure in office, he bought down that wall of debt, right? The 40% that was being deferred from school districts, I believe it went all the way back to the February payment. So, if you look at money that districts would have otherwise received in February, March, April, May, and June -- five calendar months was being pushed out into the subsequent year so that the state could balance its budget. And so the way that the state buys those back or buys that down is they gradually step into it. So maybe in the first year of the recovery, there's five months of cash deferrals. And the next year, there's four months of cash deferrals. And the next year, there's three months of cash deferrals, till you get to the point where all the cash deferrals have been bought down, which means that school districts going back to our original example, receive all $1,000 that they were promised in the current year that it's promised.
Paul:
So, it's complicated.
Matt:
That is a fair statement.
Paul:
And, just terminology wise, it is in a sense a debt, right? Like Governor Brown called this part of his wall of debt, because the state owes school districts this money?
Matt:
Absolutely. By virtue of the fact that the state has not cut the funding, they are simply deferring when the funding is being provided to school districts. It's absolutely a debt and it's absolutely owed to schools. When we talk about the lesser of two evils with a cut versus a deferral, a deferral will always be the preferred choice because it's not reducing the amount that schools will ultimately receive. It's just postponing the timing of when those funds are received.
Music Interlude
Paul:
I was wondering, Matt, if you happen to have a handy analogy in terms of helping people relate to this concept even more, maybe something that they deal with in their daily lives?
Matt:
Well, I hope that folks don't have to deal with this in their daily lives, otherwise they might need, to find a new employer (laughter). But, you know, uh, an example -- not that I am aware of any examples such as this -- but let's assume, and we'll use simple math again, that you work for a company and you make $12,000 annually and you're paid monthly. And so you receive your paycheck every month of a thousand dollars. And your employer comes to you and says, I'm having some difficulty with the business. Things are slow right now. I don't want to cut your pay. I want to keep you as an employee. I value you as an employee, but I just don't have the cash right now to pay you. So what I'm going to do is, instead of paying you in October, November, and December, in three of the 12 months, I'm going to push those payments out into the next year. Now you may look at it on one hand and say, Well, I didn't take a cut in my pay, but on the other hand, you have monthly recurring payments and obligations that you are responsible for, whether it be a rent or mortgage, a car payment, credit card bills, groceries, utilities, and the list goes on and on. And as a consumer, you don't necessarily have that same ability to go to your debtors and say, Hey, my employer has deferred payment to me. Can I defer my own payments to you? You're probably not going to get the same warm, cordial response with those vendors. So that's where the challenge is for school districts. As the money is being pushed out, school districts have a responsibility to pay their employees. And the dollar figures are obviously much more significant than the thousand-dollar example that I'm using right now. But because these cash deferrals represent such a significant amount of cash that districts would otherwise receive, when districts look at how they spend those dollars – generally speaking about 85% goes to people -- well, we're not going to go to our people who are integral to the services that we provide to our students and say, well, because the state has deferred or postponed payment to us, we need to postpone your paychecks commensurate with the state payments. That is not going to fly in any way, shape or form. So, while deferrals are always preferential to cuts, deferrals do not come without their own set of headaches.
Paul:
Thank you for that example. That's a, I think a great example. And from the school district perspective, so if they're now not receiving those dollars for say the last three months, but they still have all the same expenses, how do they as a school district get through that, what are the options?
Matt:
Well, at School Services of California, we talk a lot about fiscal stability and within the notion of fiscal stability, there's a three-word phrase that we use a lot, and that is “cash is king.” There's a lot of focus in school districts about budgets and balanced budgets and are revenues greater than expenses? And that's all fine and dandy. But in this instance where we talk about cash deferrals, your revenues can still be greater than your expenses, but if you're not collecting any cash for those revenues, you're going to have a cash problem. And so that's where we go back to “cash is king.” For a school district to really address this, this cash deferral issue, it's no longer about looking at its budget, right? It's about looking at what its cash position is in each month of the year, and one of the things that school districts are required to do and provide to their county offices of education at certain points during the year is a cashflow summary where the district essentially maps out, Here's when we think we're going to receive all of our cash, here's how much cash we think we're going to spend each month. And it gives an estimate of where they believe they're going to end each month in cash. And once you layer on these deferrals -- so if we use the governor's proposal right now, we're April, May, and June of 2021 -- it looks like we're going to receive little to no cash from the State of California. Those are months as a school district that I would look very closely at to say, What is our cash position in those three months, assuming that we're not going to get anything from the state of California?
For a school district to weather the storm, that's where we talk about reserves at School Services of California. In the absence of a steady inflow of cash, we need to go into our reserves; they get us through budget difficulties. Reserves also get us through cash difficulties. An analogy for our person at home, using our example of the person who makes $12,000 a year, if their employer defers those three months of payments, that's $3,000 in cash that they don't have that they would otherwise need or expect to be receiving. If the person has $3,000 in their savings account, then they can use the money in the savings account to get them through that period where the cash is not being received. And then once it's received, they can replenish their savings accounts. It's very similar to school districts – when the cash is not coming in, they need to look to their own savings account. And they do that in large part by preparing that cashflow summary to say, Do we have enough cash on hand to make it through these, “dry months” where we're really not seeing any cash come in the door?
Paul:
And if a school district finds that it doesn't have enough cash in reserves, can a school district borrow the money?
Matt:
They can absolutely borrow the money. There are a few mechanisms in law that allows school districts to borrow money. There are three that I can think of off the top of my head that we see as the most common ways of borrowing money. The first is that it can borrow from itself. Most school districts when they look at their cash position, they're looking at their general operation account. So, for the common consumer, that would be like your checking account, right? How much do I have in my checking account? If my checking account goes negative, well, I need to pull something from my savings account. So a school district similarly looks at their operations account, which is their general fund, and if that general fund ends up not having sufficient cash to pay the bills, a school district can look to some of its other funds that it's required to maintain under law. And there are provisions in law that, um, within certain parameters, school districts can borrow cash from those other funds. Now, generally those funds cannot be used to finance day to day operations. The borrowing has to be temporary and it has to be short term, and there are some rules around that borrowing. Now that's going to be the lowest cost option to a school district because it's borrowing from itself. Okay. It's going to have to repay those funds with interest, but it's essentially repaying itself, so while interest may be a “cost,” it's just being deposited into another fund.
The second option is borrowing from the county office of education. Now the county office is going to charge an interest rate. It's going to be a reasonable interest rate, but there will be an interest rate nonetheless that's affixed to the principle that is borrowed to help the school district get through its short term cash issue. But the difference from the first option where the district is repaying interest to itself, is under the second option, the interest is going to the county office of education. So, once you pay the interest it's gone. So that's going to be a higher cost version of borrowing.
The third option [for borrowing] is the school district goes to the outside market, the bond market, and they use a, a mechanism known as a Tax Revenue Anticipation Note -- in the school finance world also known as a TRAN. This is a short-term borrowing option, generally one year, where it actually goes out there's an underwriter, and the money is raised through the capital market. So you have investors who are saying, Hey, I'll buy some of that because I'm going to be guaranteed the interest rate, whatever they're able to sell that paper at, I'm going to be guaranteed that interest rate as an investor. So, it's an investment tool for the common public, and it's a third option that allows school districts to raise funds, to get through short-term cash crunches, such as those caused by cash deferrals.
Paul:
Thank you for walking through that, Matt. Can you tell us: What are the most significant risks for school districts with deferrals?
Matt:
When I think about the risk with deferrals, um, the number one risk that jumps into my head is that the school district is not going to be able to access any of those three options. So if a school district doesn't have any other funds or doesn't have any dollars in those other funds, then option one is off the table. Two and three -- the options that I talked about are somewhat related insomuch that if every school district in the State of California, for all intents and purposes is feeling a cash crunch, not all of them will, but the majority of them will, is there going to be sufficient capital from either county offices or sufficient appetite from the market to lend the amount of cash that's going to be needed to help school districts get through the cash crunch?
Now, if we overlay this against the Great Recession back in ’09-10 and 2010-2011, where there was a significant amount of borrowing that school districts had to take on, many of them went through the outside market through the TRAN option. The big difference between now and then is let's assume, uh, back in -- for an apples and apples comparison -- let's assume in 2011, the state deferred three months of cash, right? (April, May and June.) If we compare that with the same three-month period now, the real dollar amount that's being deferred now is going to be about 50% greater than it was then just by virtue of the amount of money that the state is investing in schools. Even if we're looking at the same three-month period, the real dollars that districts will need to borrow now are going to be significantly greater than the dollars that were needed to be borrowed back in 2010, 2011 and 2012, if we're looking at the same three-month period. While the mechanism and the approach may be the same from the legislative perspective, the impact to school districts will be more significant now than it was during the great recession.
Paul:
And you know, somebody asked me a question about this this morning that I promised I would convey to you, which is: Given that school districts who are also required to balance their budgets, have to address this typically by borrowing money. Why can't the state borrow money in the first place, so they wouldn't have to defer?
Matt:
I don't have a good answer to that, Paul You've stumped me with that question.
Paul:
All right. Well, we'll investigate that. If any state legal scholars are listening, maybe they'll help us look into that?
Matt:
That'd be fantastic.
Paul:
So, Matt, you have once again helped us take the complex and made it understandable for our listeners. I was wondering if there's anything else related to the cash deferrals in the budget that you wanted to share?
Matt:
Sure. I would go back to this notion that everyone understands a cut. A cut is a cut, and it's something that most of us have experienced in our life in some form or fashion at one time or another. The deferral is less understood because as the average person, we don't, we're not impacted by deferrals. Our employers do not defer our pay. So when people hear the word deferral, they ask the first question, Well, is that a cut? And the answer is no. And many times the conversation stops there. And while it's always the lesser of two evils, a cash deferral does come with its own headaches. And so, uh, again, it is the preferred option, but I, I do want folks to recognize that cash deferrals do not come without their own set of considerations to take into account.
Paul:
At the end of the day, when the state budget agreement is finally reached -- and if it leans towards the budget that the legislature approved – when and if state leaders start claiming it’s a budget that has “no cuts” to schools -- even though it does contain probably billions of dollars in deferrals – will it be a fair characterization for them to say it does not cut education?
Matt:
Depends how finely you want to parse the word “cuts.” Is there a reduction in revenues that are promised to schools?No. There are no cuts. Are schools receiving less cash in the current year than they would otherwise be receiving? The answer is yes. And so, it puts the onus on school districts, a thousand school districts across the state of California, to really analyze their cash position. Because again, cash is king and to ensure that during the months that are ultimately deferred as part of that budget that they have sufficient cash to cover that shortfall that the state is using the balance its budget.
“Coronavirus Blues” theme music begins.
Paul:
Well, that is where we’ll leave things for now. We hope this has helped you to better understand the ins and outs of the infamous state budget deferral.
A very special thanks to Matt Phillips from School Services of California for making the time to talk with us during an especially intense and busy time of year. Matt, we appreciate you!
And many thanks to you for listening to our series! Adventures in Ed Funding is presented by CASBO, the California Association of School Business Officials. For the latest state budget news and more, be sure to visit CASBO.org. You can also share your suggestions for this podcast by emailing us at edfundingca@gmail.com. And if you haven’t already done so, be sure to subscribe so you don’t miss an episode. My name is Paul Richman and I’m your faithful series guide. The one and only Tommy Dunbar handles all of our sound, editing and music – including these Coronavirus Budget Blues that we’re still living with. Until next time, unlike the state, don’t put off until next budget year what you can do this year. Tommy, play us out…