Public and Private School Competition and U.S. Fiscal Federalism

The traditional public school finance system under U.S. fiscal federalism has generated concern that the use of housing markets to ration resources and students to public schools may increase income and racial segregation. Thomas J. Nechyba explores possible solutions, using a simulation model calibrated to the characteristics of New Jersey school districts in 1990. According to his simulations, centralizing public school finance reduces inequalities in per student expenditures across public school districts. Nechyba argues that spending equalization can only be achieved at the expense of lower average school quality. When accounting for private school competition, his model predicts that centralizing public school finance will reduce the level of segregation across school districts because some households do not have to pay a high housing premium for public school when their school choice is separated from their housing decision. The problem in this scenario is that private schools have the competitive advantages of being able to “cream-skim” nonfinancial resources, such as better students and teachers, thereby lowering public school quality.

To solve this problem, Nechyba advocates a “choice-based” school resource rationing system in which students are assigned to both public and private schools based on an algorithm that includes parental preferences, “walk zones,” and lotteries. This mechanism, Nechyba argues, can (1) retain the traditional role of residence-based admissions by including walk zones as one of the assignment criteria; (2) foster the matching of students to schools by incorporating parental preferences into the decision; and (3) minimize cream-skimming by providing public funds only to the private schools that are willing to participate in this choice-based rationing system. This proposal’s major implication is that school financing will become more centralized, relying more on state income and sales taxes rather than local property taxes as revenue sources. Decisions about the design of the algorithm that defines priority classes for school allotments can be retained at the local level, however.

This paper was presented at the Lincoln Institute’s annual Land Policy Conference in 2007 and is Chapter 12 of the book Fiscal Decentralization and Land Policies.