Prop 98: A Deep Dive into California School Funding

*Prop 98 is so central to California education funding that it's worth understanding how it came about — because the political dynamics that created it in 1988 are remarkably similar to the tensions playing out right now.* ## A Brief History of Props 13 and 98 Before Prop 98 was passed in 1988, school funding in California was essentially at the Legislature's discretion each year. The backstory starts with the (infamous) passage of Proposition 13 in 1978, which capped property tax rates at 1% of assessed value and limited annual increases to 2%. Before Prop 13, local property taxes were the primary funding source for schools, and districts had significant control over their own revenue. Prop 13 effectively centralized school funding at the state level overnight, and **the state had to step in to replace the lost local revenue.** For the next decade, schools competed with every other state priority — prisons, healthcare, transportation — for General Fund dollars. **Education's share of the state budget declined through the early and mid-1980s**, and the California Teachers Association (CTA) and other education groups became increasingly alarmed that schools were losing ground. The fundamental problem was that there was no floor — in any given year, the Legislature could simply choose to fund education **at whatever level it wanted**. **Proposition 98** narrowly passed in November 1988 with about 51% of the vote. It was championed primarily by CTA and was (surprise!) fiercely opposed by Republican Governor George Deukmejian and business-backed special interests who argued it would make the budget too rigid. The measure amended the California Constitution to establish a **minimum guarantee for K-12 schools and community colleges**, essentially creating a formula that sets a floor below which the state cannot go without a two-thirds legislative vote to suspend it. ### The Three Tests The guarantee is calculated through three "tests," and whichever produces the highest number in a given year becomes the operative minimum. This is where it gets arcane but it matters for understanding the current situation: - **Test 1** sets school funding at roughly 39% of General Fund tax revenue — this is the test that's operative right now, which is why the guarantee **moves about $0.40 for every dollar change in state revenue** and why AI-driven capital gains are having such a dramatic effect. - **Test 2** takes the prior year's funding and adjusts it for enrollment changes and per-capita personal income growth — this tends to be the rule used during periods of moderate economic growth. - **Test 3 (added in 1990)** takes the prior year's funding and adjusts for enrollment and revenue growth, but only when revenue growth is lower than personal income growth — **this tends to kick in during downturns** and effectively acts as a "hold harmless" to prevent the guarantee from falling too fast. This created the idea of a "settle-up" from year to year. ## The Settle-Up Fight The settle-up concept recognizes that guarantees are calculated based on **revenue estimates that change**, so when the state underestimates revenue in a given year, it owes schools the difference. This is exactly what's happening now: the state estimated the 2025-26 guarantee at $114.6 billion but now calculates it at $121.4 billion, creating a **$5.6 billion obligation**. The constitutional language requires the state to eventually pay, but gives the Legislature discretion on timing. This is the loophole Governor Newsom is exploiting — and that CSBA sued over for the 2024-2025 school year. It is worth noting that the Legislature has suspended Prop 98 twice, both times during recessions (the Dot-com bust and Great Recession). The Prop 98 Public School System Stabilization Account (PSSSA) was created by Prop 2 in 2014 specifically to smooth out the boom-bust cycle: when capital gains revenue pushes the guarantee unusually high, a portion is deposited into the reserve rather than spent, and it's drawn down during downturns. **The current $4.1 billion balance in the PSSSA is the result of that mechanism working as designed during the current AI boom.** ## Why It Matters to OUSD Right Now Prop 98 was designed to protect aggregate education funding at the state level. It guarantees a total dollar amount for all schools and community colleges combined. **It does nothing to address how that money is distributed among districts, which is what the Local Control Funding Formula (LCFF, enacted in 2013) does.** And it does nothing to prevent an individual district from spending beyond its means because of structural issues — which is, of course, OUSD's core problem. The irony of the current moment is that Prop 98 is producing **the highest per-pupil funding in California history**, and districts across the state are simultaneously cutting budgets and laying off staff, because *the guarantee's growth rate doesn't match the rate at which costs (especially labor and benefits) are rising*. This is why there are growing calls to "modernize" the LCFF, which many feel falls far short of modeling the actual costs of running a public school district in California in 2026. ## Good News? About the 2026 Prop 98 Increase **The [Governor's January 2026 budget](https://sbud.senate.ca.gov/system/files/2026-01/summary-of-the-governors-proposed-2026-27-budget.pdf) reveals a $21.7 billion upward revision to the Prop 98 minimum guarantee across three fiscal years.** However, the gap between the headline numbers and what actually flows to districts as sustainable base funding is enormous. Of the nearly $22 billion in higher Prop 98 estimates, [**$5.6 billion is being withheld**](https://calbudgetcenter.org/resources/first-look-understanding-the-governors-proposed-2026-27-california-budget/) from schools to balance the rest of the state budget, billions more go to one-time grants and prior-year obligations, and most of the windfall rests on AI-driven capital gains revenue that the Legislative Analyst's Office (LAO) warns could evaporate in a stock market correction. For OUSD, this means the state budget could offer modest relief over a number of years, but *only a small fraction* of our overall structural deficit. ### The Numbers Are Deceptive The Governor's January 2026 budget estimates the Prop 98 minimum guarantee at dramatically higher levels than the Legislature enacted just seven months earlier: | Fiscal Year | June 2025 Enacted | January 2026 Revised | Increase | | :--- | ---: | ---: | ---: | | 2024-25 | $119.9 billion | $123.8 billion | +$3.9B (3.2%) | | 2025-26 | $114.6 billion | $121.4 billion | +$6.9B (6.0%) | | 2026-27 | $118.1 billion | $125.5 billion | +$7.4B (9.5%) | These increases are driven almost entirely by **higher General Fund tax revenue fueled by [AI-related capital gains](https://calbudgetcenter.org/resources/first-look-understanding-the-governors-proposed-2026-27-california-budget/)**. Test 1, which links school funding to roughly 40% of General Fund revenue, is operative in all three years, meaning the guarantee moves about **$0.40 for every $1 change** in state revenue. This also makes it *acutely sensitive to any market downturn*. The [LAO's independent revenue estimate](https://lao.ca.gov/Publications/Detail/5093) is far more conservative, projecting the 2026-27 guarantee at just **$117.8 billion** — roughly **$8 billion lower** than the Governor's figure. The LAO explicitly warns: - The S&P 500 has risen approximately 40% in two years - Price-to-earnings ratios are near historic highs - Margin borrowing and household equity exposure are at levels that have historically preceded downturns There is also a growing concern regarding the (obvious?) overexuberance of investors about **a genuinely useful technology (AI) producing unsustainable valuations**. Dot-com bubble, anyone? In short, Prop 98 will result in a record per-pupil funding of **$20,427** (and **$27,418** total including federal funds) on paper, but much of the increase is already committed to prior-year obligations, one-time activities, and reserve deposits rather than flowing to district base budgets. ## The Current $5.6 Billion Settle-Up The most consequential feature of the budget for OUSD and other districts is what the Governor is *not* releasing. Despite calculating the 2025-26 Prop 98 guarantee at **$121.4 billion**, the administration proposes appropriating only **$115.9 billion** — creating a **$5.6 billion settle-up obligation** that shifts costs to future budgets. **This money is being used to plug holes in the non-Prop 98 side of the state budget.** The key here is that, while the Legislature has broad discretion over timing and allocation of these dollars, the usual practice is to pay settle-up in the following year's budget. The Governor's 2026 proposal breaks from this norm, deferring the $5.6 billion with **no specified payment date**, which means school districts including **OUSD likely won't see these funds earlier than 2027-28**. A bit of good news: the Governor's budget *does* propose **paying the prior $1.9 billion settle-up** from 2024-25 in full. A 2018-19 contingency law provides that if any settle-up remains unpaid after the state certifies the guarantee, it converts to a block grant distributed 89% to schools by ADA and 11% to community colleges. The 2024-25 guarantee will be certified between May and August 2026. The OUSD board resolution referencing "Proposition 98 monies that were allocated in previous years but were not released to California school districts but are set to be released in the spring of 2026" **refers to this $1.9 billion prior-year settle-up, plus the $1.9 billion in payment deferrals** that are scheduled for repayment. Note, however, that the timeline of "spring 2026" is optimistic — funds appropriated in the June 2026 budget would begin flowing after July 1st, with apportionments continuing over the summer.