Public School Debt Administration [Reprint 2016 ed.] 9781512815146

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PUBLIC SCHOOL DEBT ADMINISTRATION

PUBLIC SCHOOL DEBT ADMINISTRATION WILLIAM B. CASTETTER School of

Education

University

of

Pennsylvania

UNIVERSITY OF PENNSYLVANIA PRESS •

PHILADELPHIA

© 1958, by the Trustees of the University of Pennsylvania Library of Congress Catalogue Card Number: 56-12589 Published in Great Britain, India, and Pakistan by the Oxford University Press London, Bombay, and Karachi

Printed and bound in England by W. & J . Mackay & Co L i d , Chatham

PREFACE T h e first half of the twentieth century has been witness to remarkable social change. T h e increasing complexity of civilization has been accompanied by demands for many new educational services. As educational opportunities are extended, new and additional housing and the provision of special facilities are required. Teachers command higher salaries. Birth rates are increasing. T h e drop-out rate is being sharply curtailed. These and other factors necessitate additional funds. M a n y local school districts cannot provide sufficient funds for satisfactory facilities without going into debt. W h e n and how to go into debt are questions which continually confront boards of education. T o assist them in the solution of these questions is one of the most important duties of the public school administrator as their chief executive. T h e primary purpose of this book is to provide basic background and understanding regarding public school indebtedness. If it promotes the development of sound policies governing debt administration, provides useful techniques and procedures in the operational phases of indebtedness, and serves as a source book for suggestions relative to the many problems involved in the use of public credit, its purpose will have been fulfilled. T h e author wishes to express his appreciation to the many writers and practitioners who have assisted him in the preparation of this text, particularly John J. Scheidel, Henry F. Daum, Frederick W . Hill, Henry H. Linn, and Leon Ovsiew. H e is extremely grateful to his wife, Roberta, for editing the entire text, and to Mary Le Monica and Mary Picado for helpful assistance on secretarial details. WILLIAM B . Ithan,

Pa.

December,

1957. V

CASTETTER

CONTENTS

C H A P T E R

PAGE

P R E F A C E 1

T H E

V

P R O B L E M

OF

D E B T

C O N T R O L

I

Public School Indebtedness Effects of Indebtedness Debt Policy References 2

F U N D A M E N T A L D E B T

CONCEPTS

I 3 4 g OF

PUBLIC

S C H O O L

ADMINISTRATION

10

Reasons for Indebtedness Controls Governing Local Borrowing Financing Capital Improvement Programs Characteristics of Bonds Bond Classification Description of Municipal Bonds Bond Maturities Bond Values in General References 3

PLANNING OF

AND

D E V E L O P I N G

THE

10 12 14 19 22 24 26 34 38

P R O G R A M

IMPROVEMENTS

39

Formulation of Policies Data for Decisions The Budgetary Process and Educational Planning The Capital Budget as a Planning Instrument Lay Participation in Educational Planning Professional Advisory Services References 4

PLANNING

AND

I N T E R P R E T I N G

PROPOSAL

Bond Ordinance or Resolution Contents of the Bond Contract Planning Debt Maturity Schedules Interpreting the Debt Proposal References vii

THE

39 41 47 48 60 61 69

D E B T 71

71 72 81 91 94

CHAPTER 5

PAGE

MARKETING

SCHOOL

BOND

ISSUES

Marketing Preliminaries Some Factors Affecting the Marketability of School Bond Issues Timing the Bond Sale Advertising the Bond Sale Sale Procedures Bidding Procedures Advance Planning Sale Award References 6

SERVICING

INDEBTEDNESS

95

95 96 103 108 115 117 126 128 130 131

Completing the Sale Final Legal Opinion Recording the Bond Issue Making Bond and Interest Payments Canceling Bonds and Coupons Registration of Bonds and Coupons Application of Sale Proceeds Refunding Reporting School Indebtedness Investment of Bond Funds References

131 136 136 137 143 147 149 150 153 158 163

Glossary

165

APPENDIX

A.

B. Tables for Computing Serial Annuity Maturity Schedules

174

C. Annual Interest on $1,000 Bond at Specified Rates of Interest

180

APPENDIX

APPENDIX

INDEX

181

viii

LIST OF TABLES TABLE

I II III

PAGE

Gross Debt of School Districts, 1902-1955

2

Data Illustrating Factors Affecting Ability of Eastern School District to Finance Capital Improvements Nature of State Controls Governing Public School Indebtedness

IV

11

13

Types and Characteristics of Registered Bonds

21

V

Debt Maturity Schedule for Straight-Term Bond Issue

27

VI

Comparative Costs of Four Types of Serial Maturities

30

VII

Sealed Bids Offered on $246,000, Sixteen-year Serial Bond Issue

35

VIII

Comparison of Income and Expenditures, 1953-1958, X School District

51

IX

Comparative T a x Analysis, 1953-1958, X School District

52

Summary of Capital Improvement Needs, X School District, 1958-1964

53

Estimated Annual Receipts and Expenditures, School District, 1958-1964

55

X XI XII

X

Statistical Summary of Proposed Capital Expenditures, 1958-1964, X School District

56

XIII

Debt Service Requirements, X School District

82

XIV

Advantages and Limitations of Four Types of Serial Maturities

86

Debt Maturity Schedule for Serial Annuity Bond Issue

88

Sealed Bids Offered on a $246,000, Sixteen-year School Bond Issue (Serial Type)

120

Total Bond Years on a $246,000, Sixteen-year School Bond Issue

121

XV XVI XVII

TABLE

XVIII XIX XX XXI XXII XXIII XXIV

PAGE

Net Interest Cost to School District on Each Bid Submitted

122

Method for Checking Accuracy of the Best Bid

12 3

Bids Offered on a $246,000, Sixteen-year School Bond Issue (Serial Type)

124

Total Interest Cost to School District on Each Bid Submitted

125

Net Interest Cost and Net Interest Rate to School District on Each Bid Submitted

125

Sample Worksheet to Compute Total Interest Costs of a $246,000 Bond Issue at Varying Interest Rates

126

Sample Worksheet Used to Compare Bids Submitted on a $246,000, Sixteen-year Serial Bond Issue

XXV XXVI XXVII XXVIII XXIX XXX XXXI XXXII XXXIII

127

Printing Costs of Forty-two School Bond Issues

133

Schedule of Bond and Coupon Payments

139

Bonded Debt in Thousands, Abington Township School District

140

Bond Maturity Calendar, School District

140

Abington

Township

Bond Interest Calendar, Abington Township School District

141

Schedule of Debt Retirement by Thousands, School District of Abington Township

156

Outstanding Township

157

Debt,

School District of Abington

Debt Service Requirements, Abington Township

School

District

of

Annual Interest Payments Required, School District of Abington Township

X

158 159

LIST OF FIGURES

FIGURE

PAGE

1

Portion of Bond Sale Notice Illustrating Call Features

33

2

Sample Practice Illustrating Formation of Citizens Advisory Groups

61

Sample Page from a Report Illustrating Co-operative School Planning Involving Board of Education, University, Lay Advisory Groups, Citizens, and Teachers

62

4

Sample Page from a Report Illustrating the Role of the Educational Consultant

63

5

DO's and DONT's for Planning the School Plant

64

6

Section of Bond Resolution Maturities

3

7

Illustrating

"Round

Lot" 77

Registration Form on Reverse Side of Bond Issued by X School District

80

Legal Investment Status of Municipal Bond Issues Scheduled for Sale

101

Bond Buyer Index of the Visible Supply of Municipal Bonds

105

10

Municipal Bond Statistics

107

11

Bond Buyer Calendar of Sealed Bid Openings

109

12

School Bond Sale Notice

113

13

Illustration of Bidding Specifications Contained in Sale

8 9

Notice

118

14

Bid Proposal Form

119

15

Form Sheet Sent to Unsuccessful Bidders by X District

16

Illustration of Bond Issue Calendar

134

17

Bond Issue Brief, X School District

138

xi

School

129

FIOURE

P

18

Report from Paying Agent

19

Cremation Certificate Form Used by Fiscal Agency Division, Manufacturers Trust Company, New York City

20

Excerpts from Resolution Authorizing Issuance of Refunding Bonds

xii

I. THE PROBLEM OF DEBT CONTROL

A study of the history of any school district will reveal a series of fiscal problems, the solution of which has involved the use of borrowed money. School buildings must be replaced or modernized. C o m m u n i t y expansion calls for the acquisition of new sites a n d the erection of new buildings or additions to existing structures. School buses must be added or replaced. T a x revenues decrease, forcing postponement of debt payments. These experiences occur regularly in the life of every school administrator. T h e y usually involve capital improvements of one kind or another, funds for which generally cannot be taken f r o m the current budget or provided by any other financial scheme except borrowing. T h e customary solution is a resort to long- or short-term borrowing. But the use of public credit for public school improvements often creates its own problems. This book has been p r o m p t e d by the conviction t h a t public school debt administration and, concomitantly, public school administration, could be improved if the principles and techniques of public school indebtedness were better understood. Its p r i m a r y aim is to provide suggestions and successful practices which will be of assistance to school officials in the development of sound programs for financing school capital improvements. This chapter lays the groundwork for an examination of public school debt administration. It analyzes the reasons for indebtedness, its n a t u r e and scope, as well as its implications. I n addition, an outline of guiding principles is offered as a basis for controlling indebtedness. PUBLIC SCHOOL INDEBTEDNESS

Growth of Public School Debt. Responsibility for financing American

2

Public School Debt

Administration

public education now rests largely in the hands of local communities. Local educational authorities, operating within the state legal structure, determine annually the amount of money to be raised locally and the purposes for which it is to be spent. When school revenues are insufficient to provide for community educational needs, local boards may, within limitations, engage in long- or short-term financing to meet those requirements. Despite attendant difficulties, the practice of borrowing money for educational purposes has become so thoroughly established that it now appears to be a normal function of school boards, particularly in financing capital improvement programs. The basis for this custom stems from the traditional premise that school plant and equipment are local responsibilities. Many local school districts, however, have not been able to provide respectable school plants, chiefly because of the narrow tax base to which they are confined, bonding restrictions, and the increased costs of school construction. While there is a tendency in some states to support the concept that equalization of educational opportunity involves financial provision for school plant and equipment in the state foundation program, it is quite likely that borrowing for capital improvements will remain an essential element in school financial programs. The growth of gross indebtedness of school districts TABLE I since the turn of the century Gross Debts of School Districts» i902-i955 is shown in Table I. Analysis of the data reveals that the Year Indebtedness gross indebtedness of school $ 46,000,000 1902 districts reached an all-time 119,000,000 1912 1922 1,127,000,000 high in 1955, exceeding the 2,170,000,000 1932 peak indebtedness of the de1,701,000,000 '942 pression era by more than five 3,801,000,000 1952 4,712,000,000 '953 billion dollars. In 1955 gross 5,923,000,000 '954 debts of school districts were 7,259,000,000 1955 21 per cent of all local government debts * T h e T a x F o u n d a t i o n - Faets and Figures cm Government Finance. New York: Data prepared by the U.S. the Foundation, 1956. p. 184.

The Problem of Debt Control

3

Office of Education indicate that by the end of 1965, not less than 950,000 new class rooms will be needed to house American school children. Based on cost factors developed by the Office of Education in its School Facilities Survey, 5 the 950,000 classrooms will cost $32 billion. If only a modest amount of the $32 billion is provided through public borrowing, school indebtedness will increase substantially. EFFECTS OF INDEBTEDNESS

Abuses of Public Credit. T h e cumulative effects of indebtedness for public education are not always favorable, despite educational improvements made possible by its use. T h e composition of local school boards is such that few members are prepared initially, or remain in office long enough, to cope with debt administration in all its ramifications. Consequently, blunders are committed in local financial operations to such an extent that the courts and state agencies are frequently engaged in righting financial malpractices. Moreover, payment of maturing bonds and interest has necessitated, in some instances, drastic cuts in school current budgets, resulting in curtailed educational programs, salary reductions, heavier teaching loads, and demands for general retrenchment. No one will argue that school systems exist for the sake of paying interest. Y e t this is what actually takes place in some districts when the support of the functions which make the school system worth maintaining in the first place becomes subordinate to the payment of heavy debt requirements. T h a t there is need in school administration for better understanding of principles and procedures underlying debt management can scarcely be questioned. Unsound debt administration creates conditions conducive to waste and misuse of public funds, reduced credit standings, fewer educational opportunities, demands for retrenchment, financial losses to investors and bond brokers, and a host of other factors which ultimately affect the welfare of the school child and defeat the purposes for which the school exists.

Public School Debt Administration

4 DEBT

POLICY

Guiding Principles. Few, if any, school debt proposals are approved without question. Board members, the laity, realtors, economy and taxpayers associations, the press, as well as other interested parties are likely to give serious consideration to any plan of indebtedness which involves public taxation. This is quite proper. Financial commitments have economic consequences in the community, a condition which inevitably leads to critical review of administrative and fiscal policy. Public review of local financial policy is, in essence, an audit of board of education judgment. In any evaluation of debt policy, certain critical questions arise. These questions lead directly to an assessment of the soundness of the debt policy being followed. No attempt is made here to define what local debt policy should be for any community. Rather, an outline is sketched to focus attention on certain important debt principles which may serve as a guide to the administrator in planning a sound financial program. i. Is there a reliable body of evidence to justify clearly the creation of indebtedness? Indebtedness of school systems can be categorized into the following general purposes: (a) capital improvements; (b) funding; (c) refunding; (d) operating expenses. Before any one or any combination of these forms of debt is created, a clear-cut case of need should be established. Furthermore, need should be assessed in light of its contribution to the purposes for which the school exists. Case studies in many communities indicate that indebtedness is often created to pay for elaborate and expensive stadiums, gymnasiums, and other capital outlays which have been undertaken in spite of serious impoverishment of the total educational program. It is "need" of this type which is educationally indefensible. Capital improvements are usually necessary because of an increasing school population, obsolescent buildings, or changes in the educational program. The primary duty of school officials is to determine whether or not the need exists for such improvements. Survey reports, population predictions, and all other available

The Problem of Debt Control

5

evidence should be gathered and appraised with a view toward the establishment of need. This step should precede any consideration of financial planning. If need for an improvement is established, exhaustive analysis of methods of financing the improvement should be initiated. It goes without saying that indebtedness should be avoided, if at all possible. For example, in some states funds are allotted to local school districts for capital improvements. If the state is willing to share in the improvement, indebtedness may be avoided by combining state funds with those derived from a pay-as-you-go policy. In establishing need, the matter of larger school administrative units should not be overlooked. Traditionally, small units have been unwilling to give up their identity voluntarily to become a part of a larger unit. In such cases, the narrow tax base often limits the method of paying for school improvements to long-term borrowing, with the inevitable consequences of high debt service charges and other concomitant predicaments. Indebtedness for operating expenses, funding temporary debt, or refunding long-term debt should be analyzed critically. It is a cardinal principle of public finance that operating expenses should be met from current revenues. Borrowing for operating expenses may be justified if tax collection dates and the school fiscal year are not identical. There is also a case for borrowing for operating expenses when unforeseen emergencies arise, since they inevitably occur in any financial endeavor. Funding of floating debt, however, is a practice which often indicates a breakdown in budgetary control. Loan companies often solicit business on the basis that it is quite convenient to pay off all small debts with one large loan. While there is no question about convenience, there is the problem of financial bankruptcy if this practice were condoned in a financial enterprise which must balance revenues and expenditures. Where the question of funding arises, every effort should be made to scrutinize the reasons for a financial condition which eventually will lead to perpetual debt and a neglected educational program. Payment of a debt at the time it matures is sometimes postponed for lack of funds, inconvenience, or other reasons. This deferment

6

Public School Debt Administration

of debt payment is accomplished by the issuance of new bonds to take the place of those falling due. This scheme of debt extension is known as refunding, and has often been used when term or sinking-fund bonds have been issued and funds have not been set aside for bond retirement. The type of refunding mentioned above is generally the aftermath of a hastily planned debt program. While refunding is advantageous when postponement of debt will enable the school district to effect a more orderly plan of debt retirement, the plan should be reviewed carefully before it is adopted. The convenience of debt postponement is a luxury which civil units of government can ill afford, since they do not operate for financial profit. The expensive interest costs which are entailed in floating a bond issue which later must be refunded for an extended period warrants careful re-examination of the factors which produce a refunding operation. A procedure which tends to eliminate much of the guesswork in debt policy is the development of a capital budget, which, in effect, is a long-term plan indicating the capital needs of a school district for a period of five or six years. Such a budget also contains a financial plan for paying for the projected improvements. When reviewed periodically, the capital budget will prove to be a most useful instrument in establishing both needs and debt policies. This matter is discussed in detail in Chapter 3. 2. Have all legal methods of creating indebtedness been analyzed to determine which is the most feasible and economical? In some circles the notion exists that all capital improvements should be financed by long-term borrowing. While it is true that most capital programs are financed by long-term loans, there is nothing inherent in a capital outlay program which dictates a particular method of borrowing. Let us examine the various methods of financing a school building. These may include direct taxation (pay-as-you-go), the accumulation plan (reserve fund), and short- or long-term borrowing plans. Long-term borrowing includes such methods as the issuance of bonds, state loan funds,

The Problem of Debt Control

7

local corporation, and creation of a local authority. It is quite conceivable that any one or any combination of methods might be employed in financing capital needs. For some districts, especially those which have continuous building needs, a pay-as-you-go plan may be preferable to borrowing. In other districts, a combination pay-as-you-go and long-term borrowing plan may be far from visionary. The use of short-term loans or reserve funds for sites, buses, and certain types of expensive equipment will minimize debt service charges. Consequently, the methods of financing to be employed should be based on hard facts, not convenience. That plan should be given priority which is most economical and compatible with district financial ability. 3. What is the minimum length of time in which the indebtedness can be liquidated? There is no precise index for measuring the term for which indebtedness should be contracted. The following opinions are common: a. Twenty-five per cent of the debt should be retired within a five-year period. This is tantamount to the provision which holds that school indebtedness should be liquidated within a period of twenty years. b. The life of the debt should not exceed the life of the improvement. While these rules of thumb may be appropriate, it is quite apparent that they cannot be followed blindly. For example, the estimated useful life of a school building is fifty years. If the latter index were followed, many school districts would be in perpetual debt. In many cases, the practice which is followed is that of taking advantage of the maximum term of indebtedness permitted by law. Because the statutes permit bond issues to run for thirty years, this maximum term is often adopted by school districts. A more realistic index than the foregoing is district financial ability. If indebtedness can be retired within a ten-year period without affecting unduly the educational program or the debt margin, why should a longer term be necessary?

8

Public School Debt Administration

4. What are the effects of the scheme of indebtedness upon (a) the educational program; (b) the debt structure; (c) future improvements; (d) tax rates; (e) interest rate; (f) progressive debt reduction; (g) debt margin? The ramifications of indebtedness are many and varied, and the effects frequently negative in character unless considerable care is exercised in the planning stages. At the risk of repeating a cliché, it should be noted that the school exists for the welfare of the child, not for the purpose of paying off indebtedness. The effect of indebtedness upon the educational program, therefore, must be studied to prevent the development of a condition which draws off an abnormal amount of the school budget for debt service charges. The danger point is at hand when debt service charges consume more than 20 to 25 per cent of the total school budget. A cardinal objective of fiscal management should be the establishment of fiscal policies which will ensure an educational program of high quality. The total debt picture—past, present, and future—weighs heavily in the creation of new indebtedness. What the proposed debt will mean in terms of existing commitments, and in terms of anticipated improvements, must be determined in order to judge the propriety of an additional debt burden. If, for example, the proposed debt will mean serious irregularity of principal and interest payments in the debt structure, tax rates will inevitably be inordinate at varying retirement periods. Then, too, the effect of a proposed debt may be such that future borrowings are neither fiscally nor politically feasible. In summary, if fiscal conditions in a given community are such that there is no alternative to borrowing, the objective of sound debt policy should be to keep the cost of borrowing as low as possible. The policy should seek to maintain stability in the tax structure, provide for progressive debt reduction and some leeway for future borrowing.

The Problem of Debt Control

9

REFERENCES 1

2

3

4

5

Johns, R . L., and M o r p h e t , E d g a r L . '"Financial S u p p o r t . " Review of Educational Research 22, O c t o b e r , 1952, 298-310. L i n d m a n , Erick L . , et al. State Provisions for Financing Public-School Capital Outlay Programs. W a s h i n g t o n : U . S . G o v e r n m e n t Printing Office, 1951. Linn, H e n r y H . , et al. School Business Administration. N e w Y o r k : R o n a l d Press, 1956. Miller, V a n , and S p a l d i n g , W i l l a r d B. The Public Administration of American Schools. N e w Y o r k : W o r l d Book C o . , 1952. National Citizens Commission for the Public Schools. Financing Public Education in the Decade Ahead. N e w Y o r k : the Commission, 1954, p. 36.

6

7

8

9

National Citizens Commission for the Public Schools. How Do We Pay For Our Schools? N e w Y o r k : the Commission, 1954. National C o n f e r e n c e of Frofessors of E d u c a t i o n a l Administration. Problems and Issues in Public School Finance. N e w Y o r k : Distributed by the B u r e a u of Publications, T e a c h e r s College, C o l u m b i a U n i versity, 1952. N e w Y o r k Commission on School Buildings. More Schools for Your Money. A l b a n y : the Commission, 1954. U . S . D e p a r t m e n t of Health, E d u c a t i o n , a n d Welfare. Public School Finance Programs of the United States. W a s h i n g t o n : U . S . G o v e r n m e n t Printing O f f i c e , 1955.

2. FUNDAMENTAL CONCEPTS OF PUBLIC SCHOOL DEBT ADMINISTRATION

REASONS FOR

INDEBTEDNESS

Contributing Factors. It is quite reasonable to assume that local boards of education should not borrow money unless borrowing is absolutely necessary. It is equally logical to assume that if the general public were aware of certain forces, factors, and conditions in our present tax and organizational structures, it would realize all too quickly that for many schools the only solution to the financial aspects of school plant problems is to create indebtedness. Some of the factors which force indebtedness upon local school districts may be understood more readily by examination of Table II, which provides data relevant to a school plant problem in Eastern School District. Analysis of these data reveals the following observations: Funds for new buildings must be obtained almost exclusively from the general property tax. Assessed valuations are at a small percentage of their true valuation. Increases in assessed valuations per pupil have not kept pace with assessed valuations. Increases in assessed valuations have not kept pace with increases in school construction costs. Eastern School District needs $500,000 for the improvement program. Its legal borrowing power is only $187,877. Debt service costs in Eastern School District affect the amount of funds available for the educational program. 10

Fundamental

Concepts of Public School Debt Administration

11

If further debt is created, tax rate for debt service will rise discernibly, imposing additional handicaps on the educational program. The small size of Eastern School District raises the question as to whether it will ever have a tax base large enough to provide an adequate educational program. TABLE

II

D a t a Illustrating Factors Affecting Ability of Eastern School District to F i n a n c e Capital I m p r o v e m e n t s Indebtedness Net d e b t , J a n u a r y I, 1957 Legal borrowing capacity R a t i o of debt service to total school costs Taxation Assessed valuation M a r k e t valuation R a t i o of assessed valuation to market valuation School district tax rate (dollars per t h o u s a n d ) T o w n s h i p tax rate dollars per thousand) C o u n t y tax rate 'dollars per thousand) Increase in assessed valuations (1947-57) Increase in assessed valuations per pupil (1947-57)

$

$ 6,707.765 21,094,083 .32 ( 3 2 % ) 3'-00 6.50 1.50 59% '3%

Pupil Population K.-12 K-6 7-9 10-12 School Plant Average age of elementary school buildings C a p a c i t y of j u n i o r high school Senior high school students sent to n e i g h b o r i n g high school on tuition basis Estimated cost of proposed improvements

298,850 187,877 .30 (30%)

986 594 219 173 53 years 300 pupils

$

177 pupils 500,000

The situation reported above, which reflects some of the underlying reasons for the use of public credit by boards of education, is by no means unique. There are literally hundreds of school districts in the nation which are forced, during periods of high prices, to construct buildings, payment for which is based upon the productivity of the general property tax. This fact, coupled with rigid state constitutional and statutory limits governing indebtedness and the reluctance of most states to appropriate funds for

Public School Debt

Administration

capital expenditures in the state foundation program, leaves no alternative to borrowing for vast numbers of districts. 11 CONTROLS GOVERNING LOCAL

BORROWING

Reasons for Controls. T h e power to incur indebtedness for school purposes is generally conferred upon local educational authorities by legislative enactment. This legal authorization to use public credit, however, is hedged with numerous state constitutional and statutory restrictions. T h e development of legal restrictions governing municipal indebtedness, especially as they apply to the issuance of bonds, parallels roughly the growth of urban centers in the United States. Shifting of the rural population to u r b a n centers m a d e vast capital extensions necessary in school and other public services. Since these services could not be provided completely without resort to borrowing, the several civil subdivisions of the various states were forced to issue bonds to help pay for needed improvements. U n fortunately, the results of large-scale borrowing by local units of government, especially since the Civil War, have not always been favorable. I n a d e q u a t e state supervision of local indebtedness, h a p h a z a r d accounting methods, borrowing to meet current expenses, and other undesirable financial practices caused m a n y municipalities to become so heavily indebted that they were forced to default on both principal and interest payments, especially in times of economic stress. O t h e r communities, through legal loopholes, plainly refused to meet their financial obligations. Consequently, bondholders suffered financial losses, which in turn gave rise to doubts in the minds of investors as to the merits of municipal bonds for investment purposes. 4 I n order to curb financial recklessness such as that referred to above, most states have placed certain legal restrictions on municipal indebtedness. Legal revisions in laws governing the issuance of municipal bonds have been directed primarily toward protection of community credit and financial stability, and protection of bondholders. T h e position of distinction which municipal bonds now occupy in the investment world can be attributed partly to the influence of improved legal controls. O n the other h a n d , debt

Fundamental

Concepts of Public

School

Debt

Administration

13

a n d tax limitations frequently have prevented the development of seriously needed school plant programs. As a matter of fact, some of the existing limitations are so rigid, negative, and archaic in form that a re-examination of the entire problem of financial controls appears to be in order. Types of Controls. Types of state constitutional and statutory controls governing local school indebtedness are listed in T a b l e I I I . Inspection of T a b l e III reveals that constitutional controls consist T A B L E III

Nature of State Controls Governing Public School Indebtedness Constitutional 1. Limits bonded indebtedness 2.

L i m i t s local t a x levies

Statutory 3.

B o n d issues r e g u l a t e d P u r p o s e s restricted Total debt limited F i n a l c h e c k o n a u t h o r i z a t i o n b y state a u t h o r i t y r e q u i r e d Selling below par prohibited M a x i m u m interest rates set T a x levies for d e b t service r e q u i r e d T a x l e v y for d e b t s e r v i c e l i m i t e d Serial b o n d s r e q u i r e d S t a t e a p p r o v a l m u s t be o b t a i n e d before election T i m e limit o n m a t u r i t y set B o n d s m u s t be issued by a n o n - s c h o o l a g e n c y Denomination limited P u b l i c v o t e to a u t h o r i z e r e q u i r e d B o n d s m u s t first b e o f f e r e d to state a g e n c i e s S t a t e assists w i t h t h e sale o f t h e b o n d s 4. S h o r t - t e r m l o a n s r e g u l a t e d Purpose o f loans limited A m o u n t of loans limited Provisions m a d e f o r p a y m e n t M a x i m u m interest r a t e set Sale price of warrants limited P e n a l t y set for n o n p a y m e n t

largely of limitations governing the bonded indebtedness which school districts may incur, and restraints on the amount of taxes which may be levied for school purposes. Statutory controls governing school bond issues, on the other hand, are numerous and detailed, and in some states exceedingly rigid.

Public School Debt

•4

Administration

Court Decisions. In addition to the controls exercised over public school finance by state constitutions, statutes, state agencies, and local regulations, a considerable body of legal principles has developed over the years to exert profound effect upon fiscal procedures of school districts and other units of local government. T h e r e are legal decisions* affecting every phase of the life history of indebtedness—from legal inception to retirement. T h e legal intricacies involved in borrowing are such that school officials should not attempt to create indebtedness without legal advice. It is quite difficult, for example, to market school bonds on a competitive basis without an a c c o m p a n y i n g legal opinion. FINANCING

CAPITAL IMPROVEMENT

PROGRAMS

Types of Financial Plans. W h e n school capital improvements are planned, such as the acquisition of sites, or the construction of new buildings, decisions must be m a d e by the board of education concerning the method of p a y i n g for the proposed improvements. C h a r t i n g a financial course involves consideration of numerous factors which are not readily reduced to mathematical formulae. A decision of cardinal importance, one that is basic to the development of any financial plan, centers around a familiar financial p r o b l e m — t o borrow or not to borrow. Before a financial p r o g r a m is adopted, local boards of education should investigate the methods by which capital improvements can be provided. T h r e e types of plans frequently used b y local boards of education for financing school plant construction are: ( i ) pay-as-you-go plan, (2) accumulation plan, (3) short- or longterm plans. Selection of any one or any combination of these financial mechanisms is no easy matter, for it poses questions of law, history, education, economics, sociology, and politics—questions which can be answered satisfactorily only after careful analysis of the socio-economic conditions in the community. • S e e G a r b e r , Lee O . Tear Book of School Law. Danville, 111.: I n t e r s t a t e

Printers and Publishers. An annual publication which considers all decisions rendered by the higher courts relating to school law handed down during the preceding year.

Fundamental Concepts of Public School Debt Administration

15

Pay-As-You-Go Plan. T h e pay-as-you-go plan is based u p o n the theory t h a t capital improvement programs should be paid for f r o m tax proceeds during the period in which the improvements are m a d e . This plan has both proponents a n d opponents, the claims of which are useful only when considered in terms of the capital improvement needs and financial conditions prevalent in a given situation. T h e plan is most practical in large cities in which the taxable strength can provide a d e q u a t e funds, a n d where improvement programs are continuously in operation. I n some instances, use of the pay-as-you-go plan m a y be more a d v a n tageous t h a n the reserve or b o n d i n g plans. Success of the plan depends upon relatively large tax collections over a short period of time. If calculated tax revenues are not forthcoming, serious consequences are likely to develop. This plan is not predicated u p o n the idea that f u t u r e generations, which benefit f r o m the improvements, should share any of the financial b u r d e n . T h e r e is considerable justification for use of the pay-as-you-go plan in public school finance, although it has been employed infrequently by local boards of education. Certainly the plan deserves consideration in terms of economy, prevention of extravagance, and protection of the credit of the school district. In the last analysis, the pay-as-you-go plan is closely linked with the financial status of the district. W h e r e debt service charges are not relatively large, the pay-as-you-go policy for certain types of capital improvements may well be employed. Acquisition of sites, extensions, additions and reconditioning of buildings are examples of improvements which are sometimes financed by current taxation. If the financial status of the school district does not permit complete financing of a proposed i m p r o v e m e n t by taxation, a combination of pay-as-you-go and borrowing plans m a y be used. Certain phases of the p r o g r a m then m a y be accomplished by current taxation, others by borrowing. I n effect, if improvement needs can be accomplished by the signing of checks, w h y should a school administrator prefer to accomplish the same objective by the signing of bonds ? T h e former method, to be sure, has numerous advantages.

i6

Public School Debt Administration

The Accumulation Plan. T h e basic idea behind the accumulation or reserve fund plan is that of setting aside in advance sufficient funds to finance anticipated expenditures. This plan has some advantages, especially during periods when tax collections, interest rates, labor, and construction costs are abnormally high. In smaller school districts where capital improvement needs are infrequent, and the pay-as-you-go plan will not produce adequate funds, the accumulation plan warrants serious consideration. When the accumulation plan cannot be used exclusively, it is sometimes combined with a bonding plan, wherein a part of the cost of the improvement program is provided by taxation in advance of construction, while the remainder of the cost is met by borrowing. The plan is also feasible in large school districts, especially during a transition to a pay-as-you-go policy. In such instances a certain amount of the tax dollar is set aside each year for permanent improvements. It is not unusual to find in educational literature in particular, and in the press in general, numerous examples of fraud, misuse, and mismanagement in connection with administration of reserve funds. Because of such experiences the creation of reserve funds has been looked upon with disdain, and prohibited by law in certain states. In recent years, however, a renewed interest has developed in the creation of reserve funds. Burke 1 points out: In 1938, no state authorized municipalities to create building reserves. By 1 9 5 1 , over half the states had granted such powers to municipalities, and some states have given this power to school districts. Approximately half the states have prohibited sinking funds for schools. T h e fact that reserve funds frequently have been mismanaged in no way alters the value of the plan in financing capital improvement programs. With proper legal safeguards and effective financial management, there is no reason why the accumulation plan should not become a useful instrument in local school finance. It should be added, in passing, that reserve funds have been administered successfully in many school districts throughout the country.

Fundamental Concepts of Public School Debt Administration

17

Short- and Long- Term Borrowing. T h e a l t e r n a t i v e to p a y - a s - y o u - g o or reserve f u n d f i n a n c i n g is b o r r o w i n g , the d u r a t i o n o f w h i c h is c o n d i t i o n e d b y s u c h factors as b o a r d o f e d u c a t i o n fiscal p o l i c y , l e g a l restrictions, a n d financial a b i l i t y o f the school district. A s o f 1 9 4 9 - 5 0 , f o r t y - o n e o f the f o r t y - e i g h t states m a d e p u b l i c s c h o o l s h o r t - t e r m d e b t l e g a l l y i n c u r r a b l e in a n t i c i p a t i o n o f c u r r e n t revenues.8 T h e p u r p o s e for w h i c h s u c h loans are u s u a l l y i n c u r r e d i n c l u d e : b o r r o w i n g in a n t i c i p a t i o n o f c u r r e n t r e v e n u e s ; b o r r o w i n g in a n t i c i p a t i o n o f b o n d issues; b o r r o w i n g for e m e r g e n c i e s . T h e s h o r t - t e r m l o a n , w h i c h usually m a t u r e s w i t h i n a y e a r a f t e r it is c r e a t e d , * is a h e l p f u l i n s t r u m e n t in l o c a l

finance,

b u t its use

must be carefully scrutinized. C h r o n i c borrowing on a short-term basis is h a r d l y i n d i c a t i v e o f s o u n d

financial

administration.

N o r m a l l y , c a p i t a l i m p r o v e m e n t p r o j e c t s are f i n a n c e d b y b o n d issues w h i c h c a n b e d e s c r i b e d as b o r r o w i n g o n a l o n g - t e r m basis. T h e r e a r e occasions, h o w e v e r , w h e n the use o f s h o r t - t e r m loans for i m p r o v e m e n t p u r p o s e s m a y be c o n s i d e r e d as p r u d e n t

financial

policy.® Interest rates o n s h o r t - t e r m loans are o c c a s i o n a l l y l o w e r t h a n those o n l o n g - t e r m loans. W h e r e the p r o j e c t to be

financed

does not r e q u i r e a n e x c e p t i o n a l l y l a r g e e x p e n d i t u r e o f f u n d s , the possibility o f s h o r t - t e r m

financing

s h o u l d b e i n v e s t i g a t e d , for the

savings e f f e c t e d b y this m e t h o d as c o m p a r e d to b o n d i n g m a y b e substantial. B u i l d i n g e q u i p m e n t , m i n o r a l t e r a t i o n s or r e p a i r s to the school p l a n t , a n d school buses a r e f r e q u e n t l y

financed

by

s h o r t - t e r m loans in p r e f e r e n c e to b o n d i n g . T h e feasibility o f s h o r t - t e r m f i n a n c i n g d u r i n g t h e early stages o f a school b u i l d i n g p r o g r a m is d e s c r i b e d b y L i n n : 7 Even w h e n interest rates are low, under certain conditions it m a y prove advantageous to arrange short-term loans to finance building projects. A bond issue for a school building may be approved by the electors, but it m a y take a year or more to complete the project. If the bonds are sold before the construction begins, the officials have on hand for many months a larger amount of money than they need to meet partial payments to contractors. As a rule, this money cannot be • Refers to short-term loans for current expenses. Should be distinguished from short-term loans for capital improvements.

18

Public School Debt Administration

invested to produce returns that equal the interest that must be paid on the bonds during the interim. Thus the taxpayers may be paying 4J per cent interest on borrowed money and may be receiving only 2 per cent on a part of the borrowed sum. If the money is deposited in a bank without proper security, there is an added element of risk in the event of bank failure. Under these conditions it may be more advantageous to arrange short-term loans to meet payments to building contractors during the course of construction, and to sell the bonds when the building projects nears completion. Long-Term Borrowing. Long-term borrowing usually indicates a loan which runs for a period of five or more years. Such indebtedness is usually incurred by issuing bonds, but in certain states it may be negotiated by borrowing funds from state agencies created for this purpose. Likewise, in certain states long-term loans may be arranged by the creation of holding companies, or by borrowing funds from a public authority. Bonding as a method of financing capital outlays is used more frequently than any other plan. One of the reasons why the bonding plan is so widespread grows out of the concept of financing school plant construction which prevailed until recent years. This concept held that provision for school plant construction was a local, not a state responsibility. Within the past three decades, however, the idea that the state should share in providing funds for the school plant has been gaining favor in public school finance. I n a few states, provisions for school plant construction are included in the state foundation program. Criticisms frequently leveled at bonding programs are: (1) bonding makes for extravagance; (2) the plan induces delay in debt retirement through the mechanism of refunding; (3) debt service charges on bonding are too expensive for a public concern, which does not operate, like a private concern, on a profit and loss basis. Whether or not bonding should be resorted to is, like any of the foregoing plans, a matter that can be decided only when the plan is studied in the light of the community financial setting. Bonding spreads the total cost over a period of years, a n d places part of the financial burden on future generations which will enjoy

Fundamental Concepts of Public School Debt Administration

the i m p r o v e m e n t s purchased. T a x fluenced

rates generally are not

19

in-

u n d u l y by b o n d i n g programs, nor is the t a x p a y e r de-

prived of the use of a certain a m o u n t of his m o n e y , w h i c h w o u l d be the case u n d e r the plan of p a y i n g for improvements from current revenues. W h i l e the pay-as-you-go and a c c u m u l a t i o n plans are feasible u n d e r certain conditions, it is difficult to i m a g i n e the elimination of b o r r o w i n g from the local school finance structure under present conditions, regardless of its limitations. E a c h of the foregoing plans for

financing

improvements c a n

be used to a d v a n t a g e under certain conditions. N o one p l a n is exclusively superior or inferior

per se. In the final analysis, the

success o f any plan, or combination of plans, hinges to a considerable extent on the c o m p e t e n c y of school officials responsible for p l a n n i n g a n d m a n a g i n g school business affairs. C H A R A C T E R I S T I C S OF BONDS

Definition. T h e difficulties encountered in defining a bond are comparable to the problems involved in stating exactly the m e a n i n g o f the " a v e r a g e m a n . " T h e r e are m a n y different kinds of bonds, issued for m a n y different purposes, under widely v a r y i n g circumstances. F o r example, one reference source 3 contains more than one h u n d r e d definitions pertaining to bonds of various types. T h e general characteristics of a bond are well k n o w n , however, a n d are reviewed briefly b e l o w : In general, a bond is a formal written obligation, given u n d e r seal, specifying the conditions under w h i c h a loan is to be repaid. A s a rule, bonds contain a promise to p a y : (1) A fixed sum of money at a given time in the future, called the principal, or par. (2) A

fixed

rate of interest, p a y a b l e at stipulated intervals,

usually semiannually. T h e difference between a bond and a note is largely a matter o f the length of time in w h i c h the loan is to be repaid. Notes are generally looked upon as temporary obligations to be repaid within a short period of time. T h e y are usually used to meet current operating expenditures. A bond is a m u c h more formal obligation because of the specific legal sanctions on w h i c h it rests. Bonds are

20

Public School Debt Administration

ordinarily used to secure money for capital improvements, and are usually issued for relatively long terms and for comparatively large sums of money. There is a more fundamental difference, however, between a bond and a share of stock. A share of stock entitles the purchaser to share in the ownership of the business in which his money is invested. A bondholder owns no share of the business, since he simply lends his money to a business or corporation as a creditor for a specified time. Denomination. The word "denomination" refers to the face or par value of a bond. By custom, bonds are issued in denominations of $1,000. But the reader should not infer that bonds are circulated exclusively in units of $1,000. Bonds are often placed on the market in denominations below or above this amount, depending in part upon the size of the loan. If, for example, the total cost of a school building amounts to §98,500, and it is decided to issue bonds for exactly this amount, one or more odd denominations will have to be issued. Such odd amounts are usually retired early in the life of the issue. The market for odd denominations is limited, and the price of such bonds may rise slightly above the cost of standard $1,000 pieces. On the other hand, bonds may be purposely issued in amounts of $100, $500, or $1500 to meet the needs of certain types of investors. Ordinarily this procedure is not advisable. It is employed on occasion, when it is reasonably certain that the bonds cannot be sold in the open market, and there is a possibility that the bonds can be absorbed locally. Bond Interest. Interest on bonds is usually payable semiannually. Quarterly payments were popular at one time, but the cost of collection fees and the detailed records to be kept led to the establishment of semiannual interest payments as standard financial practice. T o facilitate payment of bond interest, most bonds, especially those in denominations of $1,000, have coupons attached to the bond proper. These coupons are numbered serially, and bear the interest date and amount of interest due. As the coupons fall due,

Fundamental Concepts of Public School Debt Administration

21

they are detached from the bond and presented at the place designated for payment, which is usually a bank or trust company. Bonds which have such coupons attached are called coupon bonds. From a legal standpoint, bond coupons are negotiable instruments, that is, they can be transferred from one person to another by directly passing from hand to hand, as in the case of money or a check m a d e payable to " b e a r e r " or "cash." Bond Registration. T h e amount of money invested in a bond is such that certain procedures have been developed to provide security to the bondholder in case of theft or loss. T h e bond text usually contains a clause giving the bond purchaser the option of registering the bond. If the bondholder chooses to register his bond, the ownership of the bond is recorded on the books of the bond-issuing body. Ownership of the bond can be changed on the books only after proper legal notice is received from the registered owner. When a bond is registered, the name of the owner is inserted on the face of the bond. After a bond is registered, ownership can be transferred only by the endorsement of the registered owner in the space provided for that purpose on the reverse side of the bond. T h e bond to be transferred must then be sent to the registrar or transfer agent for re-registration, at which time a new bond will be issued or the new owner's name endorsed on the original bond. The various forms of registered bonds are listed in Table I V . According to this table, a bond may be registered as to principal only, or it may be fully registered as to both principal and interest. TABLE

IV

Types and Characteristics of Registered Bonds Types of Registered Bonds

Conditions Attending Payment of Principal

Conditions Attending Payment of Interest

Bonds registered as to principal only.

Principal payable at maturity only to registered owner; bonds are nonnegotiable.

Coupons paid on interest dates to bearer; coupons are negotiable.

Bonds registered as to both principal and interest.

Principal payable at maturity only to registered owner; bonds are nonnegotiable.

Interest paid to registered owner directly by check. No coupons attached to bonds.

22

Public School Debt

Administration

Bonds registered as to principal only have coupons attached to the bonds which are cashed on the date specified. The principal of the bond is registered, but before it can be cashed it must be endorsed by the registered owner. Fully registered bonds do not have attached coupons. Interest is paid to the bondholder directly by check. If the bond is fully registered, the face value is paid at maturity to the registered bondholder after proper endorsement. When bonds are fully registered as to both principal and interest, the coupons are detached and destroyed by proper authority. If the bond contract permits the bondholder the privilege of converting the coupon bonds into registered bonds, or of reconverting registered bonds into coupon bonds, he may exercise this option by arranging for conversion or reconversion at the office of the registrar or transfer agent. A registrar or transfer agent may be a person, such as the school treasurer, or a bank or trust company authorized by the school district to register, reconvert, or reissue bonds of the school district. For the most part, bond contracts permit the privilege of registering a bond as to principal only. Because of the expense involved, few school districts permit reconversion of registered bonds into coupon bonds. The statutes of certain states permit conversion or reconversion of municipal bonds if the bondholder is willing to pay the costs involved. BOND

CLASSIFICATION

Types. Without some scheme of classification, any approach to an understanding of the concepts and terminology of bond issues is likely to be fraught with considerable confusion. In the paragraphs which follow, a general plan of bond classification will be outlined briefly, then employed further as a frame of reference by which to describe a few of the fundamental differences among the various classes of bonds. Generally speaking, bond titles are derived from one or more of the following characteristics:2 (1) According to the character of the issuing corporation. (2) According to the character of the security for the bonds.

Fundamental Concepts of Public School Debt Administration

23

(3) According to the purpose or function of the issue. (4) According to the conditions attending the payment of principal and interest. 1. Classification of bonds under this heading gives a general indication of the nature of the agencies or corporations which issue bonds. The issuing corporations may be, for example: state and national governments, municipalities, public utility companies, or industrial concerns. Thus, there are state bonds, municipal bonds, public utility bonds, and so on. 2. When classification of bonds is considered in terms of the nature of the security given for payment, bonds may be divided into two classes: (a) secured; (b) unsecured. Secured bonds are those by which specific property is pledged as payment for the bonds in the event of default. Unsecured bonds are those which simply promise to pay the principal and interest cn bonds without pledging any specific collateral as security. Bonds issued by the United States Government, for example, are unsecured. 3. Characteristics of bonds contained in this classification are self-explanatory. A few of the purposes or functions for which bonds may be issued are: school bonds, bridge bonds, airport bonds, terminal bonds, ferry bonds, and equipment bonds. The title of the bond is derived from the purpose or function for which the money from the bonds is to be used. 4. Bonds classified according to the conditions attending payment of principal and interest may be divided into the following general categories: According to the manner in which the principal is to be paid. Legal tender bonds, for example, are those bonds which may be paid in anything that is a legal tender. According to the manner in which the interest is to be paid, as for example, registered or coupon bonds. According to the manner in which the principal is to mature, such as straight bonds, serial bonds, or sinking-fund bonds. A single issue may have one or a combination of the four general characteristics outlined above. The dividing line between the various classes of bonds is not rigid. A bond issue may be classified simultaneously, for example, as a school bond (purpose); a

24

Public School Debt Administration

municipal bond (character of the obligor); a general obligation bond (nature of payment); or a serial bond (condition attending payment of principal). Within each of the four broad schemes of classification, bond types are subdivided for descriptive purposes. For a comprehensive treatment of bond classification, the reader should consult a standard work on the subject. 2 DESCRIPTION

OF MUNICIPAL

BONDS

A Word about a Word. Bonds of state and local units of government, including those issued by school districts, are classified as municipal bonds. Unless the term "municipal bond" is explained, it may be misleading. If the phrase were interpreted literally, it would mean those bonds issued by municipal units of government such as cities, villages, or towns. In the language of finance, however, municipal bonds refer to bonds issued by any of the agencies listed below. 1 2 Regular governmental units States Counties and parishes Cities, towns, villages, boroughs, etc. Townships Special districts School districts Water districts, sanitary (sewer) districts, etc. Road districts and street improvement districts, etc. Park districts, etc. Drainage, irrigation, and levee districts Statutory authorities* Bridge authorities or commissions Port authorities Toll road commissions, etc. Housing authorities Electric power authorities (rural electrification, etc.) Miscellaneous (hospital, canal, dormitory, etc.) • T o this list should be added recent developments in authority financing for school buildings, such as state and local school authorities.

Fundamental

Concepts

of Public

School Debt

25

Administration

Security. When any of the foregoing agencies issues bonds, it gives its pledge to repay the borrowed money, or face value, at some determinable future date, at a fixed rate of interest. There are three types of pledges generally employed to secure municipal obligations: general obligation bonds; special assessment bonds; revenue bonds. General obligation bonds are those for which the full faith and credit of the issuing agency have been pledged. Bonds of school districts are usually general obligation bonds. T h e interest and principal amounts of general obligation bonds are paid for by a tax levy on all taxable property subject to levy for such purpose within the district. Special assessment bonds are issued to pay for improvements such as streets, sewers, and sidewalks. Ordinarily, the bonds are not repaid by general tax levy but from assessments levied on the property which is to benefit from the improvement. Revenue bonds are issued to pay for improvements which are to be operated as public enterprises, such as municipally owned utilities or toll bridges. Revenue received from these undertakings is used to pay the principal and interest on the bonds. Reference should be made at this point to the growing popularity of school authority bonds in financing school construction. This type of bond has been given great impetus by the state of Pennsylvania by providing for the incorporation of authorities to acquire, construct, and operate buildings to be devoted to public uses such as public school buildings. Briefly, an authority may be created by a municipality, school district or group of school districts, which issues bonds, the proceeds of which are used to construct school buildings on land donated by the district. The authority leases the school or schools to the district under a long-term lease at a fixed rental.* Standing. As a class, municipal bonds are accorded a place of prominence in the ranks of investment securities. T h e confidence • For a more detailed discussion of authority bonds, see Merrill, L y n c h , Pierce,

Fenner

Authors,

and

Beane.

Pennsylvania

School

Authorities.

David M . " U s e of Special Authorities to Finance School Municipal

New

York:

the

1953. For a critical analysis of special authorities see Ellinwood, Finance 20, August, 1952, 48-54.

Improvements."

26

Public School Debt

Administration

which they have engendered in the investment field during various types of economic conditions gives some indication of their security record. When applied to school bonds in particular, this observation is even more appropriate. According to Chamberlain and Edwards: 8 Their standing (school bonds) in the investment world is somewhat better, perhaps, than any other class of municipals, except water bonds, for, although the object for which they are put forth is not revenueproducing, yet they represent in the eyes of a community, the noblest purpose for which it can pledge its good faith. BOND MATURITIES

Types of Maturities. When the board of education borrows money by bonding, a plan or schedule must be designed to indicate when, and in what amounts, the issue is to be redeemed. The kind of maturity schedule which is devised will depend, to some extent, upon the statutes of the state in which the bonds are issued. Most states specify a certain time limit within which bonds must be redeemed. Generally speaking, the principal of a bond issue may be retired by three different types of bonding plans: the straight-term bond plan; the sinking-fund bond plan; or the serial or installment plan. From these three schemes of bond retirement, various arrangements can be devised so as to adjust the bond payments to meet any legal or financial considerations which may confront the board of education. The foregoing plans are outlined below, along with the advantages and disadvantages of each plan. Straight-Term Bond Plan. Straight-term bonds are those which are issued for a specified number of years, at the end of which the entire principal amount matures, although the bonds may be made callable in whole or in part before the final date of maturity. Interest on the bonds may be paid annually or semiannually. A schedule showing the manner in which straight-term bonds mature is presented in Table V. By inspection of this table, the shortcomings of the straight-term bond plan are not difficult to determine. O n e of the main objections to the plan is that the principal payments are delayed as long as possible, thus making the interest charges unduly heavy. In this case, 100 per cent of the

Fundamental

Concepts of Public School Debt Administration

27

principal falls d u e d u r i n g the final period of the issue. T h e interest p a y m e n t s over a ten-year period as shown in T a b l e V a m o u n t to 30 per cent of the total principal. Since there is no provision for r e p a y m e n t of the principal until the ultimate m a t u r i t y d a t e , a higher tax rate will h a v e to be levied to redeem the bonds at that time. I f the tax levy does not produce sufficient revenue to redeem TABLE

V

D e b t M a t u r i t y S c h e d u l e for S t r a i g h t - T e r m B o n d Issue $100,000 T e n Y e a r — 3 Per C e n t — B o n d Issue

Year 1 2 3 4 5 6 7 8 9 10

Principal Outstanding $100,000 100,000 100,000 100,000 100,000 100,000 100,000 100,000 100,000 100,000

Total

Total Annual Payments

Maturities

Interest Payments

$

$100,000

$ 3,000 3,000 3,000 3,000 3,000 3,000 3,000 3,000 3,000 3,000

$ I OO,(KX)

$30,000

$ 130,000

3,000 3,000 3,000 3,000 3,000 3,000 3,000 3,000 3,000 103,000

Cumulative %°f Principal Maturing 0 0 0 0 0 0 0 0 0 100

the bonds, a r e f u n d i n g p r o g r a m must be resorted to, w h i c h will only increase further the m o u n t i n g debt service charges and p a v e the road to default on bonds and interest p a y m e n t s . T h e r e is not a great deal that c a n be said a b o u t this p l a n w h i c h is favorable, for, as will be shown later, it is more costly than a n y of the other m a t u r i t y plans, and ignores one of the f u n d a m e n t a l principles of b o r r o w i n g — t h a t of reducing a debt as q u i c k l y as possible after it has been incurred. Sinking-Fund Bond Plan. T h e sinking f u n d b o n d is nothing more t h a n a straight-term b o n d , except that provision is m a d e for p l a c i n g a n n u a l l y into a sinking fund a sufficient a m o u n t of m o n e y w h i c h a c c u m u l a t e s to p a y o f f the bonds w h e n they fall due. L i k e

28

Public School Debt Administration

the straight-term bond, the entire principal amount falls due at one time, and the interest is payable annually or semiannually. The sinking-fund plan is superior to the straight-term bond plan, inasmuch as the theory behind the former scheme is that the moneys accumulating in the fund are to be invested at interest rates equal to or above the coupon rate. In theory the plan has certain advantages, for it calls for systematic contributions to create at maturity a fund large enough to retire outstanding debt. The history of American boards of education, however, is studded with experiences which show that such funds have not always been administered properly, and in certain cases have led to financial disaster. Objections to the sinking-fund plan are summarized by Engelhardt and Engelhardt: 5 1. Difficulty is encountered in providing proper investment for the sinking fund. 2. Changing personnel of school boards makes regular deposits to fund uncertain. 3. The abuses such funds are subjected to under unscrupulous and careless management. 4. Difficulty in keeping public fully informed regarding conditions of fund. 5. The possible insecurity of the investment due to careless management. 6. The general complications resulting from the problems of keeping sinking-fund accounts under separate management. 7. A more or less complex method is not necessary when a simpler method of repayment is possible. 8. The frequent necessity of refunding because of shortage in sinking fund when payments fall due. 9. The possibilities of loss or increased cost to taxpayers due to fraud, ignorance, and carelessness. 10. The general lack of confidence of the investing public in "sinking-fund bonds" issued by municipalities and school districts. 1 1 . Increased costs due to legal restrictions which limit investments for sinking funds. Difficulties encountered in sinking-fund administration are not

Fundamental Concepts of Public School Debt Administration

29

confined to the field of public education. Chamberlain and Edwards 2 cite similar occurrences in corporation finance after the panic of 1893, at which time 25 per cent of all railway obligations secured by sinking funds defaulted. The difficulties attending sinking-fund administration are so formidable that in some states establishment of such funds for bond issues is illegal. Serial Bonds. A serial bond is one which is payable in installments throughout the life of a bond issue. These installments may be paid regularly, annually for example, or they may be paid irregularly, depending upon the provisions in the bond contract. Interest on the bonds may be paid annually or semiannually. No sinking fund need be established for serial bonds since, in reality, serial bonds accomplish the purpose for which sinking funds are created. Serial Maturities. According to the serial bond plan, bonds mature in installments during the period of the total bond issue. As illustrated in Table V I there are variations by which serial bond maturities may be scheduled. If equal annual payments are made on the principal amount of the issue, the bonds are known as straight serial bonds. If the maturities are arranged so that the principal and interest payments combined are equal or approximately equal each year, the bonds are referred to as serial annuity bonds. If the first principal payments are postponed for two or more years, the bonds are classified as deferred serials. When the maturities are arranged in varying amounts, and these maturities fall due at irregular intervals throughout the life of the issue, the bonds are designated as irregular serials. Characteristics of Serial Maturities. Analysis of the four types of serial bond maturity plans shown in Table V I indicates that provision is made for systematic reduction of debt, and makes payment of the debt obligatory at specified intervals. There are other advantages. Serial maturities can be varied so that debt payments during any one period will not be unduly heavy. This is especially important when a new issue must be dovetailed into a debt structure which contains one or more previous issues. This makes for greater stability in tax rates for debt service charges.

Fundamental Concepts of Public School Debt Administration

31

T h e serial bond maturity plan is set up in advance of the bond sale. This eliminates tampering with the debt retirement schedule because of changes in board membership or fiscal policy. Attention should also be directed toward the fact that in the straight serial plan, the heaviest total payments are made early in the life of the issue, thus leaving a wider margin of borrowing power toward the end of the issue to finance maintenance or new plant construction. U n d e r the straight-term plan, the situation is reversed, for the total principal falls due in the last maturity period. T h e advantages and limitations of the four types of serial maturities are set forth in Chapter 4, which deals with the operational aspects of bond maturities. T h e advantages are well recognized by a number of state legislatures, for the laws of more than half of the states make the use of serial bonds compulsory. T h e simplicity, directness, and comparative economy of repaying a debt in this manner merit the consideration of boards of education which plan to borrow money on a long-term basis. T h e essence of the serial bond plan is simply a recognition of a timetested truism, namely, that the best way to liquidate a debt is to pay it as quickly as possible. Callable Bonds. A discussion of bond-maturities would be incomplete without reference to callable bonds. By definition, a callable bond is one in which the issuing party reserves the right to call the bond for payment prior to its date of maturity. A call feature is usually inserted in the bond contract for the following reasons: 1 . To retire outstanding debt prior to the stated date of maturity. When there is a possibility that the board of education will have a sufficient revenue surplus to retire bonds prior to the stated date of maturity, a call clause may prove to be financially advantageous to the school district. Of course, a surplus is a rare event, but if there is a possibility of collecting a large amount of delinquent taxes, or if there is some other anticipated source of revenue in amounts large enough to retire the bonds before maturity, the board may well consider the inclusion of a call clause in the bond contract. 2. To refund outstanding debt at a rate of interest lower than the

32

Public School Debt Administration

original rate. Many communities which have the foresight to include a call feature in bonds issued when interest rates are high are often able to refund such bonds at comparatively low rates of interest. The interest savings may be substantial, and reflect in part the soundness of the decisions which made such savings possible. 3. To enable the issuing party to reorganize its financial structure. Occasionally, a board of education may wish to reorganize its debt structure but is unable to do so because of a narrow margin of credit. As the credit margin becomes greater, the board may wish to shift from one type of borrowing plan to another in order to reduce interest charges, or to make a fundamental reorganization of its entire debt structure. By exercise of the call feature, certain bonds can be retired, or in some cases refunded at a lower rate of interest, thus enabling the board to arrange its financial program according to a more desirable scheme. Call Features. A call clause contains the following five features, 10 the meaning of which can be clarified by analysis of Figure 1. The period during which the option may be exercised. T h e date on which the bonds may be called for redemption. The notice of intention to redeem, which must be given to the bondholders. The amount of bonds that may be called for redemption. The price at which the bonds must be redeemed. The time at which the call feature or option may be exercised varies according to the terms of redemption. They may be made callable on, before, or after a certain date, between certain dates, or at any time after issuance. Customarily, bonds are called at some interest maturing period; usually, but not always, at par plus a premium. T h e call clause states when and where notice will be given bondholders in the event that the option is exercised. Such notices are usually published several weeks in advance of the call date, in one or more designated financial newspapers. A provision is usually contained in the call clause with reference to the amount of bond maturities which may be called. Issues may be designed for call in whole or in part.

Fundamental Concepts of Public School Debt

Administration

33

Notice of Sale

$3,300,008

SCHOOL DISTRICT C I T Y OF G A R D E N C I T Y C O U N T Y OF W A Y N E MICHIGAN School Building and Site Bonds S E A L E D B I D S f o r the issued by School District of Michigan, of the par value of »1 Garden City High School,

12th

DAY

purchase of general obligation bond« t o be the City of Garden City. County of Wayne, $3,300,000 will be received by the undersigned Garden City, Michigan, on Thursday, the

OF

APRIL,

1 9 5 6,

until 8:00 o'ctock p.m., E a s t e r n ' S t a n d a r d Time, at which time fend place aaid bids -will be puMicly opened and read. Said bonds will be duted April 2, 2956, will be coupon bonds of the denomination of $1,000 each, will be numbered consecutively in the direct order of their m a t u r i t i e s f r o m 1 to 3300, both inclusive, shall bear interest f r o m their date at a r a t e or r a t e s not exceeding f o u r (4*) per cent per annum, expressed in multiples of lA of 1?. Said interest will be payable on July 2, 1957, and semi-annually t h e r e a f t e r on J a n u a r y 2st and July 1st of each year, both principal and interest to be payable at a bank or t r u s t company to be designated by the m a n a g e r of the syndicate or account p u r c h a s i n g the bonds. Said interest r a t e f o r each coupon period on any one bond shall be a t one r a t e only. Ascrued interest to the d a t e of delivery of such bonds shall be paid by the purchaser at time of delivery. Said bonds will m a t u r e serially a s follows: $ 30,000 July 1, 195K; $ S5.000 July 1st of each year f r o m 105!) to 1 WW, both inclusive; $ 06,000 July 1, 1963; $ 70,000 July 1, 2W!4; $155,000 July 1st of each year f r o m 196ft to 15WJ7, both Inclusive; $ I »>0,000 July 1st of each year f r o m 1968 to 197'J, both Inclusive; $165,000 July 1st of each y e a r f r o m 1973 to 1982, both inclusivt. Bonds numbered 1 to '¿475, both inclusive, m a t u r i n g in the y e a r s 1968 to 1977, both inclusive, shall not be subject to redemption prior to m a t u r i t y . Bonds numbered 2476 to 3300, both inclusive, m a t u r i n g in the y e a r s 1978 t o 1982, both inclusive, mny be. redeemed prior to m a t u r i t y , at the option of the District, in inverse numerical order, on any interest payment date on or a f t e r July I, 1967, at oar and accrued interest to the date fixed f o r redemption, plus a premium as followi: SSO on each bend called for redemption on or a f t e r July 1, 19C7, but Trior to July 1, 1969; $20 on each bond called for redemption on or a f t e r July I, 1969, but prior to July 1, 1971; $10 on rach bond railed for redemption on or a f t e r July 1, 1971. Notice of redemption shall be given to the holders of bonds to be redeemed by publication not less than t h i r t y days prior to the date fixed f o r redemption, at least once in a newspaper or publication circulated in the S t a t e of Michigan which carries, as p a r t of its r e g u l a r service, noticca of sale of municipal bonds. N o f u r t h e r interest payable on. bonds so called f o r redemption shall accrue a f t e r the d a t e fixed f o r redemption, whether presented f o r redemption or not. provided the School District h a s money available f o r such redemption with the p a y i n c a g e n t .

Figure i. Portion of Bond Sale Notice Illustrating Call Features, Reprinted from The Bond Buyer, M a r c h 3 1 , 1956.

34

Public School Debt Administration

T o illustrate further the manner in which callable bonds are issued, a portion of the law governing the issuance of such bonds in Pennsylvania® municipalities is cited below: Any general obligation bonds issued pursuant to this article may be made callable in whole or in part at par, or at par and a premium or premiums, upon such interest date or dates as may be specified in the ordinance. When general obligation bonds have been made callable they shall state on their face the date on which, or subsequent to which, such call may be made and the method of giving notice thereof and the terms upon which such bonds may be called. Such notice shall specify, if less than all the bonds are to be called for redemption, the numbers of the bonds to be called and the place where such bonds shall be presented by the holders thereof for redemption. Interest shall cease to run on all bonds specified in said notice after the date fixed in said notice as the callable date. Whenever the municipality shall call for redemption less than the whole amount of any issue of general obligation bonds remaining outstanding, the bonds to be called shall be those last maturing of such issue. BOND V A L U E S IN

GENERAL

Knowledge of Bond Values. For the most part, school officials enter the investment field as borrowers, not lenders of money. Their interest in bond values, therefore, is somewhat different from that of the private or institutional investor. T h e investor is interested in lending money in order to make a profit. School officials, on the other hand, seek to borrow money for a public purpose as cheaply as possible. Accordingly, the text following is devoted largely to an interpretation of the terminology, techniques, and concepts of bond values with which schoolmen should be familiar. It was observed earlier that school capital improvements, such as the acquisition of sites, rehabilitation of old buildings, or the construction of new buildings are frequently financed by bond issues. Mention also was made of the fact that the majority of school bonds mature in serial or installment form at various dates throughout the life of the issue. For example, a school district may float a 4 per cent, thirty-year straight serial issue of $30,000, dated J a n u a r y 1, 1958. T h u s $1000 is payable on the principal amount of $30,000 on January 1 every year thereafter for thirty years.

Fundamental Concepts of Public School Debt Administration

35

The problem of bond values may confront the school administrator when the school district offers to sell an issue of school bonds. If the bonds are sold by competitive bidding, which involves the submission of sealed bids, the several bids must be evaluated to determine the bid which will cost the school district the least amount of money. Let us assume that the board of education meets to open bids on a sixteen-year serial bond issue in the amount of $246,000. Results of the bidding are shown in Table V I I . In order to interpret these results accurately, the reader must first become familiar with the basic terminology employed in buying and selling bonds. We note in Table V I I that nine bids were submitted for the serial bond issue of $246,000. These bids were submitted by bond houses, brokers, investment bankers, private bankers, and investment syndicates—-the media through which bonds are usually bought and sold. TABLE

VII

Sealed Bids Offered on a $246,000, Sixteen-Year Serial Bond Issue Bidder Number I 2 3 4 5 6 7 8 9

Interest Rate Offered 1,30/ 1 /o 12 % •i% 11%

«1% •1% 1»% >i%

Premium Offered

Bid

$3495-66 343'70 1910.19 1943.40 1778.33 I30I-34 810.00 809.34 440.00

101.421 '«'•395 100.7765 100.79 100.7229 IOO.529 100,3294 100.329 100.1792

Net Interest Rate '•585% '•588% 1.660% '•533% '•54'% '•564% ' 587% '•587% '•479%

Par, Premium, and Discount. The par or face value of a bond refers to the principal amount stated on the face of the bond, which is usually $1000. If the bond sells above par, the difference is known as a premium. If the bond sells below par, the difference is known as a discount. School bonds are not usually sold at a discount, however, since the laws of most states prohibit this practice. On the other hand, school bonds are seldom sold at par value, for the competition to purchase investments of this type is usually keen

36

Public School Debt Administration

enough that most investors offer a premium to the issuer. For example, the par value of the issue in Table V I I is $246,000. However, each of the nine bidders offered to pay a premium above the par value of the bonds. Bond Quotations. In the investment world, bond prices are quoted as a certain per cent of their original par value. A bond quoted at 107 means that the bond is selling at 107 per cent of par ($1000) or $1,070. The premium on this bond is $70. A bond quoted at 96$ means that the bond is selling at g 6 | per cent of its original par value ($1000), or $965. The discount on the bond is $35. Regardless of the par value of the bond, quotations are based on a scale of 100. The figure 100 is assumed to represent par. For example, the par value of two different bonds is $100 and $1000, respectively. The bonds are quoted at a premium of 4 per cent. Consequently, the quotations for both bonds would be 104. The actual price of each bond, however, would be $104 and $1,040, respectively. Prices on bonds, except United States Government bonds, generally are quoted in terms of eighths of 1 per cent. Government bonds are quoted in thirty-seconds of 1 per cent, the thirtyseconds being indicated by a number preceded by a decimal point. A municipal bond selling at 102^ means that the bond is selling at $1,022.50, or a 102^ per cent of par. A government bond selling at the same price would be reported as 102.8, meaning 102375. Bid prices on municipal bonds are submitted on a quotation basis, similar to the system described above. Referring to Table V I I , bidder number 2 submitted a bid of 101.395 o n a bond issue of $246,000, bearing interest at i f per cent. This means that the bidder is willing to purchase the issue at par ($246,000), plus a premium of $3,431.70, or at 101.395 P e r c e n t of par. Stated in a different way, the bidder will purchase each of the 246 bonds at par ($1000), plus a premium of $ 1 3 . 9 5 per bond. (Two hundred forty-six bonds at a premium of $ 1 3 . 9 5 P e r bond equals a total premium of $3,431.70.) Checking the list of bids in Table V I I , note that the best bid for

Fundamental Concepts of Public School Debt Administration

37

the issue under consideration was submitted by bidder number 9, who offered to purchase the bonds at a price of 100.1792, or at par ($246,000), plus a premium of approximately $1.79 per bond. The Matter of Yield. When an investor purchases a bond, it is likely that he will be interested in knowing the rate of income which he will realize on his investment. Rate of income received from a bond is known as the effective rate of interest. Previously, it has been explained that bonds are bought and sold on three bases: at par, above par, or below par. If a bond is purchased above par (at a premium), the effective or net rate of interest (yield) will be less than the rate of interest stated on the coupon. Thus, if a $1000, 2 per cent coupon bond is purchased at 102 (or at a premium of $20), the effective rate of interest will be less than 2 per cent. If the bond is purchased below par, the effective or net rate of interest (yield) will be greater than the rate of interest stated on the coupon. If a $1000, 2 per cent coupon bond is purchased at 96 (or at a discount of $40), the effective or net rate of interest will be greater than 2 per cent. Application of the concept of effective interest rate can be illustrated further by reference to Table V I I . Here we note that bidder number 9 offered to purchase the issue of $246,000 at a coupon rate of 1 £ per cent. However, the bidder also offered a premium of $440. The effective interest rate which the school district will pay for the bonds is, therefore, 1.479 per cent, a rate slightly lower than the coupon rate of 1£ per cent. Summary of Bond Values. In summary, most problems of bond values in which the school administrator is interested can be stated in the following question: Which bid will cost the school district the least amount of money, i.e., which bid offers the lowest effective rate of interest ? The answer to this question may be computed by the "net interest cost" method. This generally involves calculating the aggregate interest at the rates named in the bid, from the date of the bonds to the respective maturity dates. Premiums, if specified in the bid, are deducted from this sum. This method is explained in detail in Chapter 5. P.S.D.A.-D

Publie School Debt

38

Administration

REFERENCES 1

2

3

4

5

6

7

8

9

10

11

12

Burke, A r v i d J . Financing Public Schools in the United States. New Y o r k : Harper and Brothers, 1951. pp. 465-66. Chamberlain, Lawrence, and Edwards, George W . The Principles of Bond Investment. N e w Y o r k : Henry Holt and C o m p a n y , 1927. pp. 75-108. Crowell, T h o m a s Y . , C o m p a n y . The Practical Handbook of Business and Finance. G a r d e n City, N e w Y o r k : G a r d e n City Publishing C o m p a n y , 1930. pp. 67 ff. Cushman, Robert E. " M u n i c i p a l Debts." The Encyclopedia Americana. V o l . 19. N e w Y o r k : T h e Americana Corporation, 1944. pp. 573 ff. Engelhardt, N. L., and Engelhardt, Fred. Public School Business Administration. New Y o r k : Bureau of Publications, Teachers College, C o l u m b i a University, 1927. p. 434. Laing, Chester W . " F l o a t i n g and L o n g - T e r m D e b t . " Municipal Finance 23, August, 1950, 49-52. Linn, H. H . Practical School Economies. N e w Y o r k : Bureau of Publications, Teachers College, C o l u m b i a University, 1934. pp. 371 ff. Morphet, E. L., and Lindman, Erick L. Public School Finance Programs of the Forty-eight States. Washington: U . S . Government Printing Office, 1950. p. 97. Pennsylvania. Laws, Statutes, etc. C o m m o n w e a l t h of Pennsylvania : Act of June 25, 1941, Pamphlet Laws. 159, Art. 1 i , s e c . 211. Harrisburg: C o m m o n w e a l t h of Pennsylvania, 1941. Prime, J o h n H. Investment Analysis. New Y o r k : Prentice-Hall, 1952. p. 27. T h e Committee for T h e White House Conference on Education. A Report to the President. Washington: U . S . Government Printing Office, 1956. pp. 52 fr. W a y n e , Edward A . (Ed.) Municipals. Washington : Federal Deposit Insurance Corporation, 1941. p. 32.

3. PLANNING AND DEVELOPING THE PROGRAM OF IMPROVEMENTS

FORMULATION OF POLICIES

Problems Involved. T h e preceding chapter was devoted to a review of background and principles relating to debt administration. T h e purpose of this chapter is to set forth the m a j o r planning activities to be initiated during the first stages of the capital improvement program. Before plans for the construction of a new school building or for the rehabilitation of an old building are placed on the architect's drawing board, numerous decisions governing the educational, building, and financial aspects of the p r o g r a m will have to be made. O f the m a n y problems involved in planning a p r o g r a m of improvements, those concerning the educational p r o g r a m are of primary concern. T h e physical a n d financial requirements of the building cannot be determined accurately until the quality a n d scope of the educational program have been clearly defined. T h e most vital problem in planning long-term improvements, therefore, relates to the nature and scope of the educational program. Clarification of this problem depends upon analysis of a n u m b e r of significant issues, some of which are outlined below. This list does not p u r p o r t to be all-inclusive, but merely indicative of the more compelling questions which must be considered. Limits of the Educational Program . For w h o m should the educational p r o g r a m be p l a n n e d ? . Should the program include nursery schools ? . W h a t provisions should be m a d e for mental, physical, a n d emotional deviates ? . Should adult education be provided at public expense? 39

Public School Debt Administration Term of the Educational

Program

. What is the proper length of the school day ? . Should the school year be extended beyond the term required by law ? . Should the recreational program be planned on an all-year basis? School

Organization

. Of the various schemes of school organization (K6-6, K8-4, K7-5, etc.), which will best enable the school to achieve its purpose ? . Is the present administrative unit large enough to provide an adequate educational program ? . What should be the size and location of attendance units? . Should "fringe" districts become a part of the administrative unit ? Curriculum

. Is the existing educational program meeting the needs of children ? . To what extent should the existing program be revised ? . Are provisions for exeptional children adequate ? . What policy should be followed with respect to pupil promotion ? Educational

Services

. What educational services should be provided to improve physical, mental, and emotional fitness ? . What service personnel should be employed ? . How can the school develop an adequate food service program? . What should be the extent of school library service ? Staff

. What degree of professionalization should be established for the selection of professional personnel ? . What should be the policy on class size ? . What type of salary schedule should be established to attract, improve, and retain professional personnel ?

Planning and Developing the Program of Improvements

41

Material . What should be the quality and quantity of supplies and equipment? . To what extent should supplies, equipment, and space be provided for community use ? Program Development . What provisions should be made for encouraging research, evaluation, and experimentation ? . What means should be employed to utilize the findings of research to improve the educational program ? Examination of the foregoing questions focuses attention on both the range of factors which must be considered in developing the educational program and the need for sound educational policy. Solution of the financial and physical aspects of the program, important as they are, cannot be effected until the educational specifications of the building are determined. Administrative Responsibility. Policies relating to the plant program, are—like all other phases of educational policy making—the ultimate responsibility of the board of education. Not infrequently, the architect or the board attorney becomes the educational specialist who determines the building specifications, leaving the educational program to be fitted to the building. The success or failure of the improvement program depends in large measure upon the decisions of policy arrived at by the board of education, in co-operation with the professional staff and organized community advisory groups or agencies. The importance of the planning phase of the plant program cannot be overemphasized. A relatively large investment of public funds in a structure which is to serve future generations for a purpose which is all-important to society, should be carefully planned so as to secure the maximum educational returns. Achievement of this objective depends upon the quality of cooperative planning efforts. DATA FOR DECISIONS

Types of Data Needed. The capital improvement program cannot be

42

Public School Debt Administration

developed with a few flourishes of a pen. Long before the stage is set for preparing the building blue prints, a wide variety of facts must be gathered and refined in such a m a n n e r that they m a y be employed as a basis for policy making. Indeed, the quality of the educational and financial planning which takes place in a given system depends in part upon the nature and quality of d a t a available for developing policies and procedures. T h e facts to be gathered to serve as a basis for policy m a k i n g will depend upon the nature of the policies to be decided. If a reorganization of administrative and attendance units is contemplated, a n d plant problems are involved, the scope of the d a t a will probably be somewhat different than that required by construction or rehabilitation of a single building. If the school records are organized effectively, a large part of the necessary data will be available within the school system. O n the other h a n d , fact-gathering outside the school system is usually needed to secure whatever d a t a are pertinent to the p r o b l e m at hand. I n view of the fact that the m a j o r emphasis of this book is devoted to the financial aspects of planning, no a t t e m p t will be m a d e to discuss the techniques of making school a n d c o m m u n i t y surveys. 8 Nevertheless, types of d a t a illustrative of those to be gathered are summarized in concise form below. These d a t a m a y be classified broadly into three groups: . D a t a pertaining to the educational p r o g r a m to be housed. . D a t a pertaining to the n a t u r e of the building required to house the educational program. . D a t a pertaining to the means by which the building prog r a m is to be financed. Data Concerning the Educational Program. O n e of the most challenging and stimulating problems which continually confronts educational planners is that of adjusting the educational p r o g r a m to the changing conditions of society a n d to evolving concepts of child growth a n d development. T h e educational p r o g r a m to which we gave credence a century ago is no longer considered a n a d e q u a t e p a t t e r n a r o u n d which to educate for the conditions a n d d e m a n d s

Planning and Developing the Program of Improvements

43

of m o d e r n A m e r i c a n life. N e w tendencies in public e d u c a t i o n h a v e emerged t h r o u g h the y e a r s — e q u a l i z a t i o n of e d u c a t i o n a l opportunities, vertical a n d horizontal extension of the school system, provisions for certain services as a part of the e d u c a t i o n a l enterp r i s e — t h e s e a n d other factors h a v e had far-reaching effects u p o n educational planning. T h e search for facts upon w h i c h to base j u d g m e n t s relative to a more desirable p a t t e r n of educational experiences, therefore, must be directed t o w a r d a recognition and understanding o f c h a n g i n g e d u c a t i o n a l and social conditions, as well as their implications for e d u c a t i o n a l p l a n n i n g . D a t a w h i c h will help clarify the needs o f the e d u c a t i o n a l p r o g r a m are listed b y Burke 3 as follows: Population and enrollment data, broken down into characteristics, to anticipate present and future needs. Data on human nature, on social, economic, and political life and conditions, revealing educational problems and needed educational reforms. Summaries of all policies and decisions previously made, not only for immediate planning, but also for projecting them into the future to anticipate their effects or implications. Personnel records for all employees, showing interests, abilities, preparations, experience, handicaps, talents, and all other data essential in planning. Analyses of all curricula, offerings, services, programs, and schedules, showing enrollment, rooms used, materials used, and all other pertinent data. Personnel records for all pupils served, showing interests, abilities, problems, progress, reactions, achievements, and other pertinent facts during and after school career. Records of criticisms, complaints, reactions, suggestions, experience, and ideas from all possible sources relating to present offerings. Standards, measuring instruments, techniques for appraisal, and data on the application of these to activities or services. Property records describing the physical facilities, furniture, equipment, books, supplies, and other instructional aids available. Summaries of the resources and personnel available in the community that might make a contribution to the program.

44

Publie School Debt Administration

Summaries of program elements, personnel, materials, and facilities needed in the past but not yet provided and the reasons therefore. Criteria, principles, or guides for assigning priorities to program elements when all desirable provisions cannot be made at a given time. Data for the Building Program. A second set of problems in developing the school plant program concerns formulating building requirements to accommodate the educational program. Solution of these problems requires the collection, analysis, and interpretation of certain data in the light of educational policies previously developed. Basically, the task is one of expressing in physical form the educational policies and practices adopted by the board of education. In our approach to problems involved in determining the character and extent of the school plant which is to house the educational program, let us assume that the major educational policies have been tentatively adopted. Types of data necessary for making decisions relative to the building program can be clarified somewhat by posing a number of pertinent questions, such as the following: . To what extent can existing plant units be utilized in the over-all building program ? To what extent should they be rehabilitated ? . How many new plant units are needed, and in which attendance areas should they be located ? . Are suitable sites available in the several attendance areas? . What should be the nature of the instructional spaces (class-rooms, gymnasiums, laboratories) in the proposed plant ? . What should be the nature and extent of auxiliary facilities (auditoriums, offices, libraries, etc.) to be included in the proposed plant ? . What architectural, engineering, and educational services should be employed to design the new plant ? . What types of service systems should be installed so as to facilitate achievement of instructional objectives?

Planning and Developing the Program of Improvements

45

. H o w should the building be planned in terms of the safety of the occupants ? . How should the building be constructed as regards d u r a bility ? . How should it be designed in terms of esthetic qualities? . W h a t types of furniture and equipment are needed to facilitate the educational program ? T o secure data concerning the foregoing aspects of the plant program, certain objective techniques 1 , 8 have been developed b u t will not be repeated here. It should be said in passing, however, that it is of cardinal concern that the collection, analysis, and interpretation of building program data be worked out in relation to f u n d a m e n t a l educational policies. Otherwise, a construction project, rather than a functional school building, will emerge. Data for the Financial Program. Fiscal planning attempts to translate educational needs into specific dollar-and-cents requirements. While the educational and building programs are being developed, an appraisal must be m a d e of the ability of the school district to meet current expenditures, as well as the fiscal obligations to be incurred in the improvement program. T h e facts to be gathered relative to the financial aspects of the program must be as detailed, as comprehensive, and as analytical as the information employed in studying the educational and building phases of the program. T h e latter planning phases, however well conceived, can be executed successfully only in the light of sound financial planning. T o a large extent, public education improvement programs are still dependent upon the financial resources of the local community. 7 While there is a growing recognition of the need for increased assistance from state and federal sources for plant construction, the scope of m a n y school building programs at present must be confined to that which can be borne through local effort. I n view of this situation, it follows that a complete study of community financial ability is essential to the development of the fiscal program.

46

Public School Debt Administration

Policies with respect to financing new buildings or the rehabilitation of old buildings hinge upon answers to questions such as the following : . What will be the overall cost of the long-term improvement program ? . Will the financial structure of the school district carry the proposed financial burden? If not, what alternative methods of financing the program can be employed ? . Can the program be financed through a complete or partial pay-as-you-go policy, or by total borrowing ? . If indebtedness is to be incurred, what form of debt shall be employed ? . What will be the relationship of new debt to current expenses ? . If bonds are to be issued, what specifications should the bond contract contain ? . How should the debt maturity schedule be developed ? . Is there sufficient financial leeway to provide for plant maintenance and for improvements in the educational program? . How much tax leeway is available for capital improvements? . Will proposed expenditures for capital improvements reduce funds for current expenses ? The foregoing questions are illustrative of the problems with which boards of education are confronted in determining fiscal policy. The data to be analyzed will center around a number of factors, such as those indicated below. A study of these factors in terms of policies to be decided will shed considerable light upon the direction in which fiscal policies will be guided. 14 . The character of the community. The type of economy upon which the community's prosperity is dependent. Debt-paying ability of the community. . Amount and character of outstanding debt of school district, and of overlapping units of government.

Planning and Developing the Program of Improvements

4.7

. History of debt. S u m m a r i e s o f changes w h i c h h a v e t a k e n place in the debt of the school district d u r i n g last ten years. . History of debt p a y m e n t . History of m a n n e r in w h i c h past obligations h a v e been met. R e c o r d of defaults, if a n y . . Property taxation exemptions, tax rates, tax collections. . O t h e r revenues. S u m m a r i e s of sources o f revenue o t h e r than real estate. . Expenditures. S u m m a r i e s of current expenses, debt service, a n d capital outlays for a period of years. C o m p a r i s o n s o f expenditures w i t h school districts c o m p a r a b l e in size. . C h a r a c t e r of m a n a g e m e n t and its administrative policies. Facts relating to b u d g e t i n g , a c c o u n t i n g , b o r r o w i n g policies, sinking-fund administration, tax collections. . F u t u r e fiscal requirements. Schedule of principal a n d interest requirements for existing life of all outstanding obligations. Schedules s h o w i n g present conditions a n d future requirements of sinking f u n d . . Significant relationships. R a t i o of debt service charges to current expenditures. R a t i o of indebtedness to b o r r o w i n g c a p a c i t y . R a t i o of district d e b t to district revenues. T r e n d s in indebtedness a n d expenditures of o v e r l a p p i n g units o f government. THE

BUDGETARY

PROCESS A N D

EDUCATIONAL

PLANNING

Planning and. Budgeting Inseparable. S c h o o l m e n h a v e long contended that enlightened b u d g e t a r y practices a n d educational quality are closely related. T h e r e is some e v i d e n c e to support this contention. O n e report 5 indicates that t w o areas of administrative practice tended to differentiate o u t s t a n d i n g schools from the others.

In

order, these are : ( i ) T h e concern of the administration for d e v e l o p i n g a budget. (2) T h e degree a n d extent of i n v o l v e m e n t o f pupils, teachers, parents, and citizens in the administration of schools. These conclusions will shock few administrators, for it takes little i m a g i n a t i o n to realize that no phase of education is w i t h o u t b u d g e t a r y implications. B u d g e t m a k i n g , b r o a d l y conceived, is in effect e d u c a t i o n a l p l a n n i n g , for every plan, h o w e v e r superior in

48

Public School Debt Administration

conception or design, must be expressed and implemented through the budget in terms of dollars and cents. Sound budgetary practice is more than a statement of anticipated receipts and expenditures. It is more than adding to or subtracting from last year's budget categories. It is a continuous process, cyclic in nature, which unifies economic resources and educational theory to achieve those objectives toward which the educational program is directed. It seems reasonable, therefore, that any approach to improvement planning must involve an imaginative budgetary process which envisions the advice and support of large numbers of citizens, parents, teachers, and pupils. T H E CAPITAL BUDGET AS A PLANNING

INSTRUMENT

Co-ordinating the Plans. Capital improvement planning, however deliberate, must be translated ultimately into dollar-and-cents requirements. Some type of arrangement is necessary whereby the three broad phases of planning—education, building, and financial—are merged into a unitary pattern in order to provide a realistic approach to the capital improvement program. Meaning of Capital Budget. Devices through which educational planning is forged into reality are the annual and long-term budgets. It is through these instruments that present and future educational needs, and the plans for financing these needs, can best be organized and expressed in concrete terms. Long-range plans for capital outlays can be crystallized through what has come to be known as the "capital budget," i.e., a long-term plan which projects the types of capital improvement projects to be undertaken, the nature of their costs, and the methods by which they are to be financed. Many long-term budgets are planned for at least a six-year period. Within this period, long-term budgets may be altered to fit certain economic and other conditions peculiar to a given community. Without a long-term plan for financing proposed expenditures, the planning which does take place will probably be, at best, of the emergency type.

Planning

and Developing

the Program

of Improvements

49

Difference between Current and Capital Budgets. Until recent years, fiscal planning in local units of government, including school districts, has been limited to preparation of the annual budget. While the methods involved in planning the annual budget have been reasonably effective in exercising control over annual expenditures, the same methods are not applicable to the planning of capital improvement programs. 13 Some of the essential differences between the two phases of budgeting are as follows: 9 T h e capital budget, also called the "improvement budget," can be contrasted to the current expense or "operating budget," although both are but two approaches to a common problem. O n e difference is in the time period covered. T h e current budget in most cities extends for one year only. T h e capital budget commonly covers a five-year period or more; a six-year period has been rather popular in recent capital "programming." The first year becomes the authorized capital budget for the year of adoption. T h e remaining five years represent a tentative program. By an annual revision there is available at all times a carefully thought-out plan for six years ahead, a six-year "moving schedule." There is also a second difference—one in emphasis. T h e current budget includes all of the annual expenditures—current operating expenses, debt retirement, and capital expenditures. T h e capital budget has to take into consideration all types of expenditures (estimates of course), but the emphasis is upon capital expenditures. T h e third difference pertains to authorization. The capital budget, even if formally authorized, is a tentative program only, subject to periodic revision. Implementation of the capital budget year by year comes through the current budget. Every year as the current budget is prepared, a year of capital budget is incorporated. Capital Budget Procedure. T h e steps involved in developing the capital budget are but an extension or projection of the planning procedures suggested earlier in this chapter, where emphasis was placed largely on the procedures involved in the planning of a single building. T h e first step in the formulation of the capital budget is the determination of capital improvement needs of the school district during the next five or six years. T h e financial structure of the school district is then analyzed to determine to what extent needed improvements can be undertaken in ensuing years.

50

Public School Debt Administration

On the basis of the foregoing data, physical and financial plans are co-ordinated into a comprehensive capital improvement program. The National Resources Planning Board, in its report 18 of demonstration studies of capital improvement budget procedures, outlines five steps in long-range improvement planning. These are: (1) The financial analysis. (2) The listing of needed public improvements. (3) Preparation of the program. (4) Consideration by the governing body. (5) Public acceptance. Capital Budget Illustrated. In order to give some degree of specificity to the concept of capital budgeting, illustrations are provided in the following text to indicate one type of approach which has been employed by a school district in projecting its long-range improvement program. • Financial trends. One of the first steps taken by X School District to develop its long-range program was to prepare an historical summary of the financial operations over a five-year period. In some cases, study of financial trends for a longer term is advisable. The data shown in Table V I I I were used to analyze past experience in income and expenditures for the purpose of providing bases upon which to project future revenues and expenditures. • The tax structure. The local tax structure to which a school district is restricted is an important element in long-range planning. Productivity of the local tax structure in X School District for a five-year period is shown in Table I X . These data give school officials an opportunity to look at the productive level of local taxation, as well as the extent of tax leeway available for capital outlay in the years ahead. In addition, this type of analysis often provides the impetus to search for additional sources of school revenue. • Needed improvements. The crux of the capital budget is a description of the needed improvements, in order of priority, as well as the estimated cost of each improvement. As can be inferred

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