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.