Should fiscal dependency matter?

418 T.A. Downes Economics of Education Review 19 2000 417–429 least once, with an average of two shortfalls in the 5- year period. 3 Since shortfalls occur only if per pupil spending in a year has declined relative to spending in previous years, the existence of shortfalls signals poten- tial instability in spending in the five large city districts. In addition, instability in spending frequently occurs at the same time that state aid is increasing. For example, between 1990–91 and 1991–92, per pupil state aid to the Buffalo City schools increased by over 100 in 1991 dollars. 4 In the same period, total per pupil spending and current expenditures per pupil each declined by about 600, in real terms. The existence of shortfalls and the apparent absence of a positive relationship between state aid and spending are all the more troubling in light of relatively low levels of achievement in the five large city districts. It would seem that the natural conclusion is that either adequate resources have not been provided in these districts or, if adequate resources have been provided, these resources have not been used efficiently. Once this conclusion is drawn, arguing for fiscal independence of the five large city districts seems natural. Unfortunately, neither the conclusion that fiscal dependence is associated with inadequate or inefficient spending nor the conclusion that fiscal independence will improve the situation in the five large city districts follow from the evidence cited above. Take, for example, the above noted case of Buffalo. Claiming that this case sup- ports the conclusion that state aid increases to five large city districts are not necessarily translated into spending increases is fallacious for one simple reason: we possess no knowledge of what would have happened to spending in the absence of increases in state aid. Similarly, by themselves, shortfalls tell us nothing about the adequacy of spending or the accountability of the schools. In determining if the fiscally dependent status of these dis- tricts adversely affects the quality of education, it is insufficient to consider these districts in isolation, since it is impossible to separate the effects of urbanicity from the effects of fiscal dependency. For similar reasons, it is not enough to compare spending and student perform- ance in these districts to spending and student perform- ance in the fiscally independent districts in New York state. The foregoing discussion hints at the approach that will be taken in this paper to assess the impact of fiscal 3 While only New York City is currently subject to the main- tenance of effort requirement, the New York State Education Department calculates shortfalls for the other five large city dis- tricts under the assumption that they are subject to the same requirement. 4 These figures, and all revenue and expenditure figures that follow, are drawn from the National Center for Education Stat- istics’ Common Core of Data CCD. Thus, the figures will not correspond to those drawn from administrative data. dependence. Specifically, I assemble a data set that includes school districts from the New England and Mid- Atlantic states. Because this data set includes a mix of fiscally dependent and fiscally independent districts and a mix of urban, suburban, and rural districts, it can be used to isolate the effect of fiscal dependency on the level, the growth, and the mix of spending. Before I pur- sue that strategy, in the next section of the paper, I ask whether there is any reason to believe that fiscal depen- dency would affect the quality of education provided in the five large city districts. 2. Should fiscal dependency matter? Are the problems of the five large city districts explained in part or in toto by their fiscally dependent status? Standard economic analysis would suggest that the most likely answer to this question is no. In fact, in their discussion of the possible impact of the fiscally dependent status of the five large city districts, Dick Netzer and Robert Berne 1995, p. 53 give just such an answer: In fact, there is little reason to believe that fiscal independence would address the problems commonly cited as the reasons for change. The essence of the argument that lies behind this statement from Netzer and Berne is that there is nothing inherent in any particular fiscal structure that would pre- vent the voters from getting the level of education pro- vision that they desire. In the abstract, government sim- ply serves as an agent for the voters, selecting the spending levels for each public service and the accompanying levels of taxation that are desired. If the voters so desire, they can design political institutions such that, whether each service is provided by a different governmental unit or by a single governmental unit mat- ters not at all since individual voters will balance off their needs for these services, and for private consump- tion, in making their electoral decisions. Thus, the exist- ence of a fiscally independent governmental unit that is responsible for primary and secondary education will not provide education with favored status. Further, fiscal independence will not translate into greater account- ability. The combination of political competition and intergovernmental competition will provide the disci- pline needed to ensure that the educational services pro- vided are of the quality desired by the voters. Fiscal dependence will not create problems, then, as long as voters are able to see through the veil of govern- ment and are able to construct political institutions that make the public choice problem the same in all settings. Thus, if in fact the fiscal dependence of the five large city school districts matters, either there must exist 419 T.A. Downes Economics of Education Review 19 2000 417–429 imperfections in the political process or in the process by which information about the provision of government services is disseminated, or the structure of political institutions must be such that outcomes are likely to dif- fer between settings even if no imperfection exists. In reality, it is likely that such imperfections exist and that the institutional setting will matter. For example, in his summary of the literature on general fund financing, Mueller 1979 makes clear that the chosen level of ser- vices under general fund financing can differ from the chosen level of services when each service is, in effect, financed by an independent governmental unit. Spending on any given service could be higher or lower under gen- eral fund financing depending on the “nature and distri- bution of preference functions” Mueller, 1979, p. 94. The presence of groups of voters that are particularly interested in certain services will only serve to accentu- ate this conclusion Ingberman Inman, 1988. Even if political institutions were structured so that voters, in effect, voted on provision levels for each ser- vice, the analysis of Netzer and Berne 1995 suggests that imperfections in the political process or information imperfections could result in spending differences between the two settings. For instance, the level of edu- cation spending that is selected could be different under a system of fiscal independence of all school districts if different sets of voters participate in municipal elections and in school board elections. If this is the only source of differences between the two settings, however, it can- not be presumed that education spending would increase under fiscal independence Netzer Berne, 1995 or that the chosen level of education spending would even be socially more desirable. In fact, since participation in school board elections tends to be lower than partici- pation in municipal elections, fiscal independence could result in a chosen level of educational spending that dif- fers more from what the typical voter desires than does the chosen level of spending under the current system. Differences in the sets of voters who effectively par- ticipate in the determination of education spending are not the only possible causes of differences in the pro- vision of educational services under fiscal independence and fiscal dependence. Further, these other imperfections could plausibly create the type of problems that pro- ponents of fiscal independence for the five large city dis- tricts apparently want to address. One such imperfection could arise because those who allocate resources to the schools are not those who are ultimately responsible for the quality of the education that is provided. This mis- match can create a situation in which it is difficult for the voters to assign blame if provision of schooling is inadequate. In essence, the opaqueness that is created by the current system permits policy makers to pursue objectives that differ from the objectives of the voters Filimon, Romer Rosenthal, 1982. 5 For those who allocate the resources, these objectives could include increasing non-education spending relative to education spending, a plausible strategy since the ultimate responsibility for the quality of non-education services lies with those who allocate resources. For those who run the schools, this opaqueness may permit use of resources that is technically inefficient, since they may be able to argue plausibly that the problems are attribu- table not to technical inefficiency but to inadequacy of the resources allocated. The ultimate implication of this logic is that the mismatch between those who make spending decisions and those who run the schools means that an increase in aid can translate into an increase in technical inefficiency Duncombe Yinger, 1997. A less cynical explanation for why fiscal dependency might matter is suggested by the voluminous literature that has attempted to explain the phenomenon that has come to be known as the flypaper effect. The reasoning used above to justify the conclusion that fiscal depen- dency should not matter would also lead to the con- clusion that state or federal aid to a local government is equivalent to a grant of income directly to the constitu- ents of that government. Thus, an increase in aid and an equal increase in the income of voters should have the same stimulatory effects on public spending. The bulk of empirical evidence, however, supports the conclusion that aid increases stimulate larger increases in spending than do equivalent income increases. In other words, money tends to stick where it hits—the flypaper effect. In the case of fiscally dependent school districts, a type of flypaper effect could arise if a smaller share of school aid makes it to the schools than in fiscally independent districts. In essence, the aid has “stuck” to the general purpose government responsible for making resource allocation decisions. The flypaper effect is inconsistent with the notion that individuals can see through the veil of government. The accumulated evidence in a variety of contexts, however, supports the view that, in practice, “the location of a pool of funds can easily alter perceptions of what is fair” Hines Thaler, 1995, p. 223. Thus, spending on edu- cation out of aid that goes to a fiscally independent school district could be very different from spending on education out of aid that goes to a general purpose government responsible for allocating resources to a fis- cally dependent school district. In summary, as the preceding discussion reveals, fiscal dependency could well matter. This discussion also 5 In the literature, policy makers in such situations are said to possess and exercise monopoly power. Fisher 1996 includes a nice discussion of monopoly models of public choice. As he notes, monopoly power can only persist in those situations in which there exist institutional barriers that prevent this power from being competed away. The mismatch in responsibilities may represent just such an institutional barrier. 420 T.A. Downes Economics of Education Review 19 2000 417–429 reveals, however, that, relative to fiscally independent districts, spending levels and aid elasticities could be higher or lower in fiscally dependent districts. Thus, before venturing into a discussion of solutions to the fis- cal dependency “problem”, the existence of such a prob- lem must be established. This can only be done empiri- cally, and this cannot be done by examining only the experience of the fiscally dependent school districts in New York. The commonly cited problems in these dis- tricts may be attributable to inadequacies and technical inefficiencies in spending arising from fiscal depen- dency, but these problems could also be a result of the fact that the fiscally dependent districts are also urban districts. The work of Duncombe and Yinger 1997 sug- gests that, in New York, cost disparities contribute sig- nificantly to variation in student achievement and that deficiencies in student performance in the five large city districts cannot be explained fully by technical inef- ficiencies. Thus, the observed differences between dependent and independent districts in spending levels and patterns could simply reflect rational responses to differences in circumstances. The challenge is to isolate the effect of dependency. The next sections of this paper review some initial efforts to estimate this effect.

3. Data