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Indexation of the Schooling Resource Standard Should be Reviewed by an Independent Expert Panel

Friday June 2, 2017

The indexation of Schooling Resource Standard (SRS) against rising school costs is critical for school budgets because it is a central feature of Commonwealth Government funding of schools. If the rate of indexation fails to match increasing costs such as teacher salaries, educational materials and utility charges such as water and electricity, school budgets will be squeezed. Schools will not be able to afford the same level of human and material inputs as they have in past years.

The importance of the SRS to school budgets stems from the fact that it sets the base amount of funding from all sources (government and private) that should be available for all schools with a minimum level of disadvantage to achieve adequate student outcomes. In addition, funding loadings for different categories of disadvantaged students are set as a percentage of the SRS. Commonwealth Government funding of schools is based on these two factors.

Under Gonski 1.0, the SRS for primary and secondary schools is indexed at 3.6% per year to maintain the real value of the SRS against rising wages and other costs. This rate was based on a 5-year forward estimate of average recurrent costs of all public and private schools in 2013.

Under Gonski 2.0, the 3.6% indexation rate will be replaced by a floating rate from 2021 which will be a composite of 75% of the Wage Price Index (WPI) for all industries and 25 per cent of the All Groups Consumer Price Index (CPI). The CPI component is intended to compensate for increasing costs related to non-salary items such as educational materials and utilities. It also proposes a minimum indexation rate of 3%. Indexation will be set at 3.56% for 2019 and 2020 as a transition arrangement.

This is a significant change that should be carefully assessed. There are several reasons to consider that it will likely result in schools not being adequately funded to meet rising wages and other costs.

First, the WPI component does not accurately reflect wages growth in education because it is based on wages growth in all industries rather than in education. On average, wages growth in education and training (public and private) exceeded wages growth in all industries by about 0.5 percentage point over the last 18 years for which comparable data is available [see Chart 1 below]. The WPI for all industries will therefore generally underestimate the extent of rising costs in schools and using it to index the SRS will likely increase the SRS by less than the actual cost increases facing schools over time. Schools will face a cost squeeze because their funding increases do not match their cost increases.

Second, the wage price component of 75% of the composite index is too small to adequately fund schools. Employee-related expenses in public schools constitute 85% of total expenditure on public schools (excluding user cost of capital, depreciation, payroll tax and school transport). The larger 25% weighting given to the CPI component means that the extent of rising costs facing schools will be under-estimated because increases in the CPI for all groups historically are about one percentage point below the increases in the WPI for education and training [Chart 1].

A composite index of 85% of the WPI for Education and Training and 15% All Groups CPI (here called Gonski 3.0) is a more accurate indicator of changes in costs facing schools. Adjusting the SRS by this index would provide more adequate funding to cover rising costs compared to the proposed Gonski 2.0 composite index. Cost increases shown by the Gonski 3.0 index were significantly higher than for the Gonski 2.0 composite index in nearly every year between 1999 and 2016 and even higher than Gonski 1.0 indexation for the large part of the period [Chart 2]. Schools will not receive adequate funding to cover rising costs if the SRS is indexed at the Gonski 2.0 rate.

The fixed Gonski 1.0 indexation rate over-estimates cost increases in periods of low wage and price increases and schools as shown in the Chart for 2012 to 2016. This would lead to schools being over-funded to meet cost increases. However, if this rate of indexation had been applied since 1999 it would have under-estimated increases in school costs for much of the period and schools would not have received adequate funding to cover these costs.

Clearly, there is a case for a flexible indexation rate that more accurately reflects changes in costs in periods of low and high increases. However, such an approach brings another problem. It means that indexation is based on past cost increases and this introduces a lag between the cost increase and the funding increase. As a result, the funding increase in the current year may be less than or exceed the cost increase for the current year. This is exemplified in the proposed Gonski 2.0 indexation which is based on the past yearly changes in the wage and price indexes.

The Australian Education Amendment Bill specifies that the indexation factor to be applied to SRS funding amounts for a year is the change in the composite WPI & CPI index between the June quarter of the previous year and the June quarter of the current year. As the WPI and CPI for the June quarter are not available until about mid-July in the current year, the SRS for that year will not be determined until sometime in the 3rd quarter of the calendar year at the earliest. This seems somewhat late in the year to be relevant.

It would play havoc with school budgeting as school budgets for the current year need to be formulated in the last half of the previous year. It would create uncertainty for schools about the amount of funding they will receive year to year and make it more difficult to budget for salaries, materials and other items. Wage and price increases that are higher in the current year than the previous year could result in schools not having adequate funding to cover the higher costs. On the other hand, lower wage and price increases in the current year than in the previous year could result in small windfall gains but schools may not be able to save these gains for application in the loss years. The volatility of the CPI from year to year adds to the uncertainty [see Chart 1].

The uncertainty for school budgeting is compounded by the fact that the Amendment Bill also provides for the Minister to prescribe the SRS indexation factor by regulation if required. The Explanatory Memorandum for the Bill states that this flexibility allows the Minister to meet pressing circumstances, for instance, to ensure schools can continue to operate with reasonable funding growth in an extreme deflationary environment (where the SRS indexation factor formula would result in zero or negative indexation), or where changes in the economy-wide CPI and WPI indexes are markedly different to changes in education cost structures. Apart from the fact that schools cannot be forewarned about resort to Ministerial determination of the SRS indexation factor, it also opens the whole process to political pressure.

All schools would no doubt prefer greater certainty about funding levels over time. The proposed 3% floor for indexation of the SRS under Gonski 2.0 will provide some protection. However, for years where costs increase by more than 3%, as they have for the most part over the past 18 years, schools are not likely to be adequately funded to cover rising costs by the Gonski 2.0 indexation.

Several alternative approaches could be considered. One is to prescribe an indexation rate in legislation based on past increases, such as a rolling five-year average to the June quarter in the previous year, with a floor of 3%. Another is to set the indexation factor for five-year periods based on forecasts of the WPI in Education and Training and the All Groups CPI by an expert panel. This would involve regular five-year reviews of the SRS indexation factor. This could be the better option on the condition that it is a public process.

It is noted that the National Education Reform Agreement that established Gonski 1.0 proposed an independent review to set the approach to indexation for the SRS after three years. The Agreement stated that ministers of the participating jurisdictions would commission an independent expert body to conduct the review and ensure that body has the expertise to consider the historical approach to indexation of schools funding, the drivers of cost in education and appropriate methodologies for maintaining the ability to deliver outcomes. One of the several purposes of the review was to consider whether the approach to indexation should be applied as supplementation (that is, applied to the SRS per student amounts during the funding period) or indexation (that is, applied to the SRS per student amounts prior to the beginning of the funding period).

This review was not conducted by the Coalition Government. It is timely that a review be constituted before changing the legislation in order to draw on independent expert advice. It is a technical issue that should be subject to expert advice in public. The current provision of the Australian Education Act for indexation of the SRS at 3.6% per year should be maintained until the review is completed.

Trevor Cobbold

Charts on Indexation of the Schooling Resource Standard.pdf

  1. Trevor,

    this is a very important issue and a strong piece of analysis. Thanks.

    Can I suggest a different tack re how to set indexation rates: take a best-educated guess about next year’s cost growth, but then adjust the following for the inevitable forecasting error.

    So, for example, we would be seeing lower indexation in 2018 because the 3.6% indexation has overshot in the last few years.

    Over the medium term, this would keep indexation in line with costs.

    And, since cost growth since 2013 has been lower than the 3.6% predicted in 2013, this would free up money that could help get schools to target more quickly.

    Peter Goss    Jun 7, 03:52 PM    #
  2. Trevor,

    a couple of further (unrelated) points.

    I like the idea of your 85% : 15% split, rather than 75% : 25%, if that is closer to the underlying cost split. (Best would be an expert review to confirm.)

    I’m also not convinced that education WPI is quite as much above broad WPI as you indicate: Figure 1 in the Technical Appendix of Circuit Breaker shows it is 0.3% higher on average since 2002, versus your quote of 0.5% higher when you include some earlier years. But there does appear to be a small but persistent difference.

    My preferred policy outcome is to have these types of analysis done by an independent National Schools Resourcing Body, taking it away from politicking.

    Peter Goss    Jun 7, 03:53 PM    #

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