By guest blogger Danielle Wilson

Washington state needs to fund $700 million in school construction and believes taking a loan against future lottery proceeds is a winning bet. The proposal that passed in the Washington House of Representatives on March 4 would give grants to districts throughout the state to create all-day kindergarten classrooms and add more K-3 classes, in an effort to reduce class sizes before the 2017-18 school year.

The plan would borrow against $50 million a year in future lottery profits for 20 years with no local matching funds required. The $700 million total would include money that currently supports scholarships and state financial aid programs for higher education.

The Washington State Lottery made $565 million during the 2012-13 fiscal year. According to the annual revenue report, 60 percent of that money was used for awarding prizes, and another 20 percent was divvied up among sales, administration, retailer commission, economic development, and state programs. The remaining 20 percent of the lottery earnings was used for the Washington Pathways account that funds higher education.

According to The Olympian, the legislature is under a state Supreme Court order to fully fund schools by the 2017-18 school year.

A Wells Fargo report on lottery revenue, obtained by Education Week, states that currently an estimated 8 percent of school funding nationally comes from the $18 billion generated annually in lottery and gaming sales. To date, only a “handful” of states have explored the option of using lottery revenue to secure bonds.

Florida and Oregon have utilized lottery proceeds in this manner for a number of years for school construction projects. Oregon has an outstanding balance of $1.1 billion in lottery bonds and Florida has an estimated $3 billion. Arizona and West Virginia have recently begun securing bonds against lottery revenue.

Michael Griffith, a senior school finance analyst for the Denver-based Education Commission of the States, said that borrowing against proceeds not yet generated can prove to be a significant source of revenue, much like the bonds issued against the tobacco company settlements many states received. “States have to weigh their needs versus revenue: doing something like this is a long-term decision, so it makes sense for use for facilities and long-term projects like construction, not operational funds that don’t last long,” he said in an interview with Education Week.

In previous years, state lottery revenue generated in Washington was used for school construction after voters passed a class-size reduction measure in 2000, said The Olympian. An informal survey conducted in the state showed that an estimated 788 additional classrooms were needed in various districts. State officials estimated that funding all-day kindergarten could cost $105 million and the needed construction to lower K-3 class sizes would require an additional $599 million, according to the article.

Griffith said states build budgets based on what makes the most significant impact; often, funds are targeted where the most overall impact is likely to occur or be equally distributed to each district. He does admit $700 million sounds like “an awful large amount of money,” but it may be based on the population that the classrooms have to serve.

Arturo Pérez, a fiscal affairs program director for the National Conference of State Legislatures, told Education Week that the money is provided through bonds and an agreement is made about the conditions of the loan. These agreements include terms about payout, interest rates, and options in the case of the state not obtaining the estimated revenue being borrowed against. The investor, in many cases a bank, provides the bond to the state with a determined interest rate and maturity date. The state then provides the funding to the agencies in need. Perez said that the interest rates associated with the bonds often function like a mortgage loan where the state will have the option to refinance.

“There’s always a risk on the part of the investors, and the degree of the risk does vary,” said Pérez. He said making the decision to borrow against money not yet received is carefully assessed by policymakers and normally only considered when the funding is used for a long-term asset such as education. Most states assess if there is a significant backlog of financial resources and what the dire needs of the state are prior to exploring this option. Obtaining this type of bond can affect the state’s bond rating.

“Until the debt service is retired you have committed that those funds can’t be used for anything else,” said Perez. The debt service is calculated by the amount owed on a loan; it includes both the interest and loan payments.

The News Tribune reports that state Treasurer Jim McIntire has written a letter to Gov. Jay Inslee and state House and Senate members warning them about the implications that exceeding their debt limit would have on the state’s credit rating, including possibly driving up borrowing costs for future investments. An amendment was made to the original proposal in the state House to require the State Finance Committee and Office of Financial Management to determine the best financing structure for the lottery revenue bonds by Dec. 1, 2014. A final vote has not been made in the state Senate for the bill.

Discussions about how the borrowed lottery funds would be replaced in Washington are expected to take place next year when the legislature discusses how to spend an additional $2 billion in public schools.  According to the article, the money would not be diverted until 2016.