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Education Finance Reform and Investment in Human Capital: Lessons from California

Original Publication by Raquel Fernandez and Richard Rogerson
Journal of Public Economics, Elsevier Science S.A., 74 (1999) 327-350
Synopsis by Maggie Fromm, Claremont McKenna College '06

The argument for public funding of education has long been that investment in public education is essentially an investment in human capital carried out over the long term. However, the proportion of income that goes towards public educational funding varies from state to state, as do the systems through which funding is regulated and dispersed. This study by Fernandez and Rogerson focuses on the disparity of these systems in order to determine how the level and distribution of human capital is influenced by the varying systems of funding for public education.

Fernandez and Rogerson begin by laying out a model wherein designated communities, whose parameters are set by a majority vote, are homogenous by income between the different families. Resources and funds are then allocated to education across the community by a school financing system. California is chosen as the study location because of a series of changes in the 1970s. These included a lawsuit, Serrano v. Priest, as well as the passage of Proposition 13, that limited property taxes and allowed reassessment only if the property is sold. That shifted the burden of funding from a combination of local and state funding (a foundation system) to one solely in the hands of the state. After these funding reforms, California's primary and secondary education investment share per student fell by almost ten percent.

By assuming that individuals "have identical preferences over only two goods: consumption and education," Fernandez and Rogerson build a model wherein the quality of a student's education is solely a function of spending per student. Three different finance systems are then used to examine the equilibrium outcomes: a purely local system, a foundation system (state and local), and finally a state system. In the purely local system, "there is no redistribution and each community chooses the tax rate that funds its own education expenditures." The foundation system, however, requires a base tax level for each district supplemented by a guaranteed expenditure level by the state. Each community can choose to raise its own tax on income in order to increase funding. Fernandez and Rogerson note that in the case of a foundation system, an individual whose income is above the mean will prefer as low a tax base as possible, whereas individuals below the mean will "prefer their entire educational expenditures to be financed through the foundation grant." In the state system, all districts are guaranteed to spend the same amount per student on education, but there is no local supplementary spending. In this situation, the funding preference for those whose income falls below the mean is identical to that of the foundation situation, whereas those whose income is above the mean will, in a state system, prefer a positive state level tax.

In comparing the state system and the foundation system, it is apparent that individuals above the mean income will spend more on education under a foundation system than those in the state system. Fernandez and Rogerson conclude that "the state system delivers greater resources to education for all individuals with income below the median," but this does not necessarily imply that there is a greater distribution of resources across individuals. Furthermore, a foundation system is preferred by more individuals because it has less redistribution and an income tax closer to that which they prefer. Also included in their study is an explanation of varying calculations of income over time, and the effect of different parameter specifications on total education spending.

In changing from a foundation system to a state system, Fernandez and Rogerson note that "spending decreases because districts cannot supplement state aid." However, spending "increases relative to the foundation grant level because . . . the median voter in the state system prefers a greater tax rate." Thus, the relative levels of spending and distribution must be examined according to percent losses and gains for portions of the population. The study also goes on to show the impact of deductible local taxes on the shift of systems from foundation to state, showing that because the deductibility is lost, the drop in spending increases.

Finally, Fernandez and Rogerson explore possible alternatives to explain the drop in funding per student in California. They conclude by ascertaining the appropriateness of using a political economy model to understand educational finance. The overall effects of switching from a foundation system to a state system are two-fold. First, wealthier districts lower spending because they cannot supplement state aid. Second, these districts then require a greater amount of funding from the state. Their study, however, does not indicate a purely "negative trade-off between equity and resources devoted to education." Instead, it shows that spending decreased in wealthier districts and increased for the extremely poor. Fernandez and Rogerson also note the possibility that such a shift, in the long run, might eventually create a state wherein efficiency gains offset the total losses in spending.