IV. Funding Options for New Jersey

"The legitimate object of government is to do for a community of people,
whatever they need to have done, but cannot do at all or cannot so well do
for themselves, in their separate and individual capacities."

-- Abraham Lincoln

With a special focus on funds for telecommunications at the K-12 level of education, this report presents the range of funding models that might be adopted by New Jersey. A state-by-state chart of funding systems is included. A discussion of the potential impact of the FCC final universal service rules for discounted advanced telecommunications services follows. Finally, recommendations for New Jersey funding policy and direction are offered.

With the best of efforts there will be a need for approximately $1.605 billion in new funding over five years to meet the technology needs of New Jersey's public and private K-12 schools and libraries.5 States across the country are faced with the same challenge, and, like New Jersey, are seeking unique funding methods.6

In this report some of the advantages and disadvantages of funding models implemented by other states are presented so that New Jersey can select, adopt, or adapt the best features of some of those models--while developing its own funding solution, based on New Jersey's own political, educational, and financial needs.7

A. State Technology Funding Approaches

States have established several methods for funding educational telecommunications: legislative appropriations; bonds; telephone company excess earnings; lottery income; special dedicated taxes; user fees; and miscellaneous funds. The most common methods are legislative appropriations and telephone company excess earnings.

1. Legislative appropriations are made annually or biannually, depending on the state's budget cycle. In a few states the allocations are sporadic or even one-time-only events. Typically, the legislature appropriations funding to the state education agency, which, in turn, distributes to the schools, either on a per-pupil basis, through competitive grants, or on the basis of a completed technology plan. The technology plan is important because it assures that schools have considered all of the educational and technology planning system requirements.

Examples of States using legislative allocations are: (1) Ohio, where the state has made an allocation of $95 million for School-Net to supplement Ameritech's excess earnings fund and; (2) Pennsylvania, where the Governor has made a special case to the legislature for an allocation of $120 million over three years for the development of Link-to-Learn, a project to place computers and networking capabilities in all schools.

Pros: Legislative appropriations tend to demonstrate commitment by the legislature to educational technology and provide a quick infusion of funds into the enterprise.

Cons: Commitments can waiver from year to year, leading to instability of technology funding. Furthermore, appropriations depend entirely on tax revenues, which can vary and can become implicated in political battles at a higher level.

2. Bonds. Instead of dipping into the state's general fund for technology, a few states establish bond funds. In such cases a popular referendum often is required to secure the funds, as the bond often is substantial and places the state in debt with interest payments greater than the principal itself. Bond funds typically are distributed through the state education agency or the department of information technology. Because bonds tend to be longer term, they often are not used for the acquisition of computer hardware and equipment.

Examples of bond fund use include Mississippi, where the state has approved a bond of $41 million for school technology.

Pros: Bonds allow greater stability of funding over a longer period of time, and they permit immediate acquisition of technology hardware. Also, the immediate and direct impact of technology acquisition on the state budget is not so readily apparent through bonds.

Cons: Bonds tend to use a long-term solution for a short-term investment, so the state must continue to pay for the technology long beyond the useful life of the technology itself. A substantial portion of the bond payment is interest, which results in higher cost for equipment. Finally, bonds that require a public referendum require advocates who are willing to invest time, effort, and money campaigning for the successful passage of the referendum ballot.

3. Designated Taxes. Special dedicated taxes can be established by legislatures to acquire funding for educational telecommunications. Only one state, Missouri, now has such a tax--on videotape rentals--dedicated to education (specifically to video telecommunications). Alaska also has a tax on oil drilling, but those oil royalties are directed to the general fund, not just to technology. While there appears to be little taxpayer complaint about the Missouri video tax, such a designated tax collected on a frequently acquired consumer item can disturb the public.

4. Lotteries. Widely viewed as a painless way to capture moneys for designated purposes, many state legislatures have used the lottery as a means of funding education, and one state, Georgia, relies on the lottery to fund educational technology. The designation of lottery profits to educational technology requires a legislative act. Within states, lottery income varies from year to year.

Example. Georgia's lottery has provided a means of sustaining the telecommunications infrastructure established by the initial excess earnings fund in 1992. Whereas an excess earning fund of $50 million provided the capital funds for the infrastructure, the lottery profits pay the operating costs of the system. The lottery proceeds continuing fund now contains about $70 million, and is used mostly to support distance education.

Pros: Devoting lottery funds to education requires no funding from general revenue, and therefore no raising of taxes or reducing appropriations to other services.

Cons: Reliance on lottery funds for education sometimes undermines the state's basic commitment to the financial support of education through the general revenue. In some states general fund spending for education has declined after the designation of lottery profits to education. Furthermore, the lottery profits vary from year to year, leaving the beneficiaries--educational institutions--uncertain of their funding.

5. Telco Deregulation and Excess Earnings Funds. Depending on whether a state--and its public utilities commission--has rate cap regulation or incentive regulation, or has relatively little regulation at all, considerable sums of money might accrue from telecommunications providers on behalf of educational telecommunications in lieu of direct refunds to customers. PUCs sometimes require refunds to ratepayers, but increasingly, state legislatures consider excess earning funds and overcharges as a means to deliver substantial funds to educational institutions.

Examples. Michigan and Georgia are just two of the states in which education has benefited from excess earnings funds. In Michigan $10.5 million was placed in a fund, distributed by a state commission, for infrastructure development. In some cases, such as Texas, telephone companies contribute to an educational technology fund in exchange for deregulation. (See discussion on Texas in Appendix E).

Pros: The dedication of excess earnings to a related activity, the development of technology infrastructure, carries some commitment from technology-interested parties. The excess earnings fund is an "invisible" fund in that it has no impact on the state's general fund.

Cons: Targeting excess earnings and overcharges to education require some political maneuvering. Technically, the fund belongs to ratepayers, who might wish to receive a rebate instead of dedicating it to a "government" project. In addition, deregulation funds, though they benefit a worthy educational purpose, might be perceived as anti-consumer, because they remove some consumer protection regulations.

6. Private Industry Funds. In a few states, the respective departments of education seek funds from key in-state business partners, which take tax write-offs for their cash or equipment contributions. Vermont, for example, has benefited from a $2 million grant from IBM. The businesses gain good will for their generosity by promoting their assistance to education.

7. Cost Recovery Systems. In a few states, such as Oregon and Florida, there is an expectation that user fees from individual institutions will fund educational telecommunications. Florida charges schools for the use of its video conferencing system. Oregon, which had expected to break even on its EdNet investment through user fees, now returns to the legislature biannually to request a supplement to the user revenue.

B. An Overview of Tax-Exempt Leasing as a School Funding Source

Tax-exempt leasing is one option for providing funding that is gaining acceptance in public and not for profit schools throughout the country.

Like a car lease, a tax-exempt municipal lease allows for the purchase of a product by making a series of fixed payments over a period of time. But unlike a car lease, a tax exempt municipal lease is offered at an interest rate that is comparable to that of a small bond issue. Since it often is configured to assure that there is no residual value, it eliminates the need for a final lump sum payment, yet all the products will be owned by the school at the end of the lease period. The lease can be configured to cover hard goods (i.e., the product), as well as infrastructure, services, maintenance and training.8

A tax-exempt lease offers certain advantages when compared to other funding programs:

1. Project financing often can be obtained without a down payment;
2. The lease agreements are structured to meet IRS requirements, so the interest component of the lease payment is exempt from federal income taxes. In turn, this lowers the interest rate paid by the school;
3. A lease agreement guarantees both a fixed payment amount and a fixed lease term;
4. The lease agreement is subject to annual appropriation, so voter approval is generally not required;
5. Tax exempt financing is available for most essential use applications, and just about all technology related projects would be considered essential applications;
6. It is easier to administer than a bond issue, and has significantly lower administrative and issuance costs; and
7. It can be made available to not-for-profit education facilities (i.e., private schools).

The most valuable quality of a tax-exempt lease is that it allows the school administrators to relate the pay back period for technology funding to the life expectancy of the equipment, or duration of the related service. In this way obsolescence can generally be avoided. Another advantage is that once a product is owned it can be sold, if desired, without the administrative complexities involved with joint ownership. A lease, due to its shorter terms, facilitates this option, thereby allowing schools to recover the residual value of some of its obsolete or unused equipment.

With increasing recognition of the need for integrated technology systems, as opposed to stand alone products, the advantages of a payment program that can be related to the life cycle variables of each of the components become even more valuable. Technology systems are comprised of a vast array of products and services. Computers, printers, scanners, video systems, VCRs, telephone systems, communication networks and software are just some of the key components. To assure that all these products work properly and support a positive learning environment, there is a need for extended electrical power access, properly configured furniture, and enhanced environmental systems and controls. Each of these components has its own forecasted useful life. A lease allows the financing terms to reflect the differences in the useful life of each project component.

A lease-purchase option generally is considered an operating expense for accounting purposes. When the lease is structured specifically for a state or local institution the funds, even though applied toward the capital expenditure, tend to come out of the operating budget, generally considered to be debt. The reason that it is not considered debt is that there is non-appropriation language in this type of lease structure. If the institution is not appropriated funds in each subsequent fiscal year, the lease can be terminated, and the equipment can be returned with no legal obligation or liabilities going forward.

C. Discounts for Schools and Libraries: An Overview of Federal and State Regulatory Proceedings Regarding Universal Service

1. The new Federal Communications Commission rules will provide eligible K-12 schools and libraries with discounts ranging from 20% to 90% for the purchase of all telecommunications services, Internet access and internal connections.

The Telecommunications Act of 1996 requires the FCC and the states to ensure that quality telecommunications services are available to all Americans at affordable rates. Notably, the Act makes the provision of advanced telecommunications services to all schools and public libraries a national priority.

To implement the mandate for universal service set forth in the Telecommunications Act of 1996, the FCC adopted final rules on May 8, 1997. See In the Matter of Federal-State Joint Board on Universal Service, CC Docket No. 96-45, Report and Order (Adopted May 8, 1998).

The FCC universal service rules will provide eligible schools and libraries throughout the country with discounts ranging from 20% to 90% on the purchase of all telecommunications services, including Internet access, connection charges, monthly tariff rates and internal wiring, with higher discounts being provided to the most disadvantaged schools and libraries. Specifically, the level of economic disadvantage will be measured by eligibility for the federal school lunch program.

Total expenditures for federal universal service support for schools and libraries is capped at $2.25 billion per year, with a roll-over into following years of funding authority, if needed of half the funds not disbursed in any given years. No more than one billion dollars will be available to schools and libraries for the funding period from January 1, 1998 through June 1998.

The FCC's rules will permit schools and libraries to begin receiving federal universal service support for telecommunications services in January 1998.

At this time, it is impossible to calculate the extent to which New Jersey's schools will qualify for such assistance in competition with the schools and libraries of other states, or the degree to which the annual "cap" will limit that assistance. However, even if New Jersey were to receive a pro rata share of the schools and library cap proposed by the Joint Board, speculative at best, the annual funding may be only about $45 million.

Research indicates that the amounts needed to achieve a fully functioning advanced telecommunications and educational network in New Jersey will be far in excess of $45 million per year. It also should be noted that the federal support program takes little note of the particular needs of any school or library. Instead, assistance is allocated on the basis of economic disadvantage of the pupils. While that disadvantage likely will correlate somewhat with the needs of schools, it is also possible that older schools, including many in New Jersey, will require a greater than average level of assistance, apart from their own particular economic disadvantage, because of the age of the school buildings. Finally, it is still unclear whether the FCC will adopt the Joint Board decision.

That final rules offer many meaningful measures to begin the task of meeting the 1996 Act's universal service goals. But the fact that the broad scope of these goals do not lend themselves readily to fit the individual circumstances of each state, leave the states with the primary responsibility for ensuring that the benefits promised from universal service will be obtainable.

2. New Jersey schools and libraries will only be eligible to receive FCC discounts if New Jersey establishes equivalent discounts for intrastate telecommunications services.

New Jersey K-12 schools and libraries can only obtain federal universal service support if the New Jersey Board of Public Utilities establishes discounts on intrastate services at least equal to those established by the FCC rules. The FCC's Report and Order on universal service states that, "we require states to establish intrastate discounts at least equal to the discounts on interstate services as a condition of federal univeral service support for schools and libraries in that state." Final Order, Para 550. The rules also states that, "[f]ederal universal service support . . . for eligible schools and libraries in a state is contingent upon the establishment of intrastate discounts no less than the discounts applicable for interstate services." To be codified at 47 C.F.R. Section 54.506(c)(1).

The BPU regulates intrastate telecommunications services, which includes local phone calls. Only the BPU has the authority to set rates for those services as well as the authority to determine whether there must be discounts on intrastate, or local, rates for schools and libraries. The BPU has set a schedule for hearings, which will take place in September 1997, to examine this issue and whether New Jersey should establish its own universal service fund.

To ensure that the residents of New Jersey receive the benefits of universal service, the Ratepayer Advocate has recommended to the BPU that a New Jersey-specific universal service fund be established to guarantee that all New Jersey schools and libraries receive discounts for advanced telecommunications services. 9

The Ratepayer Advocate has recommended that the Board establish a telecommunications fund that would provide a discounted price for all telecommunications services to schools and public libraries. This state-based fund would be consistent with FCC universal service support, while avoiding certain fundamental limitations that represent potentially serious defects applied to New Jersey. These limitations include the fact that the proposed cap on total annual spending means that some New Jersey schools may not receive any discount; and, that the discount may not be sufficient to provide services to some schools with aging physical plants.10

The Ratepayer Advocate has proposed that, as an initial measure, the Board adopt the discounts set forth in the Final Rules, without the cap, as the level of discount to be afforded to New Jersey's schools and libraries.

In addition, the Ratepayer Advocate has urged the Board to require telecommunications providers to offer schools and libraries local exchange service and all other services at residential rates. Schools and libraries currently receive these services at a higher, business rate.

D. Additional Funding Options For New Jersey

There are other funding options which should be examined. These include:

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Footnotes

5 New funding needed for public schools and libraries totals $1.429 billion over five years. New funding needed for public schools alone totals $1.377 billion. Back

6 A full list of potential cost-savings opportunities and revenue initiatives is attached as Appendix D and discussed in Sections V and VI. Back

7 This national overview is based on Hezel Associates' annual research report, Educational Telecommunications: The State by State Analysis. A state-by-state analysis of funding methods is attached at Appendix E. Back

8 The extent of coverage is a function of the offering of the leasing company, and comparative shopping is recommended. Back

9 These recommendations were made as part of the BPU's investigation and rulemaking proceeding to determine whether or not to permit local exchange competition in New Jersey. In January 1996, the BPU issued its Notice of Pre-Proposal and Investigation ("NOI"), which requested comments on general issues of competition in the telecommunications industry, including universal service, affordability, and interconnection. Subsequent to the Board's initiation of the NOI, the 1996 Act was signed into law on February 8, 1996 which, as discussed earlier by its express terms, mandates the opening of all telecommunications markets to full competition. Evidentiary hearings in the NOI proceeding were commenced by the Board on September 9, 1996, and parties have submitted evidence to the BPU regarding the issues of the cost of basic telephone service, and the wholesale/resale rates to be permitted under the provisions of the Act. Parties to the NOI proceeding filed initial briefs with the BPU regarding the universal service provisions of the Act and the establishment of discounts for schools and libraries on December 9, 1996, with evidentiary hearings to be conducted in March 1997. The Division of the Ratepayer Advocate has been an active party to these proceedings. Back

10 An excerpt from the Ratepayer Advocate's brief on universal service issues is attached as Appendix G. This excerpt includes the recommendation that the BPU establish a state universal service fund for discounts to schools and libraries. Back

11 See Appendix H for a description of various federal technology funding options. See also Appendix B for a brief description of proposed state legislation that could affect technology funding. Back