State Assumption of School Debts
Memorandum 1135, April 2015

Introduction

On March 30, 2015, the Coalition for the Future of Detroit Schoolchildren (the Coalition) issued a report concerning the K-12 public education landscape and challenges in the City of Detroit. The report contained a number of recommendations and calls to action, including many that focus on educational governance, choice, finance, and service delivery. The report is concerned with all schools in the city, both traditional public and charter public schools. Of particular note in the section of the report dealing with financial matters, is a recommendation for the State of Michigan to assume certain debts of Detroit Public Schools (DPS). According to the report, these debts are first-order financial challenges for the future of public education in the city. The implication is that they must be addressed whether DPS continues to operate as a stand-alone school system or as part of a larger system of schools in the city under a different governance structure (e.g., a portfolio district that includes Detroit-based public charter schools).
As of June 30, 2014, DPS had $299 million in long-term notes outstanding. These notes were originally issued in 2005 and 2011 to finance current spending, with the recent issuance done under the authority of the DPS emergency manager to address the district’s accumulated operating deficit. The notes effectively converted short-term borrowings into long-term debt by extending the repayment period to 10-15 years. The Coalition is recommending that the State of Michigan directly assume responsibility for financing the annual debt service on these notes, which amounts to $1,100 per student, to allow these funds to flow into the classroom.
State assumption of this type of debt is not unprecedented. In recent years, the State of Michigan, through a couple different mechanisms, has assumed responsibility for financing the accumulated deficits of a few individual local school districts. In each case, a major shift in school governance accompanied the state’s actions and the existing educational entity was eliminated. By taking on the debts of local districts, the state spreads the debt costs to all other taxpayers and school districts across the state. The situation in DPS is unique from previous state actions on at least two major fronts: 1) the scale of the debt involved; and 2) the uncertainties in how the state assumption of debt might fit into a larger financial and/or governance plan for addressing public education in the City of Detroit.
As state decision makers review and analyze all the recommendations put forth by the Coalition, any specific proposal for dealing with DPS’s debts, whether as a stand-alone matter or as part of a larger vision for the future of education in the City of Detroit, can be informed by how the state has approached similar situations in the past. Also, much can be learned from the unintended consequences when the state has assumed the debts of financially struggling school districts. Most importantly, past experiences, along with the recent recommendation contained in the Coalition’s report, suggest that the State of Michigan lacks a clear and consistent statewide policy related to the provision of additional financial resources to financially struggling school districts. Formulating such a policy should be a top priority of state policymakers.

What DPS Debts are We Talking About?

It is important to clarify the debts at the center of the Coalition’s recommendation because school districts across the state issue different types of debt and borrow money for various purposes each year. The Coalition is very specific about the debts that it wants the state to assume: debt issued to address the district’s operating deficit, not its general obligation debt. It argues that this debt is the direct result of actions taken by state-appointed emergency managers tasked with addressing the district’s financial problems and that DPS students should not bear the burden of the annual debt service payments. The district is on the hook for $53 million annually for the next five years, or about $1,100 per student this year, in principal and interest payments on this debt. These payments are made from the district’s operating budget which is financed by its per-pupil foundation allowance.
The Coalition also recommends that DPS receive a financial reprieve from other financial requirements it is facing. It contends that the district should be exempt from making payments to the state-administered school employee retirement system for funding employee “legacy costs.” In Fiscal Year 2013-14 (FY2014), DPS spent $71 million, the equivalent of $1,400 per pupil, to pay these costs. Funding to meet the employer-financed payments to the retirement system, including these “legacy costs,” also are financed by the foundation allowance.
In total, the Coalition is asking the state to take on $124 million annually of DPS financial obligations for debt service and employee “legacy costs,” nearly $2,500 per DPS student, as part of a plan to reconfigure public education in Detroit.
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