| Susanna Loeb
Stanford University
Fiscal substitution and the effectiveness of school finance equalization policies
FINAL REPORT:
Many states have recently implemented reforms intended to reduce variation in per pupil spending across districts by constraining high-spending districts from above, constraining low-spending districts from below, or simultaneously constraining both types of districts. There is a small literature documenting how families with high demand for spending on education can either individually (e.g. by leaving the public sector in favor of private schooling) or communally (e.g. by voluntary financial contributions to public schools) restore differences in effective resources across students. This work and the larger literature addressing the impact of policies that are meant to affect local govemment behavior have addressed how governments respond when constrained from above. In contrast, the literature has given little consideration to what happens within the local budget or to what happens to districts that are constrained from below. That is the goal of this report in utilizing the experience of school districts in Michigan following the 1994 reform. Proposal A imposed strict spending floors and ceilings on operating expenditures for public school districts, replacing a matching grant system that allowed for local discretion in determining the level of spending on education. The spending floor is set at approximately $5000 per pupil, and is partially locally financed through a property tax charge that is constant across districts. For many districts, this new program involves large net transfers from the state. Using data on school districts both before and after reform, the report provides evidence that districts with mandated spending on school operations that exceeds their preferred level use operating revenues for goods previous categorized as capital or for goods (such as lunch) for which they had previously charged students. Yet, even while this substitution occurs, much of the increased revenues have gone where intended - to decreased class size, increased salaries, and new curricular materials.
In addition to tracing the effects of the policy change on fiscal substitution, this report provides a general description of changes in Michigan following school finance reform. Proposal A was a radical shift along a number of dimensions. It equalized spending across districts by bringing up the lowest spending districts and essentially freezing the revenues of higher spending districts; it shifted funding responsibilities to the state level and constrained the revenue raising capacity of local jurisdictions; it decreased and equalized property tax rates and increased the sales tax; and it introduced school choice to Michigan in the form of charter schools. Each of these changes creates new challenges and opportunities. The tensions that have emerged most strongly so far are the dissatisfaction in high-demand districts that wish to increase their spending levels, and the financial difficulties in districts that lose enrollment because of the mechanical tie to revenues. It is not yet clear whether these problems will be solved through tinkering with the current system or whether they will lead to more systemic change.
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