Making sense of education funding

Each January, California’s governor proposes a state budget based on a forecast of how much the state and school districts will take in through taxes. Using the proposed budget for 2026-27, this post walks you through how money flows, with a focus on education.

Heads up! We’ve included quizzes in this post. Look for them and click to reveal the answers.

There is some good news for K-12 schools in this budget: With the stock market up, inflation in check, and the number of students to serve in the state basically steady, there is some more state money. Education funding will go up for many programs. A few highlights:

• More money for community schools, teacher residencies, and learning recovery programs.
• $40 million to continue screening all K-3 students to identify risk of reading difficulties.
• $100 million to increase access to college and career pathways for high school students.
• The bad news: The costs of special education and healthcare are growing faster than revenues.
• The budget focuses on the continued implementation of previous investments, not new programs.

Not everyone is comfortable with this budget. The state’s independent Legislative Analyst’s Office (LAO) characterizes the multi-year proposal as “alarming” because it predicts a financial downturn in years ahead. The California Teachers Association (CTA) accuses the proposal of playing a “shell game” to put off committing funds owed to schools.

School boards will have to reach their own point of view about how aggressively or cautiously to manage resources, balancing today’s needs with the possibility of leaner times ahead.

The Budget Big Picture: Budget Magic

Let’s start with a quick look at where the money comes from and where it goes. This has an important impact on education because the state constitution requires about 40 percent of the general fund to be spent on education.

Revenue from the state

Most of the California budget, especially state funds for education, is contained in the state General Fund. The pie charts below show where this state money comes from and where it goes. You can see that the largest revenue source is personal income taxes.

Public school funding also relies on local property taxes, which tend to vary much less than income taxes. Federal support for public education, significant in the pandemic, has plummeted as a share of funding.

Where does the money go?

The revenues are marked to flow to Health and Human Services, K-12 Education, and other areas like higher education and transportation.

The federal budget has cut support for health and food assistance, inflicting new costs on the state budget. To protect Health and Human services, California is adding about $1.4 billion to General Fund expenses in 2026-27.

• Health care: $1.1 billion in additional costs. Medi-Cal, California’s Medicaid program, provides health care services for more than 14 million low-income Californians including kids, parents, and people who support them.
• Food aid: Nearly $300 million in costs to CalFresh, the state’s Supplemental Nutrition Assistance Program, which helps put food on the table for more than 3 million California households.

Elections have consequences. Federal cuts to Health and Human Services is one consequence. These are basic resources children need to do well in school. There may be more federal cuts ahead that further hurt children and families, which would require the state to make tough decisions in a tough budget. Anyone interested in education needs to pay close attention to this.

Balancing the budget

The chart below compares revenue to expenses in the General Fund.

How do California’s Rainy Day Funds work?

Did you notice the gap between revenues and expenditures? It’s not a typo — the proposed budget calls for California to spend more than it takes in.

Rainy day funds smooth out year-to-year changes in revenue

Like virtually all states, California’s constitution requires a balanced budget. Achieving balance has long been a challenge in this state, and the challenge has grown with income inequality.

In years when the economy is strong and the stock market goes up, investors who sell for a profit earn taxable capital gains. State tax receipts rise on these gains, generating funds for schools and other functions.

In years when the economy stumbles, by contrast, tax receipts slow or fall. Investors’ capital losses offset their gains and reduce their taxes. The boom-bust pattern, called revenue volatility, makes balancing the budget each year very difficult.

The common-sense solution — save in good years to endure tough ones — took a long time to put in place, and it’s complex. Voters created the state’s system of five rainy day funds gradually. In 2004, as part of the California Balanced Budget Act, voters created the Budget Stabilization Account (BSA). Ten years later, voters enthusiastically expanded the BSA, authorizing it to a size of up to 10% of the General Fund. Education funding got additional protection with the creation of the Public School System Stabilization Account (PSSSA). The rules that govern these accounts are rigidly defined in the laws that California voters put in place for them. Governors and legislators cannot ignore these rules to “tap” reserve funds or build them at their whim.

Most school districts keep their own rainy day funds, too, but at low levels. California law imposes a “reserve cap” level of 10% on districts (except small ones). There is political logic behind this restriction: districts without savings cannot easily weather a strike, for example. There are business interests at stake, too — if districts can’t save up for big expenditures they have to finance them through debt.

In 2024, California faced a huge state budget deficit. As a result, over the last two fiscal years, the state withdrew approximately $12.2 billion from the BSA. The Governor’s proposed budget for 2026-27 rebuilds reserves. It includes $4.5 billion in the Special Fund for Economic Uncertainties and $4.1 billion in the Public School System Stabilization Account—bringing the total amount of reserves in 2026-27 to roughly $23 billion. Again, read California Reserves Explained from the Cal Budget Center to explore these funds.

While the Budget is formally balanced in the 2026-27 fiscal year, with a discretionary reserve of $4.5 billion, it projects a deficit of roughly $22 billion in the 2027-28 fiscal year and shortfalls in the two years following. See California 2026-27 proposed budget.

Predictions are hard!

California’s wealthiest taxpayers fund our schools

In most years, about half of California’s state income tax revenue comes from taxes paid by the top 1% of earners. When stocks rise, investors who sell them pay taxes on their realized capital gains. When the market is hot (as in 2021), capital gains have amounted to as much as 11.6% of the economic activity of the state. In a cold year, when investors’ gains are offset by losses, they have amounted to as little as 1.9%.

The graph below, which the governor shows in almost every budget presentation, shows the dramatic ups and downs of capital gains as a percentage of the California economy.

From the state budget summary: “The Budget projects capital gains realizations to increase 8 percent in 2025 and 1 percent in 2026, compared to a 15-percent decline in 2025 and flat growth in 2026 assumed in the 2025 Budget Act.”

This volatility makes it very hard to accurately create a balanced budget as required by law. All kinds of things can change in the course of a budget year. Here are some known risks:

• Stock market and asset price declines—shocks that disproportionately impact high-income earners.
• Unpredictable federal policies
• Uncertainty regarding tariffs and immigration, as well as their impact on inflation, the labor market, investment, and overall demand.

Budgets are forecasts by humans, and humans can disagree. The Governor’s proposed budget anticipates a $2.9 billion shortfall in 2026-27. The state Legislative Analyst (LAO), in contrast, sees an almost $18 billion shortfall. The difference is even greater in future years. See chart below:

The LAO reports that, while the Governor’s budget proposes about $5 billion in spending solutions on an ongoing basis, “these fall well short of the amount needed to substantially address future deficits”.

Warning! The proposed budget could change in May

In 2024-25 the budget process was disrupted and delayed by wildfires, leading to flawed revenue predictions and unanticipated cuts. If other disasters lead to another delay in tax filing, the problem could be repeated.

State budget basics: the General Fund

California operates on a fiscal year that begins in July (matching the school year). Under public scrutiny, the Governor’s January proposal is formally revised each year in May. A budget bill must be passed by the legislature and signed by the Governor by June 30.

The table below looks at how money is spent in the proposed 2026-27 state budget, compared to last year.

How is the education share of the state budget determined?

California’s constitution requires about 40% of the state General Fund to be directed to public TK-12 schools and community colleges. In combination with local property taxes for education, this is called the Prop 98 budget. This funding is based on attendance, not enrollment.

The formula for how much of the General Fund goes to education includes many factors, including how well the economy is doing, whether there are more or fewer kids showing up to public school, and changes in the cost of living. The chart below adjusts for inflation.

You can see that the Prop 98 amount in red for 2026-27, after adjusting for inflation, is slightly higher than in the previous three years. But it is significantly higher than earlier budgets.

Local Control Funding Formula

The rules that allocate funds from Prop. 98 to school districts are known as the Local Control Funding Formula (LCFF). Money is allocated from the state general fund and from property taxes based on the number of students who show up to school and the characteristics of those students.

The formula directs more money to districts to support students who are low income, in foster care, homeless, and/or learning English.

Here is how it works in virtually all districts:

1. Base Funding: Districts receive a base grant for each student who comes to school. The base grant is larger for grades 9-12 than for other grade levels.
2. Supplemental Funding: Districts receive 20% additional funding per student for students with high needs — specifically defined as learning English, in low income, homeless, or in foster care.
3. Concentration Funding: Districts are provided additional money if more than 55% of children in the district qualify as having high needs.
4. Equity multiplier: Beginning in 2023-24, the state added the option of providing additional funding in support of high-need school sites where more than 70% of the student population is socioeconomically disadvantaged.

School districts then allocate money to pay for staff and programs in individual schools. Some of the money from the state also pays for targeted categorical needs such as Special Education and Arts Education.

In addition to local property tax funds, most schools receive financial support from state and federal sources. Ed100 Chapter 8 demystifies California's school finance system, including the weird stuff.

State education governance

In tandem with the budget process, the governor proposes to amend the Education Code to move oversight authority of the management of the California Department of Education and support of school districts under the State Board of Education (SBE). It’s an idea with a long history, as John Fensterwald explains in EdSource. The fuzzy lines of authority between the SBE and the state Superintendent of Public Instruction have at times led to colliding policies.

Which programs are funded in the education budget?

In addition to the flexible money that is distributed to school districts under LCFF, the budget also funds specific programs that reflect significant priorities of the Governor and the legislature.

The table below lists some of them.

The budget process ahead

Throughout the first half of the calendar year, committee hearings examine both the budget itself and education bills that might have an impact on the budget. Each of these pathways is a little different. (The California Budget & Policy Center, a non-profit organization, does a great job of explaining the distinction between these two paths.)

Going to the source...

• California 2026-27 proposed budget
• Department of Finance presentation and YouTube video
• California multi-year budget projection summary
• LAO budget overview
• LAO Fiscal Outlook for Schools and Community Colleges

As always, EdSource provides excellent coverage of California's education policy developments. If you've reached the end of this post and want more, follow EdSource.