Larry DeBoer: Inflation likely to squeeze Indiana school budgets

The inflation rate in May was 8.6%, the highest since the bad old days of the Great Inflation 40 years ago. We’re all paying higher prices. So are our school districts.

School districts face some costs that increase as prices rise, and other costs that don’t. Food, fuel and equipment prices rise, and schools must pay. But teacher salaries are set in contracts, and until those contracts expire, inflation won’t have an effect.

In 2021, Indiana public schools paid 62,000 teachers $4.4 billion in salaries and benefits. That’s more than one-third of total school budgets. Teacher contracts run for one or two years, and until they expire, pay will rise at rates set before inflation increased. After a year or two contracts will be renegotiated, and it’s likely that teachers will expect their pay to keep up with higher inflation.

Inflation had been running near 2% per year, and teacher pay increased by about that amount. The increase in average teacher salaries has been 2.3% per year, enough to keep up with inflation that was, but well short of 8.6%. After a year or two, the cost of teacher pay is likely to rise much faster.

Higher costs will squeeze school budgets unless revenues rise too. The two biggest sources of revenue for Indiana schools are the property tax and state tuition aid. Property taxes provided $3.4 billion for school budgets in 2021, and state aid delivered about $7 billion. Together they make up almost 90% of school revenue. Will these revenues rise with inflation?

Assessed value after deductions is the base of the property tax. Net assessed value increased 5.6% for taxes in 2022, the largest increase in years. That was due to big increases in home values, and that’s likely to continue for taxes in 2023.

Schools that have passed property tax referendums can fix their referendum tax rates, so that revenue can rise with assessed value. But most school property taxes are limited by a state-imposed maximum levy. The maximum levy increases each year by a percentage called the maximum levy growth quotient (MLGQ). It’s calculated as the six-year average of statewide non-farm income growth. For taxes in 2022, the MLGQ was 4.3%. School property taxes could increase no more than that. Next year’s MLGQ will include the big rise in income from 2021, so it will be about 5%.

We know from the 1970s that incomes rise faster when inflation is high. As the years pass the MLGQ will replace old low-inflation growth rates with new high-inflation numbers. Once all six reflect inflation, the MLGQ will match the inflation rate.

For the five years until then, though, the MLGQ will not fully cover inflation. And the MLGQ has a legal maximum of 6%. Property tax revenue won’t keep up if inflation runs higher than 6% for years to come.

State school aid is set by the General Assembly in budget sessions every two years. Aid in fiscal 2022 and 2023 were set in the budget passed in April 2021. Inflation was low back then. The revenue forecast had inflation at 1.5% for 2022 and 1.8% for 2023. The state’s inflation predictions were way too low. Mine were too.

Total state aid was set to increase 6.8% in 2022 and 3.8% in 2023. These were increases much higher than expected inflation. Now we know that the increase for 2022 is lower than actual inflation. Schools expected an increase in “purchasing power” above inflation to be 5.3%. Instead, purchasing power will drop by 1.8%.

In 2023 the General Assembly will pass a budget for the next two fiscal years. Even if the new budget sets school aid to rise to match inflation, it can’t affect school revenues until the beginning of the next state fiscal year in July 2023.

Some school costs are rising with inflation right now. Teacher pay likely will be affected after a year or two. Property tax revenue will not fully reflect inflation for at least six years. The General Assembly could increase school aid to offset inflation, but that wouldn’t kick in until mid-2023.

Inflation is likely to squeeze school budgets.

Larry DeBoer is an agricultural economist with Purdue University. Send comments to [email protected]