Ever wonder where the money for Michigan’s K-12 public schools comes from? The primary source of state funding is the School Aid Fund (SAF), a dedicated fund that draws from a variety of state taxes and other revenue streams.
Based on the projections for the 2024-2025 fiscal year from January 2025, the School Aid Fund for the entire state is expected to receive a total of approximately $18.5 billion. The largest single contributor to the fund is the Sales Tax, making up a substantial 43% of the total with a projected $7.83 billion. Following this is the Income Tax, which accounts for 22% of the fund’s revenue, or about $4.1 billion.
Other significant sources of revenue include:
- State Education Tax: $2.87 billion
- Lottery Transfer: $1.26 billion
- Use Tax: $959.8 million
- Online Gaming/Sports Betting: $425 million
- Real Estate Transfer Tax: $412 million
- Other miscellaneous sources: $602.2 million
The Pro-Cyclical Nature of School Funding
A key characteristic of many of these revenue sources is that they are “pro-cyclical.” This means that the amount of revenue they generate is closely tied to the overall health of the economy. When the economy is growing, people generally have more disposable income, leading to increased consumer spending. This, in turn, boosts sales tax and use tax collections. Similarly, a strong economy typically means higher employment and rising wages, which results in greater income tax revenue.
Conversely, during an economic downturn or recession, the opposite is true. As people lose jobs or tighten their belts, consumer spending decreases, leading to a decline in sales and use tax revenue. Likewise, lower employment and stagnant wages reduce the amount of income tax collected. Because the School Aid Fund is so heavily reliant on these economically sensitive taxes, its revenue can fluctuate significantly with the business cycle. This pro-cyclical nature can create challenges in providing stable and predictable funding for schools from year to year.
Guarding Against Uncertainty: The Need for a Healthy Fund Balance
Given the volatility of the state’s main revenue streams, how can school districts protect themselves from funding disruptions? The answer lies in maintaining a healthy “fund balance,” which is essentially a financial cushion or rainy day fund. This balance represents the accumulated difference between a district’s revenues and expenditures over time. It is a critical tool for sound fiscal management, providing a buffer against economic uncertainty.
Financial experts, including the Government Finance Officers Association (GFOA) and Michigan School Business Officials (MSBO), recommend that school districts maintain a fund balance of at least 15% to 20% of their annual operating expenditures. This level is not arbitrary; it is a strategic benchmark designed to ensure stability. A fund balance at or above this level allows a district to manage uneven cash flow throughout the year without having to engage in costly short-term borrowing to meet payroll and pay vendors. More importantly, it provides the necessary resources to weather an economic downturn or an unexpected mid-year cut in state aid without having to make sudden, drastic cuts to staff or student programs.
In Michigan, maintaining a fund balance is also a key indicator of a district’s financial health. The state’s Department of Treasury may flag a district as having potential fiscal stress if its fund balance dips below 5% of its general fund revenues. By keeping reserves above the 15% threshold, districts can safeguard their educational mission from the unpredictable swings of the economy, ensure financial independence, and secure better credit ratings, which lowers borrowing costs for taxpayers on future projects.
The Troy School District’s 2025-2026 Budget Outlook
The principles of fund balances and navigating tight budgets are clearly visible in the recent budget presentation for the Troy School District (TSD). The district’s 2025-2026 budget has been shaped by several key assumptions, including a projected decrease in student enrollment, a topic we explored this past week.
A look at the district’s General Fund budget reveals the pressures these assumptions create. For both the current and upcoming fiscal years, projected expenditures again are set to outpace revenues. In the amended budget for 2024-2025, this results in a negative change in the fund balance of -$3,489,920. The outlook for the 2025-2026 original budget continues this trend, projecting another negative change to the fund balance of -$3,905,550.
This practice of “deficit spending,” where the district must use its savings to cover the gap between spending and incoming revenue, directly illustrates why a healthy fund balance is so essential. The amended 2024-2025 budget is projected to end with a fund balance of 16.8% of expenditures. While the subsequent projected operating deficit will lower the fund balance, it is still projected to be 15.1% at the end of fiscal year 2025-2026. By maintaining a fund balance (barely) above the recommended 15% threshold, TSD apparently believes it can absorb the planned shortfalls and navigate a challenging budget year without jeopardizing core educational services, perfectly demonstrating the principle of a rainy day fund in action.
The Danger of a Structural Deficit on the Eve of a Potential Economic Downturn
TSD’s budget situation highlights a significant risk: a structural deficit. The projected operating deficit of nearly $4 million for 2025-26 comes after the district has already targeted $5 million in unspecified general fund reductions in purchased services. To put the magnitude of this proposed cut into perspective, the district’s total spending on purchased services across all functions in 2023-24 was just over $24 million. This means that even if the district could find a way to reduce this entire category by over 20%, it would still face a significant operating deficit. This shortfall is what will shrink the fund balance from a healthy 16.8% to a precarious 15.1%.
This situation is manageable in a stable or growing economy. However, the prospect of entering a potential recession with an existing structural deficit would be calamitous. The pro-cyclical revenue sources that feed the state’s School Aid Fund would decline, likely leading to state-level funding cuts for districts. This scenario is exactly what happened in 2011-12 when the state cut the per pupil foundation allowance by $470. A cut of that magnitude would cost TSD approximately $5.7 million, which while not likely is a possibility for which it needs a fully stocked rainy day fund. With a fund balance already at the bare minimum recommended level, TSD would have no meaningful cushion to absorb such a shock. In the event of state aid cuts due to a recession, the nearly $4 million projected deficit would quickly balloon, forcing immediate and dramatic cuts to programming and staff to avoid a negative fund balance. That scenario must be avoided at all costs, which can only happen by running a projected balanced budget.
The districtâs recurring deficits have progressively eroded its financial cushion. A fund balance that was once robust enough to withstand significant economic shocks is now projected to be at a level that can only absorb its own planned overspending. Consequently, TSD is not well-positioned to withstand an unexpected negative event, whether it be a recession-driven drop in state funding, a sudden disruption in federal aid, or any other major, unforeseen expense.
A Call for Greater Financial Oversight
A school board’s primary duty is the financial oversight required to protect the district’s educational mission. By repeatedly failing to hold the administration accountable for the structural deficits that erode the fund balance, this board has abdicated that core responsibility. Two recent recommendationsâcreating a standing finance committee for closer scrutiny and appointing a board member as treasurerâare essential steps toward correcting this. We endorse both.
While the board must approve a budget by the June 30th statutory deadline, this cannot be the end of the process. Passing the budget should be coupled with a firm commitment to rigorously study the district’s structural deficit and work with the administration to ensure spending aligns with priorities and long-term stability. The urgency of this situation cannot be overstated. As the recent financial crisis in Ann Arbor demonstrated, even high-performing districts are not immune to the severe consequences of weak board oversight.