The Commission Report

The members of the Nebraska School Financing Review Commission were appointed by Governor Kay Orr, as required under LB 940 (1988).  The sixteen-member commission consisted of representatives from the Legislature, the Governor, higher education, the Commissioner of Education, all classes of public schools, and two at large members.

The commission also had a tremendous resource in its support staff, which included Larry Scherer, Legal Counsel for the Education Committee, Tim Kemper of the Department of Education, Sandy Myers of the Legislative Fiscal Office, Bill Lock of the Legislative Research Division, Marcelle Williams of the Department of Revenue, Russ Inbody of the Department of Education, and Dick Hargesheimer of the Legislative Research Division.  In addition, various senators contributed the services of their own staff including legislative aides, Tim Erickson (Senator Scott Moore), Kim Davis (Senator Dennis Baack), LaRue Wunderlich and Dawn Rockey (Senator Ron Withem), and Corey Phillips (Senator Roger Wehrbein).¹

The commission was created to perform an in-depth and objective review of the funding of Nebraska's public school system.  The commission was specifically charged with the duty to examine whether or not income as a revenue source and indicator of wealth should play a larger role in school finance.  It also was to look at methods to reduce the burden on the property tax for support of schools and consider other state aid distribution formulas that provide greater equity for students and taxpayers.  Naturally, most of the members of the commission had an interest, perhaps a vested interest, in changing the existing school finance system.  Some of the school district representatives, for instance, were aware that a change in the formula might result in a greater distribution of state aid to their districts.  Other commission members had an interest in preserving certain aspects of the existing system, such as Senator Howard Lamb with his long standing concern for Class I districts.  Nevertheless, the purpose of this diverse group of individuals was to examine "the complex and often emotional issue of school finance in a cooperative and positive spirit."²

Before the commission had a chance to really begin its work, several events occurred to lend credence to its purpose.  The first took place in July 1988 when the Maxwell School of Citizenship and Public Affairs at Syracuse University issued its final report on a comprehensive tax study requested by the Nebraska Legislature.³  The "Syracuse Report," as it came to be called, stated what many had known and perhaps what some did not want to hear.  In essence, the report stated that Nebraska was overly dependent upon property taxes to fund schools.  To resolve this situation, the report suggested Nebraska increase state taxes to assist schools, overhaul its state aid formula, and implement a major school consolidation program.  In fact, the report suggested the consolidation piece come first, followed by tax increases and formula overhaul.  "We recommend that a school consolidation plan be implemented before reforming state aid to education," the study concluded.⁴

According to the study, Nebraska collected twice as much property tax per student as the U.S. average ($2,918 to $1,570 annually) and gave half as much state aid to school districts ($842 to $1,675).⁵  State aid typically derives from such revenue sources as sales and income taxes.  The plan to address the situation, the report stated, was to reduce the number of school districts and to target state aid to those districts most in need of such assistance.  The report presented a possible plan for reorganization that would create considerable savings to the taxpayer and to the state if the number of districts were reduced to 95.⁶  In 1988 there were 891 public school districts in Nebraska.⁷

Some of the Syracuse Report findings may have been pleasing to the eye of Senator Withem, who fought to establish a commission on the basis of over reliance upon property taxes and the need to overhaul the state aid formula.  He also was a proponent of reorganization efforts.  But Withem knew the findings of the Syracuse Report were unrealistic given the political climate concerning the issue of reorganization.  "They saw we have a serious problem with state aid, and they say before you do anything about it you have to move heaven and earth," Withem said, referring to past battles on reorganization.⁸

Withem, of course, also knew that to take a hard stand in total support of the Syracuse Report might make the work of the commission that much more difficult and prolonged.  The purpose of the commission, after all, was to seek ways to change the state aid formula rather than to resolve the issue of school reorganization.  The Syracuse Report called for a reverse order of events with reorganization occurring first.  At least one legislator, however, was free of political and practical constraints to speak more bluntly about the Syracuse Report.  Senator Vard Johnson of Omaha, a vocal advocate of consolidation, said the report told the hard truth.  "It tells a story that many people want to ignore," Johnson said.⁹

The other event occurring in the summer of 1988 may or may not have been welcome news to members of the commission as they set out to begin their work.  On June 29, 1988 the State Board of Education approved a legislative goal to more than double the amount of state aid for schools.¹⁰  The board was conducting a special meeting to formulate goals for the Department of Education.  The board embraced the dual objectives of reducing reliance on property taxes and broadening the tax base in order to increase funding for schools.  The board's state aid goal would ultimately lead to review of a formal proposal in October 1988 to increase state aid and place a 4% spending limitation on school districts.  In deferment to the work of the commission, however, the state board chose not to take any immediate action on the proposal.¹¹

Whether beneficial or detrimental to the commission's objective study of school finance, both the Syracuse Report and the State Board's proposal would play a role in the final outcome.  The Syracuse Report would be quoted in both public hearing testimony and floor debate on LB 1059 in 1990.  Aspects of the state board's proposal would find its way into the final recommendations of the commission in January 1990.  But more than anything else, the Syracuse Report and state board proposal helped to relieve the pressure that the commission might otherwise have had to shoulder itself.  That is, in order to reduce reliance upon property taxes, the state would need to increase sales and/or income taxes to offset the revenue for school districts.  Therefore, a state revenue increase was officially on the table well before the commission issued its final report.

The commission met approximately twice each month in the latter part of 1988, but it soon became apparent that the assigned task would require an extension of time in order to complete.  At a December 7th meeting in Lincoln, the commission took formal action to approve the concept of using personal income as both a revenue source and a factor in calculating a school district's share of state aid.¹²  Senator Withem then requested staff to draft legislation that would utilize the Kansas state aid formula as a model for purposes of introduction in the 1989 Session.¹³ The Kansas model utilized the 20% income tax rebate concept that would later become a part of the commission's final recommendation.

The commission would meet again in early January 1989 to review the draft legislation and determine whether to have it filed in time for formal consideration.  The decision, ultimately, was to hold off on the introduction of a bill until further study could be completed and more public input could be obtained.  Instead, Senator Withem introduced a bill seeking an extension of the deadline to finish the study.  LB 312 (1989) would extend the life of the commission until June 30, 1990, and would require the commission to submit a final report by January 1, 1990.¹⁴  The bill also would, for the first time, establish an oversight committee to "aid in the implementation of the plan."¹⁵

During the public hearing for LB 312 on January 23, 1989, Senator Withem praised the commission's work to date and noted that attendance at meetings had been very good.  He also reported that the commission had utilized less than 10% of the $100,000 appropriated to it under LB 940 (1988).  He proposed that the remainder of the original funds be re-appropriated for use by the commission.  Withem said the commission had agreed upon several principles, including the income tax rebate provision, and that the more tedious task of preparing draft legislation was underway.¹⁶

On January 30, 1989, General File debate began on LB 312.  Perhaps discussion would be a more accurate description than debate.  The Legislature seemed to be in full agreement that the commission should be granted a continuance in order to finish its work.  Interestingly, Senator Scott Moore, a member of the commission, gave a peek into how the commission was actually functioning as a deliberate body.  Moore said he voted against extending the life of the commission during its most recent meeting.  He said the property tax debate had polarized the commission into what he called two "segments":

There is a certain segment that say the definition of property tax relief is increased funding for education and then there is the segment that defines property tax relief as dollar for dollar property tax relief and at some time those two facts just have to go to war and fight it out... .¹⁷

Moore said his wish would have been to offer a complete proposal in the 1989 Session rather than wait another year.

Withem agreed with Moore's assessment of the commission and said there had been "a fairly lively debate as to whether we should ask for this extension or not."¹⁸  The prevailing thought among commission members, noted Withem, was to make sure the proposal was researched thoroughly.  The Legislature agreed and presented LB 312 with unanimous votes for advancement and ultimately final passage on May 18, 1989.¹⁹ The life of the commission was extended for another year, but there would be one other change concerning the commission, one not necessarily anticipated at the beginning of the 1989 Session.

While LB 312 sailed through the legislative process, another bill would emerge from the Revenue Committee designed to up the ante on the work of the commission.  Senator Moore's admitted frustration in addressing the property tax issue sooner rather than later lead him to introduce his own bill in 1989 to benefit both education and property taxpayers.  The original version of LB 611 (1989) presented a politically far-reaching idea to create a separate income tax dedicated to K-12 education.  The bill proposed to establish the Public Education Income Tax Act and impose a public education tax on the income of individuals, trusts, estates and corporations.²⁰  The tax rate was to be determined by dividing one half of the total state and local school district revenue by the total federal adjusted gross income of resident individuals.²¹  The Legislative Fiscal Office anticipated that the initial rate would be 2.43% on adjusted income, which would be in addition to the state's existing general income tax rate.²²

The purpose of the bill, as stated by Moore, was to create property tax relief, first and foremost.  The natural beneficiary of the tax would be public schools.  In his official Statement of Intent, Moore said the bill would provide a similar system to that of Kansas whereby a portion of the income tax is dedicated to public education.²³  Moore said the bill would produce "close to $350 million in property tax relief."²⁴

The second major objective of Moore's LB 611 was more realistic politically and actually provided the needed hammer to ensure the implementation of the commission's final recommendations, as yet undetermined.  Moore proposed to place an automatic repeal of the existing school finance formula, the School Foundation and Equalization Act, on July 1, 1991.²⁵ This would leave less than two years for the Legislature to make sure a replacement formula was implemented.

The public hearing for LB 611 was not particularly well represented by interests that would normally launch a heavy campaign in opposition to such a bill.  In fact, there were very few proponents to the bill and no opponents.²⁶  Senator Moore joked with members of the Revenue Committee during his introductory remarks saying, "I'm here to introduce LB 611 which is the granddaddy of all property tax relief bills ... ."²⁷  "You've heard $50 million bills, you've heard $100 million bills, and $200 million bills," Moore quipped, "Well this one is the Big Daddy."²⁸  "This one is $350 million in property tax relief," Moore said to the amusement of committee members.²⁹

If nothing else, LB 611 served as a precursor to what would eventually follow a year later in terms of a tax increase to fund public education.  When LB 611 appeared on General File, on April 10, 1989, Senator Withem rose to applaud Moore's efforts and said the concept behind the bill was within the "broad philosophical components" of the commission's work.³⁰ It also gave Withem a chance to test the water on the issue of a dedicated income tax provision, which would eventually become a part of the commission's final recommendation.  Nevertheless, Moore's legislative efforts may have been somewhat ahead of the process.  The commission first had to arrive at an acceptable distribution formula before determining the necessary level of state support.

By the time it arrived on Final Reading, LB 611 had been dramatically reduced in scope and purpose, but it would still have a bearing on the work of the commission.  As amended, the bill would incorporate legislative findings to recognize that, since 60% of all real property taxes were assessed in support of public schools, any future proposal for lasting property tax relief must address the issue of school finance.³¹  The bill further provided that it was "appropriate" to share the state's income tax base with schools in order to:

1. Assure all Nebraska children a more equitable opportunity for an appropriate education;
2. Provide a broad and stable system of financial support for public schools through an appropriate mixture of revenue sources; and
3. Provide equalization of fiscal ability and property tax burden among school districts through the inclusion of income wealth in the determination of a school district's ability to provide educational programs to the extent that such income is part of the accessible tax base.³²

But findings alone would not provide the "hammer" needed to ensure something would be done about property tax relief.  Consequently, the bill did call for the automatic repeal of the existing formula on June 30, 1991, and called for a new school finance system to be in place by January 1, 1992.³³

LB 611 provided intent language to replace the existing school finance system "with a system which shares the income tax base with school districts to provide substantial and enduring property tax relief and a stable and lasting school finance system."³⁴  In addition, the bill provided intent language that any new school finance system should impose spending limitations on school districts "to assure property tax relief and tax equity."³⁵  The spending limitations were to be "sensitive to local needs and spending levels," which at least gave the commission some broad parameters to determine an appropriate spending lid for schools.³⁶

LB 611 was passed by the Legislature on May 22, 1989, but not without opposition.  The two principle concerns were that it committed the Legislature, at least in theory, to using a portion of the income tax to fund public education.  The other concern involved the hammer to repeal the existing formula and replace it with an unknown, as yet undetermined, school finance system.  Both Senator Howard Lamb, who was a member of the commission, and Governor Kay Orr, who was represented on the commission, opposed LB 611.  Orr, however, did not oppose the bill enough to veto the measure.  She chose instead to let the bill become law without her signature.  In a letter of explanation to the Legislature, Orr wrote:

The Legislature is to be applauded for examining and attempting to address school financing this session.  However, the fact that the bill "sunsets" the School Foundation and Equalization Act on June 30, 1991, without proposing something to replace it is troubling.

LB 611 also suggests that options other than the state income tax have not, and possibly will not, be fully explored.  It must be understood that LB 611 may not represent the ultimate solution for the very complex problem of providing a stable and fair means of supporting Nebraska's public schools.³⁷

The automatic sunset provision was obviously subordinate to the larger concern over taxation, which Orr would later use to explain her action concerning LB 1059 (1990).  In the meantime, Orr's action, or inaction in this case, served as the first dividing point between her and the work of the commission, even before the commission released its final proposal.

By majority vote, the Legislature appeared willing to use income tax to help fund education while at the same time the Governor demonstrated her resistance to such a plan.  The commission received greater understanding of what the Legislature expected, and perhaps what it would accept, but the battle lines were drawn with regard to the administration and its protectiveness of tax policy.  The Governor's decision not to sign LB 611 did not sit well with several members of the commission, who felt she had given their work a vote of no confidence.  "A lot of my enthusiasm and excitement is diminished by this," Withem said during a commission meeting on May 31, 1989.³⁸ The Governor's representative, Cynthia Milligan, defended the Governor's decision and reasserted the administration's interest in the commission's work.

The May 31st meeting marked a renewed intensity by the commission to conclude its work.  The group, after all, had received a "drop dead date" to propose a new formula prior to the automatic sunset of the existing formula.  Naturally, nothing prevented the Legislature from granting yet another extension and delaying the repeal of the old system, but most everyone expected the commission to produce something prior to the 1990 Session.  In fact, the commission was already near the point of unveiling a final proposal shortly after the 1989 Session commenced.  The extra interim period, during the summer of 1989, gave the commission much needed time to publicly circulate the final proposal for reaction and fine-tuning.

Over an eighteen-month period, from 1988 to 1989, the commission held 21 meetings, five public hearings and listened to dozens of presentations by staff and outside experts in order to arrive at its conclusions.³⁹ The five public hearings were held in June and July, after the 1989 Session, at various points across the state in order to give ample opportunity for public discussion.  What the commission heard time after time at these hearings was resounding support for the concept of a tax shift away from the property tax for support of public schools.  School officials were generally supportive of the overall plan, but they expressed concern over the imposition of spending limitations.

Using the feedback from the public hearings, the commission made a few revisions to the proposal, but the major components, as noted below, remained in tact.  On January 1, 1990, the commission formally issued its final report entitled, "Funding Nebraska's Schools: Toward a More Rational and Equitable School Finance System for the 1990s."  Along with the findings and conclusions, the comprehensive report included a description of the existing formula, historical background materials, and numerous tables and charts to support the commission's recommendations.

In a letter to Speaker Bill Barrett, Senator Withem officially offered the report for consideration by the Legislature.  Withem wrote, "The Report focuses on the closely connected problems of excessive reliance on the property tax for support of our schools and the disparities in school districts' abilities to provide equitable educational opportunities for all of our students."⁴⁰  Withem wrote that the implementation of the proposal would dedicate a portion of the income tax for school funding, implement a new equalization formula, which would be "sensitive to current school district needs and income wealth," and impose limitations on spending by school districts.  Withem also specifically stated that the plan would require "enhanced state revenue sources to insure ongoing and stabilized funding for our schools," referring to the necessary tax increase to fund the plan.⁴¹

The commission found two major policy problems with the way Nebraska funded its public school system:

First, the burden on property for school support is excessive by any standard of measurement, resulting in inequities to taxpayers and a narrow and unstable tax base for schools.  Second, the current system of school finance, with its overemphasis on the property tax as the primary basis of support for schools and grossly inadequate equalization abilities, does not assure that all students in the state will have equitable access to appropriate and necessary school services.⁴²

The commission also found that the historic resistance to greater equalization of school fiscal support in Nebraska was closely related to the inability of Nebraska policymakers to reach consensus on what constitutes "wealth" in terms of school district resources and in terms of taxpayers' ability to pay for educational services.⁴³

With regard to the first policy problem, over-reliance upon property taxes to fund education, the report noted several "negative effects" that had occurred, including "inequities between taxpayers residing in rich and poor school districts" and "excessive tax rates on property in comparison to rates in other states."⁴⁴  The report indicated that Nebraska public schools relied more heavily on property taxes for general operation than nearly all other states, only one state, New Hampshire, rated above Nebraska.⁴⁵  At the same time, state financial support to Nebraska schools was lower than that found in nearly all other states, as demonstrated in Table 7.

The commission found that state financial assistance for Nebraska schools was actually declining in relation to the national trend, which was to increase state assistance to schools.  Despite the decreases in state support, the Nebraska Legislature continued to heap new mandates upon public schools.  The report used the example of LB 994 (1984), which established a longer school year, higher graduation requirements, enhanced accreditation standards, and tests for beginning teachers.⁴⁶

The commission also found that the heavy reliance on property taxes had resulted in "highly inequitable tax burdens between taxpayers" within school districts of similar size, "where there is a significant disparity in property wealth between the districts."⁴⁷  The report demonstrated that districts with relatively the same enrollment and cost per pupil could have vastly different levels of property valuation and levy rates.  "The Commission has concluded that this type of inequity between taxpayers cannot be justified," the report stated.⁴⁸  On average Nebraska homeowners and farmers were paying more than twice the national average in property tax rates (Nebraska 2.29%, national average 1.21%).⁴⁹

The second major policy problem found by the commission related to equitable educational opportunities for students from one part of the state to another.  The commission found that, under the existing formula, the state was expending very little in state aid on the basis of school needs in relation to the ability to finance needs.  In the 1989-90 school year, only $33 million was paid out to districts in the form of equalization aid with the majority of funds being used for foundation aid.⁵⁰ The equalization component of the formula was dramatically under-funded in comparison to the foundation component of the formula.  Moreover, the formula, in general, was under-funded.  In truth, the School Foundation and Equalization Act had never been fully funded since its inception in 1967.

The commission's report expressed doubt that the existing formula would ever be able to assure that all children receive an "equitable opportunity for an appropriate education."⁵¹  In comparing various districts under the existing system, the commission found that a district's ability to provide the resources for "equitable education opportunity" could be severely impacted by the taxable valuation base of the school district.  The report illustrated this point with a chart containing figures from two actual (undisclosed) districts with similar enrollments but vastly different valuations per pupil.  The result was a full $1,000 difference in cost per pupil, as shown in Table 8.

In addition, the commission's hired consultant, John Augenblick, reported an inverse or slightly negative statistical correlation between tax rates and spending.  This meant that higher taxing does not necessarily produce higher spending capacity.  In essence, some school districts would have to "tax much higher than average only to be able to spend much lower than average."⁵² With these considerations in mind, the commission concluded that inequities of educational opportunities existed under the current system.

After arriving at the two principle policy problems with the existing formula, the commission established, perhaps for the first time in Nebraska school finance history, the actual purposes for state aid to schools:

• First, to assure all Nebraska children an equitable opportunity for an appropriate education;
  
  
• Second, to provide a broad and stable system of financial support for public schools through an appropriate mixture of revenue sources; and
  
  
• Third, to provide equalization of fiscal ability and financial support among school districts and taxpayers through a distribution formula, which recognizes school district needs and school district wealth.⁵³

The report further stated the commission's belief that "wealth," as it relates to school districts' ability to provide educational services and in terms of taxpayers' ability to pay for such services, must include consideration of income tax revenues as well as property tax revenues.⁵⁴  Even with this admission, the issue of measuring wealth of a school district would remain one of the major barriers for support of the proposal by some lawmakers.  In fact, the issue would re-appear in many legislative sessions to come.

1. Income should be considered as school district wealth along with property, but only to the extent that it is an "accessible" revenue source to school districts.
   
   
2. All school district general fund revenues except federal categorical funds should be accountable in the computation of a state aid formula.
   
   
3. Any formula based on property wealth developed to equalize fiscal ability and property tax burden must address discrepancies in the assessment of property values among counties and, if feasible, among classes of property within counties.
   
   
4. Grant, incentive, categorical or other classified state funding be made available to schools with justifiable need.  Any grant, incentive, categorical, or other classified state funding should be separated from equalization funding formulas and/or equalization funding in order to avoid dilution or contradiction of equalization's purpose.
   
   
5. Some means be developed to assure that state funding intended to equalize fiscal ability and property tax burden be used as intended yet retain as much local control on school programs and finances as possible.
   
   
6. A permanent school finance commission be appointed to periodically monitor implementation and operation of the formula and the changes in property value assessments, tax laws, and state mandated education programs to avoid unintentional diversion of state aid purposes.

Given these broad philosophical considerations and beliefs, the commission proposed five objectives to be incorporated into the new school finance system.  The first of these objectives was that 20% of all state income tax revenues should be dedicated for support of public schools.  Specifically, this meant that 20% of all individual income tax proceeds, attributable to each school district, should be returned directly to the school district where the income tax revenues originated.⁵⁵  The idea was to assure a "broadened, growing and more stable base of support for all public schools."⁵⁶ This provision would come to be known as the income tax rebate to public schools.

The second objective involved the increase in the overall level of state support to a "target level" of 45% of the aggregate operational costs of the school system "in order to effectuate a 15% reduction in aggregate property taxes" levied.⁵⁷  Naturally, a 45% level of state financial assistance meant that the remaining 55% of public school revenue would derive from property taxes or other sources.  The second objective would ultimately be placed in the intent section of LB 1059 (1990).  The idea behind this provision was to set a goal for the Legislature to adequately and consistently fund the new formula to "assure a meaningful and realistic reduction, over the short and long term, in the share of school costs which must be supported by the property tax."⁵⁸

The third objective related to the distribution formula itself.  The commission recommended the implementation of an "equalization based distribution formula" to assure that all school districts have the fiscal ability to provide for the "realistic needs of students and which will measure district wealth in terms of both its available income tax resources and property tax resources."⁵⁹  The idea behind the objective was to "help assure" that the state will meet its responsibilities to provide equitable educational opportunities for students and assure "fair tax treatment of its citizens."⁶⁰

The fourth objective was essentially mandated, or at least strongly suggested, under LB 611 (1989).  The fourth objective called for "real and effective growth limitations" on the budgets of school districts, implying a relatively stringent base spending lid.⁶¹  But the commission also adhered to the admonition in LB 611 to impose a spending limitation that was "sensitive to differences in needs and resources of the schools."⁶²  This would ultimately result in a spending lid range and a district-by-district growth rate based upon the spending habits of each district the year before.  The idea behind the spending lid was to ensure that the additional state financial support to schools would actually result in a reduction of property taxes to support schools.  The commission suggested an initial base lid of 4% with a lid range to 6.5%.⁶³

The fifth and final objective specifically referred to the issue that would cause the greatest amount of controversy.  The commission recommended that its proposed school finance plan should be funded on an "ongoing and sustainable basis" from increases in the state sales and/or income taxes as determined necessary and appropriate by the Legislature.⁶⁴  In other words, permanent tax increases.  But the report did not specify or suggest tax rate increases, an issue which would later be criticized by opponents of the legislation.  Instead, the report suggested that this would be the responsibility of the Legislature and the Governor "to set a budget based on projected revenues and total budget obligations."⁶⁵

The commission's final product was not necessarily innovative in the arena of school finance.  The basis of the new formula would be similar to the formula used by the State of Kansas.  The commission also borrowed various aspects of a proposal offered several years earlier by the Nebraska Council of School Administrators (NCSA).  And the commission was particularly fortunate to have among its membership several school finance experts of its own.  Commission member Larry Vontz and Department of Education staff, Tim Kemper and Russ Inbody, all had a considerable impact on the final result, as did Larry Scherer, Legal Counsel for the Education Committee.

The commission estimated the cost to the state to implement the plan for the 1990-91 school year to be $211.3 million.  This would be funded in part by the dedicated income tax to schools, which accounted for $118 million of the total projected cost.  The commission anticipated a 16.1% reduction in property taxes as a result of the plan in the first year of implementation.⁶⁶  Aside from these projections, the commission chose not to recommend a legislative solution to produce the remaining state revenue necessary to fund the plan.