Estimating the effects of school finance reform: A framework for a federalist system

This paper models the effect of increased state involvement in school funding on education spending levels. Unlike previous studies that have assumed perfect sorting of voters into districts by income, this analysis assumes demand sorting. I, thus, am able to utilize the true distribution of wealth across districts to estimate tax price changes and to predict changes in district spending levels in response to a change in financing rules. I look specifically at three types of state funding programs: those in which districts receive a set per pupil grant from the state and are not allowed to raise additional funds, those in which districts are allowed to raise unlimited additional funds, and those in which this supplementation is capped. Both the model and the subsequent simulations indicate that the ostensible benefits of a system with unlimited local supplementation – that it retains much local control over funding decisions on the margin while insuring an ‘adequate' level of financing for all districts – may not be sustainable because high wealth districts have no incentive to support state funding. Additionally, a system with no local supplementation may be politically difficult because it forces many voters far from their preferred spending levels. Capped supplementation provides a balance between local control and spending equity.