Issue: Tax Reform, Act 1 of 2006

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Act 1 NEWSLETTER
Vol. 1, No. 4, August 16, 2006

IN THIS ISSUE: The Act 1 index, what is it, how is it calculated and how does it affect school districts?

SUMMARY : Like its predecessor, Act 72, Act 1 requires school districts to place any proposed tax increase that exceeds an inflationary index on the primary election ballot for approval by voters. This index is defined in Section 302 of Act 1 as "the average of the percentage increase in the statewide average weekly wage and the Employment Cost Index."

In order to better understand the index, a brief explanation of the components that make up the calculation is necessary. The statewide average weekly wage is calculated twice annually by the PA Department of Labor and Industry. As its name implies it is a statewide average of the wages and salaries being paid to those who work in Pennsylvania. This calculation does not include the cost of benefits. The Economic Cost Index is a federal statistic and is calculated by the U.S. Department of Labor. The Economic Cost Index used for purposes of calculating the Act 1 index is the ECI for Elementary and Secondary Schools. These indexes are quarterly measures of changes in labor costs for specific types of employers. Unlike the statewide average weekly wage, the ECI takes benefit levels into account. The Act 1 index calculation takes into account the statewide average weekly wage as measured on the immediately preceding July 1 and the ECI as measured on the immediately preceding Jan. 1.

The base index for 2006-07 was 3.9%. That index was used by districts participating in Act 72 in developing their 2006-07 budgets. The PA Department of Education must calculate the 2007-08 base index by the end of business today and publish it in the Pennsylvania Bulletin, the official publication for all legal notices and proposed regulations for the state and its agencies, by Sept. 1.

The term "base index" is used to differentiate that number from the "adjusted index." Like Act 72, Act 1 allows districts that have an aid ratio of greater than 0.400 for the school year prior to the school year for which the index is being calculated to adjust their index to a higher number to make up for the district's lack of wealth. Consequently, school districts that have an aid ratio exceeding 0.400 for the 2006-07 school year are eligible for an adjustment in their 2007-08 index.

In order to calculate the adjustment, the base index is multiplied by the sum of 0.75 and the district aid ratio for the 2006-07 school year. The following is an example using the 2006-07 base index and a school district with a 2005-06 aid ratio of 0.6300:

0.75 + 0.63 = 1.38
1.38 x 3.9 = 5.382

Thus, the school district in our example would have had an index of 5.38 to use in developing its budget for the 2006-07 school year.

A school district's index serves as a ceiling for how much taxes can increase before the district must place an increase in taxes on the primary election ballot. To determine the ceiling, the index is applied to the rate of taxation, not to the revenues generated by the tax. For example, a school district that was subject to the base 2006-07 index of 3.9% with a millage rate of 100 mils on property could increase that tax to103.9 mils without having to place the increase on the ballot for approval by voters. The index applies separately to every tax that the school district levies, although in most districts the only tax affected will be the property tax.

Like Act 72, Act 1 contains ten exceptions to the index. Commonly referred to as back-end referendum exceptions, these exceptions, if granted, allow districts to increase a tax by a rate exceeding the index. The exceptions themselves are for costs that are difficult for school boards to control, such as those for special education, for court or administrative orders, for increasing enrollments and other costs. The issue of exceptions will be addressed in a future issue of the Act 1 newsletter.

ANALYSIS: The calculation of the base and adjusted indexes is one of the clearer provisions of Act 1 and does not lend itself to multiple interpretations or questions to the extent of some other provisions of the act. The important facts are 1) that it is applied to the rate of taxation not to the revenue produced and 2) that it is applicable to all of the taxes the school district levies.

The index is of obvious importance to school districts in developing their preliminary budgets. Districts that cannot balance their budget, even after including revenue to be obtained by increasing taxes to the maximum extent allowed by the index, are eligible to seek one or more back-end referendum exceptions and must then determine the exceptions for which it qualifies. If the additional dollars received through the

exceptions are still not adequate to balance the budget, districts must either decide to go to the voters for approval of a tax increase or make further cuts to its budget to fit the revenues available from the maximum index tax hike and the exceptions granted.

The calculations and projections required to make this model work will likely prove difficult for the first few years of life under Act 1, but hopefully will become easier with continued use.

Questions and Answers
Act 1 index

Q: How soon will each school district know its own index?
A: Under Act 1, the Department of Education must let all districts know their specific index by September 30.

However, as soon as a district knows the base index, it can perform the calculation mentioned previously in this newsletter to figure out its own index for 2007-08. A list of all school district indexes will eventually appear on the PDE web site: www. pde.state.pa.us.

Q: How has the index fared historically?
A: In the last five years, the base index has ranged from a low of 2.9% to a high of 3.5%. Generally, this index will fall in the 2.5% - 4.2% range. The PSBA web site has a five-year history of the index. Simply click on "Research and Data" under the Issues and Research heading. Click on "Growth allowance index" to get the history.

Q: Must a district increase taxes by the index each year?
A: No, the index is meant to serve as the maximum percentage by which a district can raise its taxes without seeking voter approval. Districts must propose the maximum tax increased allowed by the index in order to qualify for a back-end referendum exception.

Q: If a district does not increase taxes up to the maximum allowed by the index, does it get additional authority to increase taxes in the following year?
A: No. PSBA advocated for the concept of "banking" the index. That is, districts could get additional authority to increase taxes if they had not "used" the entire index the previous year. However that concept was not accepted by the General Assembly.

Q: Are there any incentives for districts to keep increases in taxes at or below the index?
A: There are the obvious good will benefits that will districts will get from its taxpayers, particularly those on fixed incomes. Act 1 also includes a provision that allows districts to develop its budgets on the traditional May/June if the board adopts a resolution in January not to increase taxes by more than the index.

Q: Could districts potentially have two separate questions on the 2007 primary election ballot?
A: Yes. All districts except Philadelphia, Pittsburgh and Scranton must have a "front-end" question, which asks voters how they want to shift taxes within the local school district to generate revenues to fund property tax relief. Some districts will also have a "back-end" referendum question, asking voters to approve an increase in taxes over the index. The two are separate questions and each have their own requirements.

Q: Could the index apply to a district's current earned income tax?
A: Yes. Act 1 prohibits any school district from increasing the rate of a tax levied for the support of the public schools by more than the index. Most districts that use an earned income tax are already levying it at the maximum possible rate. However if the district can raise its EIT and still be under the maximum allowable rate, it must apply the index to the current percentage levied.

Q: Does the index apply to an income tax levied under Act 1?
A: As far as we can tell, the index does not apply to an income tax levied under the authority of Act 1. Those income taxes cannot be increased without voter approval and the revenue raised must be used to reduce property taxes. The maximum rate of any income tax authorized by Act 1 is the rate that produces sufficient revenue that, when combined with gaming revenue, allows districts to offer the maximum allowable level of property tax relief in that specific district.