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| AN ANALYSIS OF THE TAX IMPLICATIONS OF SCHOOL FUNDING LEGISLATION THAT "TARGETS AID" AND REPEALS THE STATE PROPERTY TAX December 15, 2004
Conclusion Education funding proposals that repeal the state property tax such as the Lynch plan and the Asselin/Dokmo plan, violate the Claremont decisions to the extent that they use local property taxes to fund any part of the cost of an adequate education. These plans substantially increase the cost of an adequate education from its present $805 million. We project that the Lynch plan would increase the cost to around $1.6 billion, while the Asselin/Dokmo plan would increase the cost to around $2.3 billion. Because these plans repeal the state property tax, which generates $371 million, they would require new state funding of approximately $1.2 billion to $1.9 billion. The Lynch plan, however, uses local property taxes to fund part of the cost of an adequate education. Consequently, a court applying the Claremont decisions would have to strike down the funding portion of the Lynch plan. Likewise, to the extent that the Asselin/Dokmo plan uses local property taxes to fund some portion of the cost of adequacy, its funding scheme also would have to be struck down. In the case of the Lynch plan, this will leave approximately a $1.2 billion funding hole, while the Asselin/Dokmo plan could produce a hole of nearly $2 billion. The only taxes capable of filling such a hole are an income tax, a sales tax or a state property tax, or some combination of these taxes. Accordingly, education funding proposals such as the Lynch plan and the Asselin/Dokmo plan should not be passed until after a constitutional amendment is passed that allows the local property tax to be used to fund the cost of an adequate education.
Introduction On December 1, 2004, a new legislature was sworn in. And, in a matter of weeks, John Lynch will be sworn in as our new Governor. This changing of the guard appears certain to bring with it various proposals to change the way that we define the "adequate education" mandated by the Claremont decisions and the way we fund it. The common thread running through all these proposals is that they would redefine an adequate education in a manner that substantially increases the cost of adequacy while repealing the state property tax that currently pays for about one-half of the cost of adequacy. For example, it has been reported by iNews (www.nh-inews.org) that Representatives Mike Asselin and Cynthia Dokmo are sponsoring a bill that would change the current statutory definition of an adequate education to incorporate the Department of Education’s standards for school approval and to include the cost of special education. This expanded definition of adequacy appears to increase the cost of an adequate education from its current $805 million to over $2 billion. An entity calling itself the New Hampshire Citizens’ Voice Project contends that the cost of an adequate education should be increased by approximately $790 million. And it appears that Governor Lynch’s education funding plan would double the present cost of an adequate education. Some of the sponsors and supporters of these education funding proposals claim that we can fund a substantially increased cost of adequacy and repeal the state property tax, without passing an income or sales tax. As discussed below, as long as the Claremont decisions remain the law of New Hampshire, we cannot. For example, the Asselin/Dokmo bill discussed above would necessitate a 21 percent sales tax or a 7 percent income tax. In order to understand why education funding proposals that substantially increase the cost of adequacy and/or repeal the state property tax will require a sales tax or an income tax, we will need to analyze: (1) what the Claremont decisions really say about the funding of an adequate education, (2) how the cost of an adequate education affects tax policy, and (3) the effect these proposals would have on the cost of an adequate education. The key points of our analysis are:
Discussion
In relevant part, the Claremont decisions say that no part of the cost of an "adequate education" can be funded with local property taxes. In order to avoid any ambiguity or confusion, let’s start by defining the terms "adequate education" and "local property taxes." Local property taxes are property taxes set by the school district and collected within the school district. Adequate education is a legal term of art that appeared for the first time in a 1993 supreme court decision that we will refer to as Claremont I. In Claremont I, the supreme court said that all "educable students" in New Hampshire have a constitutional right to an adequate education. The court also said that the legislature and governor have a constitutional duty to define an adequate education. In 1997, in a decision we will call Claremont II, the supreme court rejected the definition of an adequate definition that had been developed by the State Board of Education, not because it was substantively inadequate but on the procedural ground that the legislature could not delegate this duty. The court then went on to say that the legislature’s and governor’s duty to define an adequate education required the definition to be based upon a definition of educational adequacy developed by the Supreme Court of Kentucky in 1989. In 1998, the legislature and governor enacted RSA 198-E:2, which essentially defined an adequate education based on the Kentucky definition, with the addition of math and science, which apparently are instinctive or unimportant knowledge in Kentucky. The part of the Claremont II decision that most concerns us here, however, is what the supreme court had to say about funding an adequate education. The court said that local property taxes could not be used to fund an adequate education. The court’s rationale was that any tax used to fund an "adequate education" was subject to a requirement that the tax be "proportional and reasonable" on a statewide basis. In plain English, "proportional and reasonable" means that the subject of the tax, for example real estate, must be valued the same way throughout the State and that the tax rate must be uniform throughout the State. When Claremont II was decided, the principal way that education was funded was through local property taxes, which as we noted above are property taxes set by the school district and collected within the school district. The rates of local property taxes varied widely among school districts, which the supreme court said rendered them unconstitutional. It is important to understand why local property tax rates varied. One reason was local control; different school districts chose to spend different amounts on education. Another reason was differing amounts of State funding among school districts. Another reason, and what concerns us, is demographic differences between school districts; the number of students and the size of the tax base differed from district to district. The demographic differences between school districts mean that uniform per student spending among districts will not result in uniform tax rates among districts. For example, whether the cost of an adequate education is set at $1 per student or $7,800 per student, funding that cost through local property taxes, that is setting a tax rate within the school district that generates taxes equal to the per student cost of adequacy multiplied by the number of students in the district, would not produce a uniform tax rate among school districts. Districts with smaller numbers of students and/or larger tax bases would have lower tax rates than districts with larger numbers of students and/or smaller tax bases. This means that, under Claremont II, adequacy cannot be funded to any extent with local property taxes. Rather, to the extent that a property tax is used to fund an adequate education, it must be a state property tax. After Claremont II, some maintained that the Claremont decisions did not require the State to fund the entire cost of an adequate education. They did so based on language in the Claremont decisions describing the State’s "duty" as "to guarantee adequate funding," and argued that the State’s duty could be met by "targeting" funding to school districts that had the highest local property tax rates. However, in Claremont IX, which was issued in 2000, the supreme court made it crystal clear that what it meant by "duty" was that the State must fund all of the cost of an adequate education. Claremont IX arose out of a bill, SB 462, that the Senate sent to the supreme court for an advisory opinion that used the local property tax to fund part of the cost of adequacy. The total cost of adequacy was projected at approximately $910,000. Of that amount, about $750,000 was to be raised though state taxes, while only about $160,000 was to be funded through local property taxes. Nevertheless, the court said the bill was unconstitutional. Under SB 462, some municipalities would not have needed to raise any money through local property taxes because a state property tax of $6.10 per $1,000 would have covered their entire cost of an adequate education. In other municipalities, however, state funding would not have been enough and local property taxes would have been needed to make up the difference. These communities would, to differing degrees, pay higher tax rates to fund the cost of adequacy. Thus, because of the use of local property taxes to fund a portion of the cost of adequacy, the tax rate on property being taxed to fund adequacy would not be equal across the State, as required by Claremont II. For this reason, the supreme court ruled that SB 462 was unconstitutional. In order to clear up what the supreme court described as "lingering confusion" about its prior decisions on education funding, the court in Claremont IX added that "the New Hampshire Constitution imposes solely upon the State the obligation to provide sufficient funds for each school district to furnish a constitutionally adequate education to every educable child." The court also stated that "[i]f the legislature chooses to use a property tax [to fund adequacy], the tax must be equal and proportional across the State." As we discussed above, in plain English this means that local property taxes cannot be used to pay for any portion of the cost of an adequate education. No subsequent supreme court decision has revisited the issue. So, while there is room to debate whether the supreme court got it right in the Claremont decisions, there is no room to debate what the court has said about how the cost of an adequate education must be funded. The State must fund all of the cost of an adequate education and to the extent that a property tax is used to fund an adequate education, it must be a state property tax. Despite the supreme court’s attempt to dispel lingering confusion about education funding in Claremont IX, there remains a school of thought whose plans for education funding result in replacing the state property tax with local property taxes. The most prominent member of this school of thought is Governor-elect Lynch. The belief is that this will eliminate the so-called "donor towns" and "receiver towns." There is a wrong way and a right way to eliminate donor towns, if that is your goal. Repealing the state property tax is the wrong way, however, unless you are willing to replace it with a sales tax or an income tax. Before we consider the Lynch plan, let’s first arm ourselves with some information about donor and receiver towns. The total cost of an adequate education for the 2004-2005 school year is approximately $805 million. About $371 is to be raised through the state property tax. The remainder, $434 million, will come from Sweepstakes profits, business taxes, the real estate transfer tax and other revenues. For the 2004-2005 school year, in 202 municipalities, the state property tax will generate less than the cost of an adequate education in those municipalities. These municipalities, the receiver towns, will retain all of the state property tax they collect, and will receive from the State the difference between the state property tax and the cost of adequacy. In 52 municipalities, the state property tax will generate more than the cost of adequacy. These are the donor towns. Donor towns will send the difference between the state property tax and their cost of adequacy to the State, which will distribute this money along with the $434 million derived from sources other than the state property tax to the receiver towns. The amount passed on to the State by the donor towns is less than $21 million, which means that less than 5 percent of the money actually distributed by the State to fund adequacy comes from donor towns. While Lynch was reticent about disclosing the particulars of his education funding plan during the campaign, enough details came to light to allow us to draw the conclusion that Lynch’s plan appears to be either the HB 717 that passed the House in 2003, or some variation of that bill. Thus, Lynch’s plan would define the cost of adequacy as the average statewide expenditure per student, which would approximately double the cost of an adequate education. As we noted above, it also would repeal the state property tax. The funding formula of HB 717 is complicated, but it would result in some portion of the cost of adequacy being funded by local property taxes. Let’s see how. State funding, under HB 717, is the difference between a municipality’s "education need" and its "fiscal capacity." Education need is calculated based on per student spending. Fiscal capacity is determined equally by median income and property tax base. It is important to understand that the difference between "need" and "capacity," that is what the State funds, is less than the cost of an adequate education. In other words, the municipality funds the cost of an adequate education up to its fiscal capacity, while the State funds the remainder. While HB 717 is silent about the source of the municipal funding for adequacy, it must be the local property tax, because that is the only tax that school districts are authorized to impose. As we discussed above, property tax bases differ between municipalities. So does median income. Thus, fiscal capacity will differ among school districts, which means that the rate of local property taxes being used to fund adequacy will not be the same across the State. And, thus, the Lynch plan obviously fails to comply with the Claremont decisions. If, or more accurately when, it is challenged in court, a court will rule that the plan’s funding mechanism violates the Claremont decisions, because local property taxes are being used to fund adequacy. At that point, we will have to reinstate the state property tax, albeit at a much higher rate to pay for the much higher cost of adequacy under the Lynch plan, enact a sales tax or an income tax, or enact some combination of the foregoing taxes. In the next sections, we will discuss why the choice is limited to these three taxes, and why we should not count on being able to reduce the cost of adequacy to avoid passing one or more of these taxes. But before turning to the topic of how the cost of an adequate education affects tax policy, let’s conclude this topic by considering a school of thought on the other side of the political spectrum from Lynch that maintains that we can simply repeal the state property tax and replace it with local property taxes. These conservatives are not interested in increasing government spending on education. Rather, they desire to repeal the state property tax, which they consider unfair. They contend that the tax revenue lost by repeal of the state property tax would be only the $21 million from the donor towns. However, the result would be a $371 million hole in the budget, that is the entire amount to be raised by the state property tax in the 2004-2005 school year. To illustrate the point, let’s assume a law under which the cost of adequacy remains $805 million, the amount of funding from the State remains $434 million, but the state property tax is repealed and replaced with local property taxes. Under this law, local property taxes will fund the cost of adequacy up to the lower of the $3.33 per $1,000 rate of the current state property tax rate or the rate that funds adequacy within the district. Thus, once the state property tax is repealed, taxpayers in donor towns would be paying for the cost of adequacy with a property tax rate less than the state property tax’s $3.33 per $1,000, because the donor towns would be able to fund the entire cost of adequacy in their school districts at lower rates. As a result, property taxes used to fund adequacy would not be the same rate across the State. This tax scheme also clearly runs afoul of Claremont II. As a result, once our hypothetical law is challenged in court, the hole is no longer just the $21 million from the donor towns, but the entire $371 million from the repealed state property tax because the local property tax would be declared in violation of the Claremont decisions to the extent that it was funding the cost of adequacy. As we’ll discuss in the following sections, once such a decision is issued we will be right back where we were after Claremont II was issued; either the state property tax will have to be reinstated or it will have to be replaced with a sales tax or an income tax. There is a school of thought among the conservatives that a court ruling striking down the state property tax can simply be ignored. These conservatives should recall that they’ve been there (the aftermath of Claremont II), tried to do that, and it didn’t work. Gambling that a future Claremont II decision would have a different outcome is a really bad bet. In sum, as long as the Claremont decisions remain the law, the State must fund all of the cost of an adequate education and to the extent that a property tax is used to fund an adequate education, it must be a state property tax.
As we noted above, the total cost of an adequate education for the 2004-2005 school year is approximately $805 million. As we established above no part of the cost can be funded with local property taxes. In this section we will illustrate that, because of the sheer size of the cost, it must be funded to some extent by either an income tax, a sales tax, or a state property tax. Let’s begin by looking again at how this $805 million is funded.
As we discussed above, about $371 million is to be raised through the state property tax. The remainder, $434 million, will come from Sweepstakes profits, business taxes, the real estate transfer tax and other revenues. We’ll call these ancillary taxes. To the extent that the cost of adequacy remains at the $805 million set for the 2004-2005 school year, it is not possible to fund adequacy without an income tax, a sales tax or a state property tax. The reason is that raising nearly another $400 million from the ancillary taxes is not feasible. A study done by the New Hampshire Center for Public Policy Studies in 2000 shows that, for example, increasing the tobacco tax by ten cents would only generate an additional $18 million of taxes. Increasing the Business Enterprise Tax by 150 percent would generate less than $50 million of additional taxes. Other examples can be found on the Center’s website. And it is worth underscoring that, as the Center concedes, its study assumes that taxpayer behavior is static, which is an incorrect assumption. For example, increasing tobacco taxes have led to less smoking. Similarly, increasing business taxes would likely lead to less business activity as businesses can relocate to more hospitable environs. Thus, to the extent that the cost of adequacy remains at or above the $805 million set for the 2004-2005 school year our choice is to fund adequacy with a sales tax, an income tax or a state property tax, or to pass an amendment that modifies Claremont II. Because the state property tax has been so politically unpopular, it is perhaps worth taking a few sentences to remind ourselves of the comparative merits of property taxes to income and sales taxes. Unlike sales and income taxes, a property tax does not automatically increase every time our incomes and expenditures increase. And, unlike sales and income taxes, which are hidden taxes, a property tax is painful because we write relatively large checks twice a year to pay it, which reminds us to be vigilant about government spending. Thus, government is smaller and more accountable when it is funded by a property tax. With the exception of a constitutional amendment that would allow the local property tax to be used to fund part of the cost of an adequate education, a state property tax is the most fiscally responsible response to the Claremont decisions. Additionally, the current state property tax is capped at $371 million, which will attenuate the "donor town" effect of adequacy funding. So far we have assumed that the cost of adequacy will remain in its current range of $805 million. Before examining the Lynch plan and the Asselin/Dokmo bill, which according to the Claremont Coalition would define adequacy in a way that "is far more than what the State is currently providing," we need to look at the effect on tax policy of materially increasing the cost of adequacy. By a material increase, we mean an increase beyond the funding potential from increasing the ancillary taxes that fund the cost of adequacy. Based on the analysis we just completed, the answer is obvious. If the cost of adequacy is materially increased and we keep the state property tax capped at its current level, an income tax or a sales tax will be needed. To the extent that the state property tax is reduced or repealed, the rate of the income tax or sales tax will have to be higher. In sum, because of the sheer size of the current cost of adequacy, it must be funded to some extent by either an income tax, a sales tax, or a state property tax. If the current state property tax is reduced or repealed and/or the cost of an adequate education is increased materially, an income tax or a sales tax will be required to fund adequacy. Now we are ready to consider how much the proposed redefinitions of adequacy would cost.
By "school approval rules" the bill presumably means to incorporate certain rules of the New Hampshire Department of Education for the approval of public schools and public academies. These rules, which we will refer to as Ed 306, are titled "minimum standards for public school approval." However, the title is misleading because while the standards in Ed 306 may be the minimum necessary for a school to be approved in New Hampshire, schools meeting these standards provide far more than a minimum education. Let’s survey Ed 306 to see the kind of costs the State would have to fund if the Asselin/Dokmo bill became law. Ed 306 requires that schools must have a principal, library media specialist, and teachers. There must be one teacher for every 25 students in kindergarten through the second grade. For grades three through twelve, there must be one teacher for every 30 students. Elementary schools must have a reading specialist. Schools with 500 or more students must have an assistant principal. Elementary schools must have one full-time guidance counselor per 500 students. Other schools must have one full-time guidance counselor per 300 students. Under the Asselin/Dokmo bill, the State would be responsible for funding all of the salaries and benefits being paid to these teachers, guidance counselors, etcetera. Ed 306 requires elementary schools to offer arts education, computer education, English language arts and reading, health education, mathematics, physical education, science, and social studies. Middle schools are required to offer arts education, music, computer education, family and consumer science, English language arts and reading, health education, industrial arts/technology, mathematics, physical education, science, and social studies. Junior high schools must offer arts education, music, computer education, family and consumer science, English language arts and reading, health education, industrial arts/technology, mathematics, physical education, science and social studies. High schools must offer arts education, business education, computer education, family and consumer science, foreign language (at least two different languages if more than 300 students), health education, industrial arts/technology, English, mathematics, physical education, science (including physical science, biology, chemistry, physics, and earth science), social studies (including sociology, psychology, anthropology, political science or philosophy; national and state history; business and economics; and geography, economics, world history, or global studies). High schools must also offer a vocational program that provides experiences leading to licensure and/or certification for entry level careers and further education and training. Under the Asselin/Dokmo bill, the State would be responsible for funding all of the expenses involved in offering this curricula. Ed 306 also requires middle, junior and high schools to offer a "co-curricular program" that provides opportunities for students to participate in activities that supplement academics, such as sports, clubs, performing groups, and community service. Under the Asselin/Dokmo bill, the State would be responsible for funding all of the expenses involved in offering this co-curricula. Ed 306 also requires that custodial and maintenance services providing daily cleanings and regular maintenance, and secretarial services to maintain all school records in accordance with local policy, and state and federal laws, rules, and regulations. Schools are required to make a meal available during school hours. Schools must have trained personnel to do health inspections, treat minor injuries and make referrals to health agencies. Ed 306 also requires schools to provide for guidance services that include the delivery of career, occupational and educational information, student appraisal and placement, and identification of students in need of special services, including suicide prevention and psychiatric referrals. High school guidance is required to include college counseling and career counseling. Ed 306 also requires schools to provide a developmentally appropriate collection of instructional technology resources supportive to the curriculum and student needs, the necessary equipment and technology, designated spaces for accessing these resources; and instruction in the retrieval and utilization of these resources. Under the Asselin/Dokmo bill the State would be responsible for the funding of these janitors, secretaries, meals, health care, coding of students, suicide prevention, psychiatric care, college and career counseling, and technology. To this point, we have covered just the first part of the four parts of the
Asselin/Dokmo definition of an adequate education. In addition to these costs, the State
will also have to fund assessment and accountability testing, the cost of meeting fire and
safety codes and the cost of special education. Additionally, the State must fund any
costs created by incorporation of the State frameworks into curricula and meeting. Now that we have an understanding of the scope of the Asselin/Dokmo cost of an adequate education, we can attempt to estimate its cost. According to the website of the Claremont Coalition, "[a]bout 70 percent of educational operating expenditures are due to salaries and benefits ... . The majority of the remaining expenses go towards meeting state educational mandates." Under the Asselin/Dokmo definition the State would have to fund all salaries and benefits. The State would also have to fund the cost of meeting state educational mandates. Thus, the Asselin/Dokmo definition would require the State to fund virtually all operating expenses. According to the Claremont Coalition’s website "educational expenditures in New Hampshire were $1.9 billion in 2002." As that number has been rising an average of nine percent per year, the number for the 2004-2005 school year would be approximately $2.3 billion. The New Hampshire Center of Public Policy Studies estimates $2.45 billion. Even using the lower number, the State still would have to fund an additional $1.5 billion under the Asselin/Dokmo definition of adequacy. Based on a study done by the New Hampshire Center of Public Policy Studies in 2000, raising this amount of money would require a 16.7 percent sales tax or a 5.9 percent income tax, in addition to the state property tax ($371 million) and ancillary taxes ($434 million) that are currently funding the cost of an adequate education. Using 2002's equalized property tax base, the state property tax rate would have to rise to over $16.70 per thousand to fund all of the additional $1.5 billion cost of adequacy. If the state property tax is repealed, funding the cost of adequacy, under the Asselin/Dokmo definition, would require a 20.8 percent sales tax or a 7.4 percent income tax. Our numbers probably overstate to some degree the percentages required to fund $2.3 billion because we are assuming no growth in population or income since 2000, but they should give us a rough idea of the magnitude of new taxes needed to fund the cost of an adequate education under the Asselin/Dokmo definition.
Now let’s take a look at what the Lynch plan would cost. Recall that the Lynch definition of adequacy would be average per pupil cost, which in 2003-04 was $7,809.49. (It should be noted that this figure does not include transportation or capital expenditure costs.) Multiplying the average per pupil cost, $7,809.49, by the average number of students that actually attended school in the 2001-2002 school year (the most recent year we could find), 199,347.4, produces a cost of an adequate education of $1.6 billion. Because the Lynch plan repeals the state property tax, over $1.1 billion would have to be raised from a sales tax or an income tax or some combination of these taxes. Relying on the study by the New Hampshire Center of Public Policy Studies, a 12.5 percent sales tax or a 4.4 percent income tax would be required. Since the cost of an adequate education advocated by the New Hampshire Citizens’ Voice Project is approximately the same as the Lynch plan, the same tax consequences would result. In the first section, we noted that ignoring a court ruling that the funding mechanism of these plans violated the Claremont decisions is not a tenable option. But what about responding to such a decision by redefining the cost of adequacy back to a lower amount, for example from $1.6 billion back to $805 million, which would allow us to reinstate the state property tax and thereby avoid an income or sales approach. The problem with such an approach is that the supreme court likely would hold that such legislation does not represent the true cost of adequacy, but is simply an attempt by the State to avoid its funding obligations. The court would deem the $1.6 billion the true cost of adequacy, which would lead it to rule that the new replacement funding system used the local property tax to fund one-half of the cost of adequacy in violation of Claremont II. That would put us in the position of having to raise an additional $800 million of taxes, which as we hope is clear by now can only come from an income tax or a sales tax or a state property tax or some combination of these taxes. Even if the supreme court didn’t strike down legislation reducing the cost of adequacy back to $805 million, it is unlikely that such legislation would pass the current House. The number of "Main Street Republicans" and Democrats are sufficient to block any such legislation, and it is reasonable to assume that they would oppose any attempt to reduce the cost of adequacy. * * * In sum, to claim that we can fund a substantially increased cost of adequacy and repeal the state property tax, without passing an income tax or a sales tax, is to claim that we can have our cake and eat it too. Voting for such legislation, before a constitutional amendment is passed that allows the local property tax to be used to fund the cost of an adequate education, is equivalent to voting for an income tax or a sales tax. |
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