School vouchers trigger credit, legal concerns in Southwest states

Texas Governor's Office

Texas' big move into private school vouchers has raised credit concerns about its public school districts amid a more competitive environment that could lead to diminished enrollment and decreased state funding. 

The state will launch what Gov. Greg Abbott called "the largest day-one school choice program in the nation" in the 2026-27 school year. The Republican governor, who made education savings accounts his top priority for the 2025 legislative session, on May 3 signed Senate Bill 2, which creates an initial $1 billion state-funded program that allocates about $10,000 per student to attend alternatives to public schools.

With state funding of public schools allocated primarily on a per-pupil basis, a shift of students and funding to private options could result in budgetary pressures as the voucher program ramps up, according to a July 31 KBRA report.

"While near-term effects may be muted, the long-term impact on individual districts will depend on their ability to adapt through strategic planning, operational flexibility, and efforts to attract and retain students," the report said.

Larger urban districts are probably the most vulnerable as some struggle with student achievement and have long-standing trends of enrollment declines, according to KBRA analyst Peter Scherer. 

Wealthy suburban districts with high student achievement and popular amenities will likely see limited enrollment shifts to private schools, KBRA's report said, adding that the impact might also be limited for rural districts where private schools may not be available. 

In a June report, Moody's Ratings said the ESA program is a negative credit factor for Texas public schools "because it diverts funds away from them.

"As students have access to additional educational alternatives, public schools are likely to face enrollment declines unless their competitive profile improves," the report said.

The primary source of state funding for Texas public schools is the basic allotment, which is based on average daily attendance. It was raised less than 1% to $6,215 per student for the 2025-26 school year from $6,160, where it had been since 2019.

Bond rating agencies have cited stagnant funding as a contributor to budgetary strains that have led to some underlying rating downgrades or negative outlooks for Texas districts in recent years. Public school general obligation bonds carry triple-A ratings through the Texas Permanent School Fund's bond guarantee program.

ESA demand could increase the cost of the Texas voucher program to $4.8 billion by fiscal 2030 with the appropriation level ultimately determined by the legislature, according to an April Legislative Budget Board report on the bill. 

Costs have mushroomed in Arizona for vouchers enacted in 2022 that then-Gov. Doug Ducey called the most expansive school choice law in the nation. The universal empowerment scholarship account program, which does not have a spending cap, could approach $1 billion in fiscal 2026.

The program's escalating costs could crowd out Arizona's other discretionary spending and introduce uncertainty into its education funding framework, a S&P Global Ratings report last week said.

"For some school districts, the ESA program has contributed to enrollment erosion, further challenging revenue stability under Arizona's enrollment-based funding model," the report said. "The program's fiscal footprint and its implications for both state-level expenditure growth and local education funding equity will remain key considerations in assessing the broader financial impact on school district credit quality."

S&P, which rates 56 Arizona school districts, noted that reform efforts have not succeeded, "leaving the program on a significant growth trajectory."

Democratic Gov. Katie Hobbs' push this year for guardrails on vouchers, including "responsible income caps" and greater transparency on how the money is spent by parents and guardians failed to gain traction in the Republican-controlled legislature.

In fiscal 2025, the majority of the 87,602 students in the program received between $7,000 and $8,000 and the cost of ESAs on an annualized basis was pegged at $901 million, according to a May quarterly report, which also said 57% of the nearly 64,000 students who were universally eligible for the program came from public schools. For the coming school year, the program's total enrollment stood at 89,502 as of Monday.

S&P also has its eye on potential developments that could affect the bond-issuing charter school sector.

A split decision by the U.S. Supreme Court in May quashed an effort in Oklahoma to allow the nation's first state-funded religious charter school. St. Isadore, which is part of the Catholic Archdiocese of Oklahoma City and the Diocese of Tulsa, appealed a June 2024 ruling by the Oklahoma Supreme Court that found state funding for St. Isadore's operations violates the state constitution.

"The outcome of this Supreme Court decision supports credit stability for the charter school sector by maintaining the long-standing funding framework under the charter school laws in 47 states plus Washington, D.C. that consider charter schools as public schools and generally require that they be nonsectarian in order to receive public funding," S&P said in a May report that noted the high court could revisit the issue in the future.

It added that charter authorization frameworks and funding reliability are key aspects of its credit analysis "and any material modifications to the framework could have consequences for a school to pay its debt service obligations on time and in full."

More than 1.3 million students participate in some form of private school choice available in 35 states, according to EdChoice, a nonprofit, nonpartisan advocacy group. 

State funding for the programs has led to court battles. 

The latest legal challenge to Arkansas' Education Freedom Accounts was filed in U.S. District Court in June by a group of public school parents and guardians.

Lawmakers combined vouchers with teacher pay raises in a bill signed into law by Gov. Sarah Huckabee Sanders in March 2023. The state's LEARNS Act created the accounts, which were provided to 5,548 students for the 2023-24 school year at a cost of nearly $35 million, according to the program's latest annual report. 

While participation in the program was initially limited, the state launched universal eligibility for the coming school year. Applications have topped 49,700.

The lawsuit claims most of the private schools eligible to receive state funding under the program are religious based in violation of the U.S. Constitution's Establishment Clause. It also cites an Equal Protection Clause violation and seeks an injunction to stop the vouchers. 

Defendants, who include the Arkansas Department of Education, members of the Arkansas State Board of Education, and the governor, filed a motion to dismiss the case on July 28. 

The Utah Fits All Scholarship Program, which launched in the 2024-25 school year, continues to operate while it awaits a state Supreme Court ruling on the state's appeal of a district court ruling that found it to be unconstitutional, according to a spokesman for the Utah Board of Education.   

The lawsuit brought by the Utah Education Association, which represents teachers, contended the vouchers violate constitutional requirements by diverting income tax revenue to fund private schools that are not free, not open to all students, and not controlled and supervised by the State Board of Education.  

For the 2025-26 school year, $102.5 million in state funding was appropriated for the program, the spokesman said.