The blog of the Urban Institute
February 12, 2019

Local responses to education funding formulas might force incremental change

February 12, 2019

Nearly all states allocate money to local school districts using an education funding formula, where dollars are distributed according to student needs and district resources. Most education funding is a partnership between local education agencies and states, so state legislators who want to change school funding must consider how localities will respond to formula changes. Because local responses are hard to predict, and because of provisions that ensure communities are protected from sharp funding declines, most state funding changes are incremental, implemented through small formula tweaks or changes that are drawn out over many years.

Factors such as the incentive for raising local funds, the local housing market, the leeway allowed by the state for raising additional local funds, the availability of outside education options, and local residents’ preferences for education could affect how districts react to formula changes. Local behavior changes on two fronts: local education agencies may change the level and distribution of local funding, and households may change education and housing decisions.

Districts respond to the “price” of additional spending

For local education agencies (typically school districts), a change to the state funding formula can change their allocated state dollars or the district’s incentive to raise local revenue. In many states, districts can increase or decrease the level of local education funding that they contribute, and thus districts typically respond to state formula changes by changing their local funding allocations.

When school districts receive additional aid, such as through grants designated for low-income students, this funding might crowd out some local spending (PDF), particularly in school districts that have more leeway to reduce local revenue, even as spending increases overall. This phenomenon means that an additional federal or state dollar directed to a district may result in a less-than-a-dollar increase in overall spending.

The response will also be determined by the tax “price”—the amount of revenue it receives for their local tax effort—a district faces if it increase local spending. This price is determined by the structure of the school finance system. In some formulas, districts could  “buy” a dollar of additional education spending (PDF) for less than a dollar of local tax revenue, potentially inducing them to spend more, because they receive a bonus for each dollar they raise. Similarly, if some portion of local spending is recaptured by the state through the finance system, districts could face a higher tax price, because an additional dollar of local tax revenue buys less than a dollar of education spending.

If the state restricts a district’s ability to raise more funds, districts might try to increase education dollars from other sources, such as via capital expenditures or private donations. In Michigan, where centralized funding means that districts can’t change their local contributions for current expenditures, some school districts have increased educational spending by increasing their education capital expenditures.

Individual households respond to changes in school expenditures and local taxes

Just as school districts might respond to a new funding formula, households residing in that district might respond by changing their education and housing preferences. These changes, in turn, can affect the local resources—such as property values and taxable income—that can be drawn upon for education funding.

Changes in education funding can cause families to move between school districts, affecting housing prices. For example, finance reform-induced increases in school district spending are associated with increases in property values. Similarly, funding formulas that penalize districts with high property values might trigger a decline in property values, as residents in those districts end up paying additional taxes for funding that does not go to local students.

When local school funding does not reflect the value that local residents place on a high-quality education, some families might also opt out of the public school system. Multiple studies have shown that declines in public spending on education, typically induced by school finance reforms, are associated with increases in private school enrollment.

We can’t exactly compute local responses to formula changes

Although some of the factors affecting local responses to funding formula changes can be calculated—such as the “price” that a district faces within the formula—other factors, such as residents’ education preferences or changes in the housing market, are harder to quantify and predict.

This element of uncertainty could be one of the reasons that most state funding formula changes are aimed at incremental improvement. Formula changes that force small changes, such as “hold harmless” provisions that prevent districts from losing funds, can slow large reforms but could make the effects of formula changes more predictable over time.

Photo by areetham via Shutterstock.

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