Anatomy of a billion-dollar deficit
Last Wednesday, the School District of Philadelphia’s finance team hopped on a conference call to review a spreadsheet full of large numbers.
It should have been boring. But it wasn’t.
Over the course of that hour, the following people and topics would be invoked:
Governor Tom Wolf, tax delinquency, the U.S. Department of Education, the price elasticity of hard alcohol, the fate of Philadelphia’s restaurant industry, the global stock market, and school Superintendent William Hite.
And that’s only a partial list.
One day later, district CFO Uri Monson revealed a sobering new budget. It projected Pennsylvania’s largest school district to have a $1 billion deficit by fiscal year 2025.
So how did the school district come up with those figures?
The short answer: a mix of instincts, math, and bedrock principles.
The longer, more interesting answer can be found by following that conference call — which district officials allowed WHYY to monitor.
Accounting isn’t the sexiest government job — but right now it’s one of the most important.
Across Pennsylvania, a small army of people are trying to gauge the budgetary fallout of the coronavirus epidemic.
If you want to see the full scope of the epidemic on government budgets, the School District of Philadelphia is a good place to look. The district relies on a huge range of unrelated taxes — taxes that connect to disparate corners of the economy.
District officials can’t control the rate or collection of these taxes. In economic downturns, they can only watch the storm clouds gather, and predict how bad the damage will be when the tempest arrives.
In this instance, the district’s financial staff started its conversation about five-year revenue projections by examining local real estate taxes. It was an easy conversation.
The city provided a projection that showed real estate values holding steady, but a four-percentage point drop in the proportion of people expected to pay their taxes. It would cost the district about $44 million.
One staffer thought the delinquency estimate was too pessimistic. Monson agreed.
“I don’t disagree with you,” he said. “But our policy on real estate has always been that we take their projections.”
One of the budget office’s guiding principles was to avoid inference wherever possible. If the city says it will collect ‘X’ million — that’s how much money to put in the spreadsheet. If the mayor or governor proposes spending a certain amount on education in the upcoming budget, use that figure until the legislature passes its own bill.
“Generally speaking, we will not do a change unless there is some sort of public document,” said Monson afterward.
It’s a useful rule because it removes the district from guessing or being accused of playing politics.
But in a global pandemic, it’s not always easy to apply.
Take the case of the school income tax, a levy mostly related to stock market profits. The district typically gets around $50 million through this tax.
There was no reason to expect any drop in this line. The tax is based on gains made in last year’s stock market — and the city was not excusing folks from this tax. It’s typically paid by wealthier Philadelphians — the type who could probably still afford to pay during an economic crisis.
Monson wondered: Would people simply neglect to pay the levy because they were distracted or money-conscious?
“I warned the Board [of Education] yesterday that I think this is the biggest question mark,” Monson said. “Just because it’s people’s behavior.”
Much of the conversation revolved around predicting human response to this unprecedented crisis.
Nowhere was that more apparent than in their debate about the liquor-by-the-drink tax, a restaurant and bar levy which normally brings in about $80 million.
The group first had to establish when it thought restaurants in Philadelphia would start to reopen. In a prior meeting they’d landed on June 1, but had now pushed that back to July 1.
They also had to determine whether people would want to drink at restaurants once they opened again. Monson mused about a “two-week spike” in sales upon first opening, followed by a dip as folks looked into their thinning wallets.
Finally, the team had to think about the “elasticity” of drink prices in Philadelphia. Would restaurateurs try to entice folks out with discounts? Would they jack prices to make up for months of lost revenue?
After some debate, they settled on a number for the coming year: $71.6 million. Bars would reopen on July 1, they guessed, and over the next year they would lose about a month’s worth of revenue compared to normal.
“I’m still wondering if that’s too high or not,” Monson said.
Where there was no clear guidance from the tax-collecting agency, Monson and his staff relied on gut instinct and publicly available commentary. They read newspaper articles and economic projections from analysts at Moody’s and Goldman Sachs.
Monson described himself as a voracious reader, and said he’d been paying close attention to coverage of consumer behavior in places like South Korea — where society has started to reopen.
Somehow all of that led to $71.6 million and a July 1 restart.
“That was purely just gut,” Monson said later. “And that’s what some of this is. When there’s nothing factual — when even the experts don’t have an answer for you — my role has to be based on reasonable assumptions and what’s reasonable at the time.”
Predicting the politicians
Of all the humans whose behavior Monson had to predict, none mattered more than those in Harrisburg who pass and sign state budgets.
What would Governor Tom Wolf and the members of the Pennsylvania Legislature do?
“Let’s get to the fun stuff,” Monson said to his staff. “State revenue.”
This is where Monson broke his own rule.
Typically, the school district takes the governor’s education funding proposal and plugs that figure into its budget.
In recent years, this can create an unusually rosy picture since Wolf, a Democrat, tends to propose more education spending than his Republican colleagues will often approve.
But again, it’s a rule of engagement that removes district judgment from the equation.
This time, though, Monson and his team went off-script.
Although Wolf has not yet changed his proposed budget, the state’s Independent Fiscal Office released a report in April that showed state revenues dropping by a staggering 10 percent due to the COVID-19 crisis.
Since the IFO report is an official government projection out of Harrisburg, Monson felt it was fair to extrapolate from it. He and his team mapped out a 10 percent cut to education spending.
“I had multiple attempts to communicate with the governor’s office to get some kind of direction on that,” Monson said later. “I even warned them that we’re gonna come out and say this unless you give me a reason not to. I got nothing back. So I have to do something.”
The district’s budget office made a crucial, second change to its predictions on state revenue.
It said it was no longer reasonable to assume that the legislature would pass a proposed change to the charter school funding formula — one that would have significantly boosted the district’s financial outlook. This time there was no government document to reference. Monson said it was based on information from legislators and a dose of the obvious. With all focus on the pandemic, there would be no time for a debate on charter schools, Monson said.
Combined, these two changes were a massive hit to the district’s financial outlook.
Betsy DeVos to the rescue?
As the call wound down, Monson’s team discussed a final tweak to the state’s numbers.
Originally, they assumed a ten percent cut to state aid. But they found a clause in the federal stimulus package that gave them hope.
In order for states to receive money from the recently passed stimulus bill, they had to agree to certain conditions. One was that states would give every educational institution — K-12 or higher-ed — at least as much money in the upcoming budget as they did in the average of the prior three years.
There was a waiver process for this clause. States could apply to the U.S. Department of Education for the freedom to make deeper cuts. But so far, as far as Monson knew, Pennsylvania hadn’t applied for that waiver.
The district budget team set the three-year average as the new cut line. Instead of losing $120 million from the state’s basic education subsidy, the loss was now around $80 million.
Spread over years, this was still a major hit — just not quite as bad as before.
“It’s more complex to explain, but I think it’s more justifiable as an assumption,” Monson told the group.
State money was always the hardest pot of money to predict. No economic model or Moody’s analyst could forecast the whims of Pennsylvania’s lawmakers.
More shoes to drop
For all the assumptions made in this one-hour phone call, there are many more the school district hasn’t made yet.
District officials expect the state to ask for districts to contribute more money toward the state’s pension system for teachers. That hasn’t been accounted for yet.
The district’s two largest unions have labor contracts about to expire. That hasn’t been accounted for yet.
The virus could come roaring back in the fall. That hasn’t been accounted for yet.
And after this conversation, Philadelphia Mayor Jim Kenney proposed a property tax increase. That hasn’t been accounted for yet.
One could walk away from the phone call thinking the district was far too optimistic. Will restaurants really be open by July 1?
Or one could conclude that the district was doing a doomsday exercise so it could project a big deficit and scare politicians away from making big cuts. Was the state really going to gouge its education budget?
The only certainty is that these numbers will change — more than once.
“We don’t know the end of this,” Monson said. “When you have that much uncertainty, that’s where it gets really, really hard.”
Through some combination of political guesswork and behavioral economics, the district had set its new financial course.
Ultimately, these numbers will become people: Jobs gained or lost. Programs saved or cut.
But even when they’re just numbers in a spreadsheet, there’s humanity woven into them. Monson and his colleagues will watch how you respond to this crisis — how your elected officials act.
Then they’ll hop back on the phone.
“Everyone stay safe,” Monson said at the end of the call. “I’m sure we’ll be circling back soon.”