It's a Gas

I've written a great deal about the 90% of our spending which has to with compensation and benefits. This article is going to be about something in the other 10% - our cost for natural gas.

Natural gas is one of those commodities for which "futures contracts" can be written to lock in prices for points in time out in the future. Commodities futures trading and its first cousin, options trading, are a favorite investment vehicle for speculators, and are often viewed negatively because of it, but they have legitimate purposes beyond speculation.

For example, farmers like to know, before they plant in the Spring, what they'll be able to sell their crop for in the Fall. They can do that by signing a contract to sell a certain amount of corn, for example, at some point in the future for a certain price. This week, the price of corn to be delivered in December 2012 is about $550 for 5,000 bushels. A farmer who signs such a contract would be obligated to deliver 5,000 bushels of corn this December, and accept $550 in payment.

So what's the harm in that?

What if a big October windstorm flattens his corn before he gets it harvested?  The contract still obligates him to deliver 5,000 bushels of corn in December, and be paid $550 for it.  In order to fulfill his contract obligations, he'll have to buy 5,000 bushels of corn from someone else.

Remember that this $550 price was set in March. Now it's December and a lot of things might have changed. It could be that a lot of the corn crop nationwide was lost, and the price of corn has therefore skyrocketed due to the reduced supply. Maybe he'll have to pay $800 for 5,000 bushels of corn, just so he can turn around and sell it for $550. And he's already out all the money he had invested in the crop that was wiped out by the storm.

A farmer can further "hedge his bet" by buying futures options, but that's another topic for another time.

By the way, anyone who uses the phrase "dumb farmer" has no grasp of the complexity of the fiscal decisions these folks have to make in order to have any hope of surviving over the long haul. They have to be prepared to make a nice profit when the opportunity presents itself, and to survive times when it seems like Mother Nature and the commodities market are conspiring to put them out of business. Both situations require knowing when to buy supplies and heavy equipment and how to use the futures market and crop insurance to mitigate risk. They don't just throw seeds in the ground in the Spring and rake in the money in the Fall.

Our school district is a commodities player as well. We have to buy significant quantities of electricity, natural gas, and diesel fuel to operate our buildings and buses. As every American is painfully aware, the prices for these commodities have never been more volatile.

So it is reasonable for the school district to make purchases of these commodities via futures contracts that give us some predictability as to our future costs. There is risk if we do, and there is is risk if we don't. If we don't buy futures contracts, the prices could shoot up rapidly, creating havoc in our budget.

This was the concern back in early 2008, when natural gas prices were going through the roof. In the first six months of 2008, natural gas prices increased from around $8 per MMBtu* at the beginning of the year to over $13 by early summer. That's over 60% in just six months. At that rate it could be $20 by the end of the year.

Panic.

Our school district is a member of a buying consortium called the Metropolitan Education Council (MEC), through which nearly 200 Ohio school districts have joined to buy everything from school buses to IT services. When this run up of natural gas prices was happening, the MEC joined a larger buying group to purchase millions of dollars of natural gas futures. While I was not part of that decision process, I imagine that the intention was to  create some predictability for our budget, and also to lock in the current price should the price continue to go up at that astronomical rate.

This consortium started buying futures contracts in June of 2008. They were at a price of $11.45, with monthly delivery dates stretching through May 2014. In July, they bought a bunch more at a price of $10.19.

Those had to look like pretty smart decisions after seeing the price hit $13 in early July. If prices had indeed doubled by the end of 2008, as it looked like they might, we would have saved a ton of money.

But they didn't. This is the pricing chart for 2008:

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As you can see, by year end the prices settled back to about where they had been at the beginning of the year. Now we're holding contracts to buy natural gas for 50% over the market price. So what did they do?

In September 2012, after the prices had dropped back to the pre-spike levels, they bought another batch of natural gas futures for around $9. By the way, you can identify pricing spikes only in retrospect. While the prices are rapidly increasing, it's impossible to tell whether it is a spike, or a permanent lift in prices. In 2008, the folks making this natural gas decision thought it was the latter. A decision to buy more contracts at $9 is reasonable if you're relatively sure the prices are still generally headed up.

But they weren't. This is the pricing chart for 2012. Instead of going up, natural gas prices have continued to plummet. Right now, the price for natural gas to be delivered in December 2012 is lower than for gas to be delivered this month. Now it doesn't look so smart to be paying $9-11 for natural gas when we could just buy it from anyone today for a third the price.

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So we want to get out of our old deal. What does that entail?

Well, we need to get someone to buy all these high-priced contracts. But frankly, there's no reason for anyone to pay any money at all for a contract set to a price that is higher than the market price. It would be like me standing next to a pump at a gas station, trying to sell a can full of gas for $10/gal when the price on the pump is $4.00.

If I really want to get rid of that can of gas, I'll have to give to you the gas AND $6.00/gal to make up the difference in price.

That's what your School Board voted to do at the March 12, 2012, when we passed item F1 on the agenda. This authorizes the Administration to pay the cash necessary to get us out of the old contracts. Given current futures prices, this is estimated to be about $300,000.

In other words, since 2008, we have been paying a substantial premium over market prices for natural gas, and are now having to pay another $300,000 to get out of that deal.

So were the Administrators who recommended this deal, and the School Board members who approved this in 2008 all bozos?  It's easy to make that assessment with 20/20 hindsight isn't it?

But what did the situation feel like then? I can tell you - it looked pretty scary on all economic fronts. I was so scared about the state of our financial system that I pulled all of my retirement savings that I had in money market accounts - instruments that had always been considered extremely safe ways to hold short-term cash - and shifted them to FDIC-protected Certificates-of-Deposit at commercial banks.

It was a reasonable bet, and I think that - had I been sitting on the School Board then - I might well have voted in favor of that resolution as well.

Decisions can't be remade in the past. All we can do is make decisions for the future. That's what this resolution at the last meeting was all about - to get out of what has become a bad deal, and make the best decision we can for the future. By being able to return our natural gas prices to current market levels, the payback on this buyout cost will be less than two years, and I think that's reasonable.

Should the decision have been made sooner?  Probably, but that's hindsight too. Our natural gas costs have apparently been way above market for at least three years. But remember, that as soon as the spot prices dropped, the cost to get out of the futures contracts we already owned went up simultaneously. Wouldn't it have been stupid to buy out of these contracts in 2009, then have prices go back up in 2010?

Like I said, there's a risk associated with such decisions. There's also a consequence to not making decisions. It could have gone either way.

This new resolution authorizes the Administration to enter into a new buying agreement via the MEC, through which a new set of natural gas futures contracts will be purchased. It seems like a good move to buy futures when prices seem pretty low. But who knows what the opening of the vast gas fields in eastern Ohio will mean to us. Can/will natural gas prices go any lower?

When these futures will be purchased, for what delivery dates, and at what prices will be determined by a "Hedging Committee" appointed by the members of the consortium. I hope our own Treasurer Brian Wilson gets to sit on this committee, but if not him, then our Operations Team is gunning to have Jeff McCuen, the Treasurer of Worthington City Schools be our voice.

* Natural gas is sold in a unit of measure called the "MMBtu," or millions of British Thermal Units, which is a unit of energy, not volume. This is because natural gas can be transported and consumed at various pressures, allowing it to be in the form anything from a dense frozen liquid (very high BTUs/gal) to the gas that comes out of your kitchen stove. By pricing the commodity in units of energy, it doesn't matter what physical form it is in when the transaction takes place.

STRS Time Bomb: Facing Reality

This is the fourth article* I've written about the precarious condition of the State Teacher's Retirement System (STRS). It is prompted by a recent article by Kathie Bracy, an activist for the concerns of retired Ohio public school teachers (Ms. Bracy is a retired 30-year veteran of Columbus City Schools).

She writes about a recent special meeting of the STRS Retirement Board, during which they received a report from their actuarial consultant, Price Waterhouse Coopers. It wasn't good news.

Actuaries are highly specialized financial professionals who use a mixture of finance, accounting, statistics and risk analysis to determine if organizations can honor their future financial obligations. Their work is especially associated with insurance, where one must figure out if the money taken in over time (premiums), plus investment returns on the collected funds, will generate enough cash to pay future claims. One could think of a pension system as being just another kind of insurance.

But no one knows exactly what the future will bring, so actuaries have to make guesses - well reasoned as they may be, but guesses nonetheless - on pretty much all of these variables.

So what did PWC have to say to the STRS Board?

Inflation:  They said that they believe current and future inflation rates will be less than previously assumed. This is mixed news. The good side is that the lower the actual inflation rate, the less the investment rate of return will need to be. But low inflation also means that interest rates on current investments will be lower.

Today is kind of an insane time, when the 'safe' sovereign debt instruments like short term US Treasury Bills and German government bonds have near zero - and in some case negative - rates of return.

Mortality: People are just living longer. I've heard it said that Social Security was designed around the assumption that people would retire at 62 and die before they reached 70, which may well have been the average life expectancy 80 years ago. Today, most of us expect to live well into our 80s. In the case of teachers, who can potentially retire in their late 50s with 30 years of service, the time span of retirement can equal the length of their working career.

This may be good news is most contexts, but in the case of a retirement system - it's a big problem.

Investment Returns: STRS has been assuming that it could make 8% return on its investments.

One of the core tenants of investing is that Risk and Return are inversely related. Students of finance have long been taught that the "riskless" return rate in our country should be the rate one can receive investing in US Treasury Bills, with the assumption that the US government would never default on its debt. That's the reason it was such a big deal when Standard & Poors, one of the world's most influential debt rating agencies, downgraded its rating of US Treasury debt a few months ago. They were in essence saying that there is some risk of default by the US government. Fortunately, most investors have ignored that, and are continuing to buy record quantities of US Treasury Bills.

STRS has been assuming for a long time that it could earn 8% on its investments. That's perhaps no big deal when US Treasury bills are paying 5% interest, as they we so many years ago. One doesn't have to take a lot of risk to earn 3% more than that.

But with 'riskless' interest rates near zero, an 8% annual return requires finding investments that pay 8% more - a relatively large 'spread.'  It's like saying you can make 13% every year when Treasury rates are 5%. Not easy, and not without risk. (Here's what the New York Times wrote about this).

STRS was reminded of that recently, when its portfolio heavy in stocks and real estate lost nearly half its value - from $80 billion in 2007, to $47 billion in 2009. They're lucky the stock market has recovered a lot of what they lost, and the portfolio value now sits at $63 billion.

But they're still down nearly $20 billion from their peak portfolio value. Not only that, but since their assumption was that they would make 8% on their portfolio, they're down $45 billion from the $109 billion the portfolio should be worth had they made 8% every year since 2007 when the portfolio was worth $80 billion. That's $45 billion they should have had to pay for future benefits, but now don't.

PWC has advised STRS to lower its expectations of investment earning from 8% to 7.75%. That may not sound like much, but one would have to deposit 9% more today to generate the same dollar amount 35 years from now, assuming just 0.25% less in annual return. Think about raising the contribution rate from the current 24% of salary (10% by the teacher and 14% by the taxpayers) to 33% 26%. We're talking millions of dollars more per year.

Salary Growth Assumptions:  The teachers retiring now were paid peanuts 30 years ago when they started their careers. But most are now being paid in the neighborhood of $90,000/year in their final years. Their annual pension is determined by their final pay, not their lifetime earnings, and for a teacher retiring right now under current STRS rules, with 35 years of service, the annual pension will be about $80,000/yr - for life - plus  annual cost of living increases.

What about a teacher being hired right now?  Under the current collective bargaining agreement with the teachers' union, the starting salary for teacher with no experience and only a Bachelor's degree is $38,362. If we assume the salary grid structure stays as is for 35 years (ie 4.15% steps and 6% raises for additional education), base pay increases are 1% every year (they were 3% or more from 2004-2010), and the teacher reaches the Masters+ level by the 10th year, then the final pay of such a teacher at 35 years of service would be about $136,000, and the pension would be about $103,000 per year.

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Don't overreact to that.

We don't know what's going to happen to compensation outside the realm of public education. Maybe private sector salaries will increase at an even greater pace than this. Maybe it will be less. Over a period of three decades, we're apt to have both boom and bust times. We don't know. But for the purpose of analyzing the state of STRS right now, the actuaries have said salaries have increased in recent times faster than they assumed they would, which means more benefits will have to be paid out than had been planned for. That's not good.

The sum of all this is expressed in a single statistic STRS calls the "funding period."  It is the amount of benefits that will be paid out in the future (I think they mean the 'present value' of the future benefit costs) divided by the current annual contribution rate (ie what working teachers and the school boards are paying into the retirement system each year - currently a total of 24% of salary). By law, this is required to be 30 years or less.

Think of it as being a calculation of how long it would take to pay off your credit card balance given monthly payments of $X, understanding that each month the credit card company will charge to the account another 18% or so of the unpaid balance for interest.

We all know that if you make only the minimum required payment on your credit card balance, it will never be paid off.

This is the case with STRS right now as well. The "funding period" is infinity - there simply isn't enough money being taken in to pay what will be owed to current and future retirees, even with an aggressive assumption of investment earnings rates.

So What?


As stated at the beginning of this article, the main variables relative to a pension plan is the amount of money being contributed, the size of the current fund, the earnings rate on investments, and the amount being withdrawn to pay benefits. For a pension fund to pay out all the benefits promised, those factors have to be in balance.

Right now they are not. Not even close. Too much has been paid out and the investments haven't generated as much earnings as expected. In fact, they have lost tens of billions of dollars in recent years.

Changes have to be made - soon - or the fund with go bust, leaving both retired teachers and teachers yet to retire with no benefits.

The question is who is going to bear the cost of fixing things. There are only so many options:

• Make the currently employed teachers pay more: They already pay 10% of their salary into the retirement system.
• Reduce the benefits to retired teachers: Take back some of the benefits the teachers already retired now receive. That might not seem fair, but one could argue that teachers now retired are receiving far more than the system was designed to pay them, largely because of the rapid ramp-up of teacher salaries in the past decade or so. Remember that pension benefits aren't determined by lifetime earnings - only what the teacher was paid in the last 3 years of service.
• Reduce benefits to future retirees: Reduce the payout percentage, or calculate the final pay by averaging more years. An increase from 3 years to 5 years is already being considered. Require teachers to work more years before being eligible for retirement.
• Make investments that might generate higher return, but carry more risk: At what point does investing become speculating, or just plain gambling with the teachers' pension money? I think that chasing even 7.75% returns means taking an unacceptable amount of risk.
• Make the taxpayers pay more: As taxpayers, you and I already pay 14% of all the teachers' salaries into the retirement system. Note that this means that the dollar amount we contribute each year goes up with the all the increases the teachers receive: base pay, steps and degrees.
  
  The taxpayer share could be made to increase via several ways. The General Assembly could simply mandate that the school district pay a higher percentage of salary. That will eat up budget dollars, and contribute to larger and more frequent levies, or cuts in programming and services.
  
  Or the General Assembly could divert some of the state budget to augmenting the contribution stream. But if they do this for STRS, they'll have to do it for OPERS (Ohio Public Employees Retirement System), SERS (State Employees Retirement System), and the Police and Fire Retirement Fund. That will require an increase in our state taxes, or further cuts in state services and funding to local goverments (like school districts, which would in turn cause us to cut services and programming or raise local taxes).

What do you think needs to happen? What combination of the above do you think is fair?

*Prior Articles:
Dec 2008: Time Bomb
Sept 2009: Still Ticking
Nov 2009: Beginning to Understand

Putting It Together

In the last two articles, the sources of school funding were reviewed, as well as how all that money gets spent. In this article, we'll put those two pieces together, and explain what that might mean for our future.

You've heard me say before that I believe that one of the most important documents published by our School District is the Five Year Forecast. And once again I'll say that I believe this not because money is the center of everything, but rather because money is the fuel with which we run our school district, and we need to manage it attentively. More than one auto racing team leading a big race has lost because they misjudged their fuel consumption, and ran out of gas on the final laps.

We can't let that happen to us. A lot of time, effort, and money has been invested to get our school district to the position it is in, but it can be erased in the blink of an eye if good and timely decisions aren't made - soon.

Like a racing team, it's important to know when we can step on the gas - accelerating our rate of advancement, but burning gas at a higher rate - and when we have to let up a bit and conserve fuel. Racing teams prepare a strategy for fuel management before the race starts, and adapt as conditions change.

The Five Year Forecast is our fuel management strategy, and is an important component of the overall strategy of the District, as documented in the 2020 Initiative.

The current version of the Five Year Forecast shows our annual spending growing from $160.6 million in FY2011 to $181 million in FY2016. Meanwhile, annual revenue is projected to grow from $157 million to $169 million in the same time frame. The accumulated difference between revenue and spending reaches $9 million by the end of FY2016, in spite of the new revenue from the 5.9 mill levy which narrowly passed in November. In graphic form, it looks like this:

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The School Board has committed that - unless the State of Ohio materially whacks our funding even more - another levy request will not be made before 2014. Given the spending budget built into the Five Year Forecast, there is little question that a levy will be proposed in 2014.

But how about after that?

If you examine the red line in the chart above - Projected Expenses - you'll note that in the period from 2003 to 2010, expenses grew at a rate of about $7 million per year. This is a time when the contract with the teachers' union included base pay increases of 3% and more per year, in addition to step increases (see Teacher Salary History to learn more).

Then the spending growth is shown to nearly flatten out through 2013. This is for two reasons: 1) the teachers' union agreed to freeze base pay at 2010 levels through 2013, to delay some step increases, and eliminate one altogether; and, b) the projected effect of an early retirement incentive program, which has been accepted by about half the teachers eligible.

But by 2015, the spending growth is projected to resume at an annual rate of about 4%, or about $7 million per year.

Why?  Compensation and Benefits - the same reason as always. The Five Year Forecast assumes that the current step schedule is resumed in 2014, along with annual base pay increases of 1%. What that means is that about half of our teachers would be getting 5% annual increases, while those on the higher end of the pay scale (at an annual salary of $79,000 or more) would receive 1% pay increases. This represents about $4 million per year in spending growth on compensation, or 3.8%.

Benefits are projected to increase at an even higher rate - 6.3% per year, driven mostly by health insurance costs, in spite of the increase of the employee share of the cost from 10% to 15% in FY2012. This is another $2.6 million/year of the spending growth.

The remainder of the annual growth - about $350,000/yr - is all the other things the districts spends money on, such as utilities, diesel fuel, and consumable supplies.

So what kind of levy schedule is required to sustain this kind of growth rate? I've put together one scenario which assumes that the spending growth rate of 4% per year goes on for twenty years while the student population remains essentially the same. I'll also assume that in spite of a static student population, our funding from the State of Ohio will grow by $1 million per year. Lastly, new levies would occur at a frequency of every three years, but would grow in size (See Budget Knobs). Here's what that looks like:

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You'll note that the Revenue line (blue) closely follows the Spending line (red), which is desirable as it means the amount of cash reserve (green) stays fairly constant. But since the Spending is growing at a constant percentage (4%), the year to year growth in dollars increases, and that means that each successive levy needs to get larger.

For this scenario, I made the 2014 levy be 5 mills, then increased the millage rate by 1.8 mills with each successive levy. That would mean that by the time we get to 2032, the levy on the ballot that year would need to be nearly 16 mills. Fat chance of that passing.

So what has to change?

Well, it would be nice if the State of Ohio returned more of our tax dollars back to us. According to CUPP Report produced by the Ohio Department of Education, we get back only 41% of what we pay annually in income taxes. To be sure, we have a responsibility to fund our share of other State programs like Medicaid and the corrections system, but are we funding more than our share of the cost of other school districts? There are some folks, such as the Ohio Association for Equity and Adequacy of School Funding who argue that the poorer districts in this state still aren't getting enough. I think my assumption that our State funding will grow by $1 million/year is realistic - maybe even a little optimistic.

It would be even better if the municipalities which overlap our school districts, especially Hilliard, Dublin and Columbus, would bring in lots of new commercial development, generating an growing revenue stream for the schools (and the cities) without adding to the student population. But for now, the cities seem intent to encourage the construction of family-friendly apartment complexes, which add to the student population but generate much less school tax revenue than single family homes. Granting TIFs to apartment developers, as was the case with the Schottenstein apartments at Roberts and Alton-Darby Rds, just makes matters worse.

As I've said many times, our costs are driven primarily by how many people we employ, and how much we pay them. Our economic solution has include making strategic changes in these elements.

Asking our teachers, staff and administrators to forego pay increases for another 20 years is mathematical solution to the situation, but it's not reasonable. We certainly need to work with the unions to seek a more sustainable compensation model. I think that could mean introducing mechanisms that cause total personnel costs to better track the general economic conditions of the community. By that I mean that when times are good, the team should enjoy that along with the rest of us, and when times are tough - like now - they should take the hit along with the rest of us then as well.

On that point, one could debate the role the Senate Bill 5 situation had in causing the 2011-2013 union contracts to have base pay freezes, step delays and higher health insurance contributions, but the fact of the matter is that the teachers, staff and administrators have at least temporarily slowed the growth in personnel costs, and I for one appreciate that.

We also need to think about the breadth and depth of our programming and services. One of the first steps might be to carve off extracurricular programming, and make them full pay-to-participate activities. This would be a step fraught with emotion - especially for the parents of teenagers, the primary consumers of these programs. But there is a growing fraction of the voters who are saying that they're tired of their property taxes going up every 3 years, and they want to see this kind of stuff cut before they'll vote on any more levies.

Maybe it's time to think about adding an income tax component to our funding structure. Ohio law allows school districts to use two forms of income tax. The first kind is on all income, and is paid by everyone who lives in the school district. It is not imposed on businesses however, so the funding burden is more concentrated versus property taxes. The cities could bring in lots of new commercial activity, and it would cause no revenue lift to the schools.

The second form of income tax permitted is called an 'earned income tax,' and that essentially means that only income from W-2s is taxed. This form of income tax was supposedly created to ease the burden on retired folks (like me!), but it also has a political angle:  retired folks typically represent a large voting bloc in a community, and while they are less likely to favor increases in property taxes, they are very easy to sell on the idea of a tax they won't have to pay.

Income taxes have a dark side: while revenues tend to grow while the economy is healthy, there can be a rather sudden decline in revenue when things go sour, as has been the case for the past 5 years. This is the reason that the Federal, State and municipal budgets are in such disarray - not so much an increase in spending as a sudden loss of revenue.

Property taxes are a very stable source of funding for schools, but that can draw us into complacency.

The only thing that is clear is that we've reached an inflection point in the economic health of our school district. We can't do things for the next 20 years in the same way as they have been for the past 20. The sooner we face up to that, and start building a new model, the less painful the transition will be.

There's a saying that goes "A good decision made late is the same thing as a bad decision."  I think that's very applicable right now.

The Spending Side of the Equation

In the previous article, I discussed how our schools are funded, and hopefully was able to dispel some of the misconceptions folks have.

This article address on the other side of the equation:  Spending. Where does the money go?

Treasurer Brian Wilson, in collaboration with Superintendent Dale McVey, periodically presents a Five Year Forecast to the School Board, as they are required to do by state law. You can find the current version here, on the District's website, where a number of other pieces of financial information are posted as well.

It takes about 2 minutes of examination to understand that nearly all - 88% - of our operating funds are used to pay the salaries and benefits of our team of teachers, staff and administrators.

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Many people have assumed that I point this out because I think it's inappropriate. I don't. A school system is a professional services organization, and as such, will always spend the bulk of its money on people.

I'll not rehash here the many articles I've written about teacher compensation (click on "teachers" in the topic list to the right if you are interested in reading them). For new readers, an article I wrote last year titled "Teacher Salary History" might be helpful in understanding how our teachers are compensated, and how that pay structure is defined.

Please understand: the only reason I keep bringing up compensation and benefits is because it's the only component of our budget which changes much over time, as the chart above shows. There is a myriad of stuff that falls into the category "Everything Else," and certainly, we need to demand that our team does a great job of keeping those costs as low as possible.

One way that happens is through efficient use of electricity, natural gas, and diesel fuel. You may have seen the announcement that our District received an incentive check of $112,000 from American Electric Power to reward us for a number of energy conservation projects which have been completed. As time goes on, I'm sure we'll find additional ways to save money on energy usage.

You might be surprised to learn that the cost of paper textbooks is significant for our District, as it is all school districts. That's the reason there is so much interest in the potential of electronic textbooks, delivered on devices such as Apple's iPad or the Amazon Kindle.

But we're not there yet. The publishers of scholastic textbooks still need to go through the same painful industry transition as has the music industry. Capital Records et al had to accept that they're in the 'music industry' not the 'record industry,' and that they would have to make their money by producing content people desire, and not via the manufacturing and distribution of plastic discs. The textbook guys need to do the same.

Until they do, there is no money to be saved with electronic books, as the prices the publishers set for electronic editions remain close enough to the printed editions so as to leave no room to purchase and maintain the reader devices. We'll get there, but there are still many barriers to being able to save money via the use of electronic books.

We spend a lot of money to run our school district - $160 million per year and growing. It's a little more than $11,000 per student per year. That's not some magic number. It's just what we have decided to spend.

Some say we have to spend that much to maintain our rating of "Excellent with Distinction."  I don't agree. The median spending for the 81 districts rated Excellent with Distinction in 2009 was $9,600, and it ranged from $7,200 (Bethel Tate/Clermont County) to $21,000 (Orange City/Cuyahoga County). Which one is the right number?

We could spend a lot less in our District and still be Excellent with Distinction. But we would not be able to offer the richness of programs and services that we do. A district can be Excellent with Distinction without offering Chinese as a foreign language, or Pre-Engineering. Having well kept buildings and grounds is not a factor in our Excellent with Distinction rating. Nor is having exceptional extracurricular programming. These and many many others are all over-and-above programs we have locally decided to offer, and are a significant driver for our cost of operations.

I'm not comfortable with the notion of an a la carte public school district. I believe that every opportunity we offer should be available to every student without regard to their economic status. I don't even like the fact that we charge academic fees, where even the elementary schoolers have to chip in for the cost of consumable supplies. It's just an unvoted additional tax, and a regressive one at that.

But as we offer more and more variety of programming, each program serves a smaller part of the total student population. And not all programming costs the same. Offering Chinese means finding one qualified teacher, but there may be only 10 students in the class. Offering Ceramics means a qualified teacher plus a kiln and other equipment. A cross country team needs a coach or two and a path to run on. Football requires magnitudes more than that, but also generates substantial income.

Maybe an a la carte system is the way we have to go. We can't keep asking every taxpayer to fund every program. Maybe we have come to the point where our public school system is just too expensive given the resources and demographics of our community, and we need to think about a different way of organizing and funding all these things that we do.

That's not going to be an easy conversation. But it needs to be had.

I welcome your comments.

School Funding (reprise)

The way public school funding works in Ohio isn't hard to understand. It really isn't. But folks find it easier to just believe whatever misinformation they hear from a neighbor or friend than doing the research themselves. And frankly, few school districts or elected representatives are trying to educate their constituents about school funding either, so misinformation continues to propagate, and gets reinforced in its repetition.

One of those is about the constitutionality of using property taxes to fund our public schools in Ohio. Most people believe the Ohio Supreme Court ruled that property taxes may not be used to fund schools. We saw that mistaken belief expressed yet again in a Letter to the Editor published by The Columbus Dispatch today.

The Ohio Supreme Court never said that property taxes were an unconstitutional way to fund our schools. What they said was that the funding system used at the time the lawsuit was filed (DeRolph v. State of Ohio), granted insufficient state funding to some districts, which caused those districts to have an "overreliance on property taxes."

The funding system the Supreme Court made this ruling about is gone. It was replaced first by the "Evidence Based Model" championed by Governor Strickland, and then the temporary funding plan implemented by Governor Kasich. So the Court's ruling in DeRolph is moot. The most we can say is that the constitutionality of the current system is untested in court.

Okay, so let's focus on the simple facts. Let's start by looking at the sources of our funding:

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Residential Property Taxes: This is our primary funding source, providing 47% of our total funding, or $5,200 per student per year. It changes due to two primary things: a) a new operating levy is passed by the voters; and, b) when new homes are built in the school district. Every dollar of property tax we pay stays in our school district.

Let's correct another common misconception: EVERY residential property owner in our school district pays EXACTLY THE SAME property tax rate. Our property taxes fund many agencies, and the agencies which appear on our individual tax bills depends on which municipality one lives in. Our school district includes all of the City of Hilliard, pieces of Dublin and Columbus, and all or some of several townships. Each may impose their own property taxes, making us have differing total tax rates. But we all pay the same school property tax rate, and it all comes to Hilliard City Schools.

Commercial Property Taxes: These are property taxes paid by the commercial property owners in our school district. They don't get to vote on the levies we put on the ballot (unless the commercial landowners are also residents of the district), but they pay the same property taxes as residential landowners nonetheless - unless a property tax abatement is granted by whichever municipality the business lies in. It's a bizarre thing: a city may waive up to 75% of the property taxes for a business without the approval of the school district. But it's not their revenue to give away in the first place!

Nonetheless, a city and school district acting in partnership will often decide that an abatement is a good thing. Such a decision was made at our last School Board meeting, when we agreed with the City of Columbus to grant a ten-year 75% abatement deal to Boehringer Ingelheim Roxanne Labs, who is competing internally for the opportunity to expand their operations. To not grant this abatement would mean losing the opportunity to collect any new revenue. It's a reasonable deal for an important community partner that we'd all like to see grow and be successful.

As is the case with Residential Property Taxes, every dime of the Commercial Property Taxes collected in our school district stays here. Today it is 15% of our funding, or about $1,700 per student per year. When our family came to the school district thirty years ago, the total Commercial Property Taxes was about equal the total Residential Property Taxes. This commercial percentage has gotten smaller not because there are fewer businesses now than then, but rather because there are thousands more houses, and of course thousands more kids to educate.

The problem here is that the incremental property tax revenue generated by the typical new single-family home is a fraction of the incremental cost to educate the school age kids who will live in that new house. That's why we need lots more commercial property development in our school district. Otherwise the school funding burden created by new homes has to be funded with new levies - meaning more taxes on the rest of us.

Federal Grants: As you can see, this is a relatively minor revenue source, consisting mostly of things like our Title 1 funding to help disadvantaged children. It amounts to about $500 per student per year.

We got a nice Federal stimulus gift of a few $million for a couple of years, and that's not reflected in this percentage, but it was one-time money and is long gone.

State Grants: This is our second largest source of funding, representing 33% of our revenue stream, or about $3,700 per student per year. The bulk of this is the so-called Foundation Aid, the primary state funding stream. Foundation Aid increases with the number of students, and decreases with the perceived affluence of a school district, as measured by aggregate property values, whether residential or commercial.

This is the component of our funding which causes all the angst among Governors, members of the General Assembly, and a myriad of lobbying groups such as:

• The Ohio School Boards Association - representing the interests of School Boards (we're a member)
• The Ohio Education Association - the statewide teachers' union
• The Ohio Association for Equity and Adequacy of School Funding - representing mostly lower income school districts. This was the group that file the DeRolph case.
• The Alliance for High Quality Education - representing mostly affluent suburban school districts. Hilliard City Schools is a member

In the past ten years, our Governors and the General Assembly have tried three different approaches to determining how much funding each of the 614 local school districts should receive from the State. None of them have satisfied everyone, and we still don't know what the Kasich administration is going to propose as a replacement to temporary funding mechanism now in place.

But the common philosophy of all past, and likely all future State funding schemes is that the more affluent a local district may be, the less State funding that will be provided. Here's a chart which shows how much Ohio income tax is paid by the residents of several local school districts versus the amount of state funding they received:

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In our case, we get back 41¢ for each $1 we pay in Ohio Income Tax.  Three area school districts, Pickerington, Reynoldsburg and Canal Winchester get back every penny they pay in Ohio Income Taxes. Two districts, Whitehall and Hamilton get back multiples of what they pay.

This isn't going to change.

The assumption made down at the Statehouse is that districts like ours have the capacity to pay an ever-increasing fraction of the cost to run our schools. That's the reason they thought it was okay to accelerate the phase-out of our Personal Property Tax reimbursements, which is one of the primary reasons we put a 5.9 mill levy on the ballot in November.

So that's it - school funding in a nutshell. I'm happy to answer your questions. We'll discuss spending (again) in an upcoming post.

All data used in this article were taken from the 2010 CUPP Report, published by the Ohio Department of Education.

Navigation

One of the top news stories this week has been the wreck of the the cruise ship Costa Concordia, which struck submerged rocks off the coast of Italy and sank. Fortunately, nearly all the passengers and crew were able to reach safety. It sounds like the one right thing the Captain did - before he cowardly scampered overboard to safety, leaving his passengers and crew behind - was to quickly steer the ship to shallower waters so that it wouldn't fully capsize, like in the movie The Poseidon Adventure. This action undoubtedly saved many lives.


But this tragedy was set up by decisions he made a long time before the hull was torn open.

I've had the opportunity to stand bridge watches on one of our Navy's ships of the line. I never saw the Captain just 'wing it' when sailing close to land, or in a narrow channel. Before leaving or entering port, or just sailing near a coast, the Captain and Navigator develop a maneuvering plan which includes waypoints and course bearings, and in doing so they pay close attention to all the depths and obstacles marked on the official nautical maps. Once underway, observations are taken continuously via radar, sonar depth finders, and visual means - even with the existence of things like GPS. Every few minutes, the actual position of the ship is plotted on official charts, which become part of the legal record of the passage. Other than maneuvers which might required to avoid other vessels, there is no deviation from the plan.

You don't kid around with this navigation stuff, whether the ship is a naval vessel, an oil tanker, or a cruise ship. Mistakes can be extraordinarily deadly and expensive.

Big ships can be surprising fast. Not only are our nuclear aircraft carriers the largest ships in the fleet, they're also the fastest. Although you won't find official confirmation, in the right sea conditions, carriers are said to be able to go over 40kts (about 45mph) - think a thousand foot long, 100,000 ton ski boat. Carriers need to be fast because the amount of weapons load an aircraft can carry when being catapulted off the flight deck is directly related to the amount of airspeed which can be generated over their wings, which is the sum of the actual windspeed while pointed into the wind, the speed of the carrier, and the terminal speed of the catapult.

But you had better not want to change course very quickly if you're sailing a carrier at flank speed. And if someone falls overboard, the carrier doesn't even try to go back and rescue the poor soul. It takes many miles of turning and a good deal of time for a carrier to return to a spot it has passed, so it's much quicker to dispatch a helicopter or one of the other ships always sailing with a carrier.

The captain of the Costa Concordia didn't think his maneuvers through very well. He clearly picked a track on which no large cruise ship had ever before sailed, and he was reportedly doing it to show off to the folks on the island they were passing. Apparently lots of cruise ship captains do this in this part of the world. Maybe this captain wanted to be the hottest of the hot-dog captains of the Mediterranean cruise industry, so he took a gamble. But even if they had seen those rocks from a mile away, it would have been too late to avoid a collision. The ship is too big and too fast. Inertia wins every time.

Our school district is like one of these big cruise ships. There has been a huge investment of talent and treasure to get us where we are. The quality of the experience our kids will have going forward will be dictated by the quality of decisions and plans made largely out of the view of the students and parents.  But once execution begins, and the kids roll into the classrooms, things happen fast, and changing course can be very difficult. There is such a thing as organizational inertia as well.

The executive team of our district produces a few key planning documents which are used to lay out the course. The longest-range plan is the 2020 program, initiated in 2006 by Superintendent Dale McVey. It sets the  general course for the school district, and gives guidance for planning and action all the way from the central office to the classroom. It should be read, reread and adjusted as necessary to make sure all stakeholders agree on the course and speed of our collective journey.

I very much enjoy reading naval history, especially of the World War II era. I'm currently reading Neptune's Inferno by James Hornfischer, which tells the story of the battles at Guadalcanal in the south Pacific. It never occurred to me before reading this that even with the sinking of many battleships at Pearl Harbor, the US Navy still had a fair number of battleships in the fleet. However, in the first couple of years of the war, battleships were not used much in the Pacific.

Why?  Because they were gas hogs (actually they burned a very thick fuel called Naval Fuel Oil). The admirals had only so much NFO available which to operate their fleet, and a limited number of tankers available to transport it to the ships, so they decided to give priority to the carriers, which were much more effective in the ship-to-ship warfare of the early years of WWII, such as the Battle of Midway.

It was a tough choice. Battleships might have lost their prima dona role in the fleet to the carriers, but when it came time to land on the beaches, the Marines very much liked having the big guns of the battleships around to pound enemy emplacements. There would be a time and place for the battleships, just not right then.

The point is that these were resource-constrained decisions the admirals had to make. They would like to have had unlimited fuel available, and been able to sail both carriers and battleships in their fleets, covering vast distances in short periods of time. But most of their fuel was coming by slow tankers from ports on the west coast of the US, and so the admirals needed to make fuel availability and fuel consumption a core part of their planning. More ships require more fuel. Faster sailing speeds consumes more fuel. Tradeoffs had to be made.

Our version of that is depicted in the Five Year Forecast. If you've been a long time reader of this blog, you know that I write about the Five Year Forecast very often. It's not because I believe the Forecast, prepared by Treasurer Brian Wilson, is the most important document in the world, or because I believe financial matters trump everything else.

It's because a school district than runs out of money is like a naval fleet that runs out of fuel: Dead in the water.

The Navy didn't have an infinite supply of fuel in WWII (or now for that matter), and we don't have an infinite supply of money. The Five Year Forecast illustrates how fast we plan to burn fuel, and helps us determine when we need to be resupplied (ask for another operating levy).

Barring some significant change in thinking, the current execution plan for 2020 shows us needing to be refueled sometime after 2014. For that to be true - for it not to be sooner - we have to limit our spending to the rate shown in the Forecast - about 1.3% growth per year. There also needs to be no further erosion of supply (eg further cutbacks of State funding).

As implied by the name, the current Five Year Forecast paints one version of our fiscal future through FY2016. It shows the spending growth rate kicking up to a little more than 4% per year starting in FY2015. The main difference versus earlier years is the assumption made as to the cost of compensation and benefits. Those costs will be driven primarily by what programs and services we want to offer, how many people we employ in the district to deliver those programs and services, and the terms of the next collective bargaining agreements with the teachers' union and the support staff's union, which will need to be renegotiated by the end of 2013.

Maybe our planned fuel consumption rate and our assumptions of the fuel resupply rate are accurate and in balance. I suspect they may not be. Both may need some adjustment, and the conversations won't be easy.

We can't wait until 2013 to start having these conversations. The captain of the Costa Concordia could have avoided this tragedy by doing better long-range planning, rather than assuming that he could make last-minute decisions if needed to avoid disaster.

We need to do the same.

Spending Priorities

The first meeting of the School Board each calendar year is an organizational meeting, and ours was held last night. The purpose of the meeting is for the five of us to elect a President and Vice-President, and for the new President to make committee appointments for the other Board members.

There is also a resolution authorizing the Superintendent and Treasurer to take various actions during the course of the year, essentially delegating authority for a specific set of things to those two executives.

The Board also authorizes expenditures to sustain our memberships in a three organizations, the National School Boards Association, the Ohio School Boards Association, and the Metropolitan Education Council.

I thought it was appropriate to discuss the need to continue our NSBA membership, and made a motion to amend the resolution to delete references to NSBA - in other words to terminate our membership. I thank Heather Keck for seconding my motion, and allowing a discussion to take place. These were my verbatim comments:

"The cost of our NSBA membership and services last year was $13,000.

It is not my contention that this is wasted money - only that I don’t believe it’s our highest priority. We’ve promised the people of Hilliard that we wouldn’t put another levy on the ballot before 2014, and to keep that promise, we have to be even more frugal with our spending.

I believe our highest priority should be in classroom and school buildings. This $13,000 could purchase a dozen additional ELMO digital overhead projectors, or allow us to upgrade some of the well-used copiers in our buildings. We could buy more of the innovative student tracking software like we saw demonstrated by the math department at Davidson recently.

It could buy new tires for a bunch of school buses, or patch up a few potholes in school parking lots.

Or it could not be spent at all, and help us regain the 10% operating reserve which is our policy.

No spending cut is without impact, and this is a relatively small amount of money in comparison to a $160 million budget. But I believe this sends the right message to the community and to the employees of the school district - that the Board is willing to make cuts in its own budget as well."

Other Board members expressed their opinions in regard to the value our district receives from our NSBA membership, primarily in two areas: a) the importance of continuing professional development for Board members, both for the benefit of the members and to set an example for the professional team; and, b) the value of the national and state lobbying efforts made by NSBA on behalf of its members.

I don't disagree, but think there are more impactful ways to spend the taxpayers' money.

My motion was defeated 1-4, with me casting the one "yea" vote. The main resolution then passed 5-0.