Palo Alto Unified is bracing for $33 million in budget cuts next school year.

A statewide legal fight over withheld school funding is unfolding as the district works through its own budget shortfall.

The California Teachers Association filed a lawsuit Tuesday, Sept. 15, seeking to recover $3.9 billion in Proposition 98 funding the state withheld for the 2025-26 fiscal year. The suit, filed in California Superior Court, argues the withholding violates Proposition 98, the constitutional funding guarantee for public schools that voters approved in 1988.

The California School Boards Association said it plans to file a similar challenge, EdSource reported.

The statewide stakes are large. The CTA, which represents 310,000 educators, estimates the $3.9 billion shortfall works out to $638 less per student across California, according to the lawsuit's filing.

PAUSD's exposure to the Prop. 98 fight is indirect. The district is a "basic aid" district, meaning roughly 83% of its revenue comes from local property taxes rather than the state funding formula most California districts depend on. No PAUSD official has publicly said whether the lawsuit would have a direct financial effect on the district.

Still, the district's own fiscal picture is grim. After approving teacher raises of 5% this year and 5.4% next year, plus two $5,000 bonuses per teacher, PAUSD's ending fund balance dropped to a projected $37.4 million, less than half the $84.6 million it held a year earlier. The raises add $12 million in ongoing costs. The expiration of the Measure O parcel tax, which generates nearly $17 million a year, widens the gap further. Voters rejected Measure B, a parcel tax renewal, on June 2.

"Salaries and benefits are 86 cents of every dollar," Chief Business Officer Charen Yu said at an Aug. 19 board meeting, as reported by The Paly Voice. "A gap this size cannot be closed by cutting supplies, travel or consultants."

Board President Shounak Dharap, speaking at a Sept. 15 meeting covered by Palo Alto Online, framed the deficit as a deliberate choice: "Where we are now in the budget is not a mistake by the board. It was not the result of some slow, longterm mismanagement. It is a decision that the board made, and I think unanimously, we own that decision."

Superintendent Jason Glass has said layoffs would be a last resort and that central office and administrative costs would be cut first.

Back in Sacramento, the state has run deficits for four consecutive years totaling $125 billion, according to Gabriel Petek, the Legislature's budget analyst. He has described the accumulated obligations as a "wall of debt," CalMatters reported. The CTA also challenged $1.9 billion withheld from the 2024-25 budget. The state repaid that amount, but the lawsuit argues it still cost schools $350 per student that year.

Newsom has said districts will get the $3.9 billion if projected revenue is collected early next year. The state budget sets the Prop. 98 minimum guarantee at $125.5 billion for 2025-26, with the withheld funds not due until the May 2028 budget revision, according to the Association of California School Administrators.

No hearing date has been set. PAUSD expects results from an external audit in mid-October and will present its first interim budget in December. If the district cannot resolve its fiscal problems, the Santa Clara County Office of Education could intervene in the district’s budget process.