Executive Summary

State governments are in midst of one of the most severe fiscal crises of the last half century. Many local governments are experiencing fiscal problems that are equally daunting. The magnitude of the fiscal challenges facing state and local governments highlights the importance of sound fiscal planning and access to key financial indicators. Without an early warning system that assesses financial condition, the extent of a government’s financial problems might go undetected until they are so severe that draconian measures are required. As used in this report,

condition of school districts is defined as the ability to finance adequate student performance over the long-run with reasonable tax burdens and without temporary disruptions of service. Adequate student performance implies students reaching the academic standards set by the New York State Board of Regents.

The framework used for the financial condition indicator system (FCIS) developed in this study includes four components applicable to a school district: short-run financial condition; long-run financial condition; economic condition; and student performance. Short-run financial condition captures the ability of the district to pay its bills, and balance the budget without extraordinary measures. Long-run financial condition measures the capacity to finance adequate services over the long-run without onerous tax burdens and debt burdens. Economic condition is broken out as a separate category to reflect the importance that the local economy has on student needs, and on the capacity of the district to raise taxes. The fourth component, student performance, is included as a measure of service level adequacy.

The FCIS is designed to accomplish several important objectives. No single indicator or even a small set of indicators is likely to accurately identify school districts at risk of future financial crises. Thus, the FCIS incorporates 50 different measures to provide a comprehensive view of financial condition in New York school districts. Second, the FCIS is designed to be modular. One of the advantages of the FCIS is that it provides separate measures of each of the four components of financial condition as well as a number of subcomponents. Third, the FCIS was designed to reflect the judgment of financial experts in New York on what financial measures are important, and how these measures should be combined into overall assessments of financial condition.

In designing the FCIS to meet these objectives, the research team and advisory board confronted several challenges. Combining the 50 different measures becomes a challenge, because they are often measured in different units. Second, while it is desirable to tap the knowledge of experts in designing a complex evaluation system, the judgments of experts is often context dependent. In other words, how an expert evaluates an indicator depends on context in which the judgment is being made. For example, financial experts might view low debt burdens favorably, but only if the government has made adequate capital investments.

To address these challenges we have employed a state-of-the-art evaluation tool—fuzzy rule-based systems (FRBS). To handle the many indicators and units of measures in the FCIS, FRBS converts all indicators into membership levels in three “fuzzy” sets (e.g., high, moderate, low). Drawing from fuzzy set theory in mathematics, a school district can be classified as being a member of a more than one set at the same time. For example, a district’s fund balances could be classified as poor to some degree and fair to some degree. The use of fuzzy sets makes the evaluation results in a FRBS much less sensitive to small changes in measurement. The second key component of a FRBS is the use of “rule bases” to combine several measures into a composite measure of performance. Rule bases are a collection of rules about how these measures should be associated with different levels of performance. It is the use of rule bases that allows a FRBS to capture the contextual judgment of experts.

A key step in the FCIS development process involved selection by the New York State Education Department (SED) staff of a panel of experts to serve as an advisory board to our research team. The advisory board reviewed each stage of our work and offered valuable advice regarding both the framework and set of indicators for the FCIS, and the rule bases.

The results reported here should be viewed as tentative, because the system is still a prototype which requires additional field testing. Average results are presented for need/resource capacity categories, and generally fit expectations. The high need urban districts as defined by SED are in poor to fair financial condition on all the different dimensions. The financial condition of the Big 4 is particularly weak. On the other end of the spectrum, low need districts are in fair to good financial condition, due largely to strong economies and high student performance. The high need rural districts had shortrun and long-run financial condition that was comparable to average need and low need districts. Despite relatively poor economic condition, many high need rural districts appear to have successfully managed finances at least up to 2001, the last year for which we have fiscal data.

The principal contribution of the FCIS is a detailed view of the components of financial condition in a district. This information could be used to identify districts facing potential short-run and long-run financial crises. To illustrate this potential, the financial condition of an anonymous district is analyzed using the results of the FCIS. The FCIS could be used to develop an early warning system that could help SED identify when a district is at risk of financial problems. SED, in conjunction with the New York State Association of School Business Officials (NYSASBO), New York State Council of State Superintendents (NYSCOSS), and New York State School Boards Association (NYSSBA), could use the FCIS as a training tool to assist districts in identifying and tracking key financial indicators. Individual districts could use the results of the FCIS to examine how their financial condition compares to districts of a similar size or need/resource capacity category. An important feature of the FCIS is that it permits a user to peel back the layers that make up the system to see where a school district’s financial condition is good and where it is in need of improvement. For example, districts at risk of a credit rating downgrade may be able to take action to correct the problems identified by the credit rating agencies.

Ultimately, the FCIS has the potential of providing a financial information system that can be used by school administrators, school boards, teachers, and concerned citizens. The system could generate user-friendly reports that explain why particular judgments were made about the district’s financial condition and what actions could be taken to improve it.