All School Finance Equalizations are not Created Equal

I. Introduction

School finance equalization (SFE) has affected American schools in the areas of school spending, private schooling, and achievement for over 30 years. Economists have become interested of SFE because optimal social investment in human capital depends on how school spending is distributed across students. However, in spite of its importance, SFEs are still poorly understood in practice.

State courts and legislators are confused, not on their goals or legal issues, but on how to implement such goals. States have relied on lawyers rather than economists for the implementation of programs. Owing to this, the schemes became manifestations of legal rhetoric of equalization rather than economic logic about taxation and redistribution.  As such, equalization debates and court cases recur and states have started to give up understanding school finance to identify trial-and-error methods of finding suitable schemes.

SFE schemes sometimes bring results that were not intended. They can reduce total school spending even if it is divided evenly (levelling down). Hence, greater equality in spending also brings lower average spending. In extreme cases, spending may possibly drop even in districts that were meant to be beneficiaries. Several commentators from the famous California SFE argued, however, that the spending reduction that they experienced was not a result of levelling down and was not associated with SFE.

II. School Finance Schemes

A. Pure Local Property Tax Finance

The core of most state systems remains to be local property tax finance. Districts spend their local property tax revenue and households divide their disposable income among property taxes, housing consumption and other consumption.

B. Categorical Aid

Before SFEs became popular, categorical aid was the most famous method of redistribution among    school districts. Unlike SFEs, categorical aid is financed by state income or sales taxes. It is also manifested on one or more district attributes – like mean household income or poverty rate – but not on property values as with the case of SFEs. This type of aid seeks to help school districts that are liquidity constrained or those that have children that are expensive to educate. With flat categorical aid, the disposable income of households is reduced by a school-related tax on income. Each district then receives a grant for each student that is a function of the income and demographics of households. Meanwhile, matching grant categorical aid schemes matches spending that were raised locally[1].

C. Foundation Aid

The most common type of SFE scheme is the foundation aid (FA). FAs are like flat grant categorical aids except that they redistribute not on socio-demographic characteristics of households but among districts based on per-pupil property values. FAs are usually self-funding, so that total foundation taxes that are paid equates to the total foundation grants disbursed. Moreover, FA programs are more stringent in states where the foundation grant is higher relative to per-pupil spending.

D. Power Equalization/Guaranteed Tax Revenue Schemes

Guaranteed Tax Revenue (GTR) and power equalization schemes are often used by states who intend to employ stringent equalization. These schemes attempt to make the same tax rate yield the same revenue for each school district in the state. Many GTR schemes provide equal revenue for each school district in the state. They also offer stronger redistribution for districts that have higher tax rates. These schemes are self-funding at times, where tax rates and guarantees are selected to make sure that contributions from high property value per pupil districts help those that have low property value per pupil. To prevent districts from bailing out of GTR schemes, states require a minimum local tax rate. GTR schemes make each district's tax price – the amount of revenue it has to raise in order to spend an extra dollar – a positive function of its per-pupil valuation. A district's tax price can be derived by differentiating its budget constraint with respect to its local tax rate.

III. School Spending Under Various School Finance Schemes

School finance schemes are not always mysterious. They can be characterized by a few variables that summarize their income and price effects. It was observed that they level down compared with categorical aid schemes that are supposed to achieve the same amount of redistribution. This is one of the consequences of having a scheme for redistribution among jurisdictions based on assets whose prices rest on how people regard the jurisdictions. If the few crucial variables are used, the conflicting evidence on the effects of SFE can be settled.

Both categorical aid and SFE can decrease the distribution of spending. Theory, however, does not indicate how categorical aid and SFE affect spending significantly. Whether categorical aid levels are up or down compared with local finance is still an empirical mystery. Even though GTR or matching grant categorical aid can influence tax prices, almost all actual variation in tax prices is generated by GTR schemes.

IV. Beyond the Direct Effects of Equalization on Spending

Beyond the direct effects of SFEs, it was observed that the consequences of SFEs can be capitalized. Also, some SFE schemes have integrated feedback loops that augment the chance of leveling up or down. Meanwhile, Silva and Sonstelie (1995) mentioned that an SFE may begin with mean state spending, but the target will eventually move towards the median level of preferred spending in the state because of the decisiveness of the median voter.

Households are having a hard time enrolling to their desired schools after an SFE may shift to private schooling. They might send their children to private schools or create local educational foundations that privatize parts of local schooling. SFEs may also affect student achievement by changing school resources and schoolmates.

It was detected that achievement is likely to increase more among low-performing students than among high-performing ones. Lastly, even an equalization that initially levels up can level down as it ages if voters respond to the SFE by constraining the state (through property tax limitations and targets that are strictly tied to inflation) so that future adjustments in the formula cannot further utilize their property wealth.

V. Data

Data on expenditure, enrolment, property values, property tax rates, socio-demographic characteristics, and information about each state's school finance laws were derived from the following sources:

• Census of Government Data (1972, 1982, 1992)
• Census of Population And Housing data summarized at the school district level
• Consolidated districts and special districts
• Property values from statistical abstracts as well as data from the Census of Population and Housing
• The Public School Finance Programs series I derived basic information on school finance laws from the
• Series of Public School Finance Programs (1968-1969, 1970-1971, 1978-1979, and 1987-1988 school years)

 VI. Facts about School Finance Equalizations

Close examination of SFEs from 1970 to 1990 reveals interesting facts. First, the incentives imposed were not accurately revealed by the categorization into court-ordered, legislative, and "no equalization". It was also observed that the majority of states in the "no equalization" category have equalization activity. This activity suggests that judicial or political situations can make an SFE known, even if it is more modest than other states' routine changes to their school finance laws. Furthermore, some court-ordered and legislative "equalizations" change parameters in an anti-equalization direction.

Such behavior makes one doubt whether a dummy variable for equalization will correctly represent the economic content of school finance schemes or the usefulness of an empirical strategy with two dummy variables.

VII. Estimation Strategy

The values of the school finance variables were calculated for every district in the United States in 1970, 1980, and 1990. This brought all of the schemes into a common framework. Regression analysis was utilized to estimate the effect of SFE on the following outcomes:

· The level of per-pupil spending

· Inequality in per-pupil spending

· Property values

· Private school attendance

· Student achievement

An education production function was estimated in the last case using the high school drop-out rate as the measure of student achievement and SFE as a shock to districts' spending. Endogeneity of the observed values of the school finance variables was accounted by simulating the values each district would face if it were to have remained at its pre-SFE tax rates, spending, and property values.

VIII. Spending Results

Two important findings were detected:

1. Changing the inverted tax price that a district encounters can cause dramatic changes in spending (the magnitude of the effect of the inverted tax price); and

2. Flat grant categorical aid has almost no potential to generate levelling-down

After calculating what mean per-pupil spending would have been if no equalization scheme were in effect, it was observed that equalization schemes have generated both levelling-up and levelling-down. Meanwhile, results for the pupil-weighted coefficient of variation in per-pupil spending for each state in 1990 reveal that the standard deviation of New Hampshire's per-pupil spending would have been 5.6 percent more of its mean per-pupil spending if there had been no equalization program. Furthermore, the log 90-10 ratio[2] shows that students at the ninetieth and tenth percentiles would face spending that differed by about 59.3 percent if there had been no equalization scheme.

New Hampshire had a moderate FA scheme in 1990. Majority of states have equalization experiences as moderate as that of New Hampshire. However, although the most common equalization experience in the United States is moderate, it is not necessarily optimal. Among states that experience similar equalizing, there is still variation in whether the state is levelling down or up.

The states with the most dramatic equalizing are all levelling-down[3]. In these states, the difference between spending at the ninetieth and tenth percentiles would be almost 20 percent greater if no equalization program were in effect. In the states with the greatest increases in mean per-pupil spending[4], less dramatic equalizing was detected. In these states, the difference between spending at the ninetieth and tenth percentiles would be only about 10 percent greater if no equalization program were in effect.

Levelling-up schemes tend to have more simple equalizing than levelling-down schemes because these states face little or no direct cost when they set inverted tax prices close to zero but face substantial costs when they set inverted tax prices higher. It is costly to bribe districts that would prefer low spending into spending a lot but it is inexpensive to forbid high spending.

Usually, courts and legislatures are required to achieve a combination of equity and adequacy in school finance. To detect whether a scheme is achieving a good mix of equity and adequacy is the criterion: "Do no harm to poor districts." This means that if in pursuit of equity goals, a scheme makes mean spending fall significantly that spending is less sufficient in poor districts, it has almost certainly gone too far. 

IX. Other Effects of School Finance Equalization

SFE schemes can change property values, both because SFE schemes tax school productivity that has been capitalized in house prices and because SFE schemes themselves can be capitalized. Meanwhile, the most extreme leveling down schemes[5] raise the share of students who attend private school by about 3 percentage points. Furthermore, the private school share falls by about 1.5 percentage points in districts that have the inverted tax prices of 1.5. In general, the private school share will rise in "property-rich" districts and fall in "property-poor" ones.

For dropout rates, it was found that that dropping-out is affected only in districts that would otherwise be very low-spending. This will only occur in districts that were forced to boost spending by the imposition of the flat grant. Results imply that equalization enhances student performance the most in schools that would have very low spending if left to their own.

X. Conclusion

The findings show that some spending equality can be obtained with leveling-up or mild leveling-down. However, near equality of per-pupil spending cannot be achieved without very strong incentives. In theory, either leveling-down or leveling- up SFEs could incorporate such strong incentives, but, in practice, they are included only in leveling-down SFEs because it is cheaper to prohibit high spending but it is expensive to bribe districts to spend more than they prefer to.

Surprisingly, there are poor districts in the United States that might have higher spending if their state attempted to achieve less complete equality. Because equalization schemes can contain feedback where they reduce their own spending targets, underprivileged students can be worse off under equalization schemes that are more generous than the categorical aid schemes they replaced.

House prices drop in districts that are reprimanded for having high property value per pupil. The converse is also true. Such capitalization somewhat undoes the impact of a school finance equalization scheme. Parents are persuaded to send their children to private schools in districts that are penalized for having high property value per pupil.

Even though the estimated effects of equalization on student achievement are weak, it appears that the drop-out rate falls in districts that are constrained to increase spending by the imposition of a per-pupil spending floor.

These results imply that states should be careful in choosing their equalization schemes in order to move toward their equality and adequacy goals. The outcomes also hint that school districts react like economic agents to the incentives created by equalization schemes. Additionally, school finance equalization schemes generate unintended consequences because they centre redistribution among jurisdictions on assets (property) whose prices rely on how households value the jurisdictions. School finance equalization does not merely redistribute from people with greater to people with lower ability-to-pay. Another consequence is that it redistributes from schools that are more productive to schools that are less productive. It can also redistribute from people with greater taste for education to people with lower taste for education. Over time, its own formulation gets undone and a feedback that amplifies its intended effect is generated. Categorical aid, on the other hand, does not produce such unintended consequences.

Source:

Caroline M. Hoxby, “All School Finance Equalizations Are Not Created Equal” Quarterly Journal of Economics, Vol. 116, No. 4 (November, 2001), pp. 1189-1231.

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[1] The matching rate is a function of district demographics

[2] The log of the ratio of per-pupil spending at the pupil-weighted ninetieth percentile and per-pupil spending at the pupil-weighted tenth percentile

[3] California, New Mexico, South Dakota, and Utah

[4] New Jersey, New York, Pennsylvania

[5] Schemes that lower the inverted tax price from one to zero