ALL SCHOOL FINANCE: Some Useful Results

In order to understand school finance equalization, we need a few results from the Tiebout literature. First, in Tiebout equilibrium with local property tax finance, productivity differences between school districts are capitalized in house prices. If a district has a reputation for consistently being better run and using its money more efficiently than neighboring districts, households will be willing to pay more for houses in the district because the tax burden on homeowners will be small for any given level of school quality.
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Second, in Tiebout equilibrium with local property tax finance, households’ maximizing their utility is equivalent to households maximizing their property values. That is, households actually maximize their utility, but their actions are identical to those they would pursue if they were attempting to maximize their property values. If binding constraints are put on the property tax rates they can set or on the property values they can tax, their property values will end up being lower.

ALL SCHOOL FINANCE: Categorical Aid as an Add-On 4

A very simple guaranteed tax revenue scheme with two guarantees might have a budget constraint like:
That is, regardless of how much local tax revenue a district raises and what its local tax rate is, it will always get the basic guarantee. California has a minimum tax rate of 10 mils so that districts cannot opt out of local public schools. Since there is no incentive for residents of a district to ever let themselves be taxed at more than the minimum rate and local schools do not benefit directly from increases in local property values, it is not surprising that Proposition 13, which makes 10 mils the maximum tax rate as well as the minimum tax rate and prevents house values from being reassessed for tax purposes so long as they remain under the same owners, was passed in a referendum soon after the Serrano II equalization scheme was put in place. Fischel (1989,1994) explains the political process by which the Serrano II equalization led to Proposition 13. Thus, for equation (8), r”m—r/”®*. California’s formula was not initially self-funding because the state started with a large budget surplus. It has been more or less self-funding, however, in most years of its operation.
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ALL SCHOOL FINANCE: Categorical Aid as an Add-On 3

The stringency of a foundation aid program is greater as the foundation level,/ rises relative to per-pupil spending in the state (making / rise relative to r). A state that imposes a foundation aid program in which the foundation level is, say, at the 75th percentile of the per-pupil spending distribution is a state in which nearly all property taxes from nearly all districts have to go towards funding the foundation grant. In such a case, only few districts would want to set a rt higher than / in order to raise additional local revenue to pay for spending beyond the foundation level. It is, of course, theoretically possible to set /and/so high that no district wants to spend more than the foundation level.
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Below, I explain why foundation aid schemes are fundamentally different from, say, categorical aid schemes that attempt to achieve a similar amount of redistribution. This explanation only makes sense after a Tiebout-style model of school spending determination is presented (in the next section).