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Urban Institute

How School Funding Formulas Work

How School Funding Formulas Work - Urban Institute

School funding is a blend of federal, state, and local dollars. Local funding largely comes from property taxes. Federal money, which accounts for just 10 percent of all education funding, tends to target low-income students or other distinct groups. State funding is where things get complicated.

In all but five states, statewide formulas control most school funding. State education funding formulas have been the subject of controversy, confusion, and even lawsuits. Designed to ensure adequate funding across schools-and occasionally to promote equity-funding formulas distribute revenue to districts based on a variety of factors.

Here, we explore the most common funding models states use and how districts might respond to those models. No one model is best-they create different incentives for districts that can bring distinct advantages and disadvantages.

Foundation Grants: States Ensure an Equal Foundation for All Districts

The most popular model for school funding is the foundation grant. Under this model, the state decides the minimum amount that should be spent per student, calculates each district's ability to pay, and fills in the gap.

Minimum funding per student Local contribution

We illustrate this model with an imaginary state that has 20 districts, each with a different level of property wealth. The yellow dotted line represents the state's predetermined funding minimum; in this state, the combination of district and state funds must add up to at least $10,000 per student.

This state requires districts to assess a percent property tax and has estimated each district's ability to pay based on that amount. The tax rate is indicated by the pink dots, and each district's per-student contribution is represented by a blue bar.

As you can see, the amount each district raises through a 1 percent tax varies widely, with one raising more than $10,000 per student. Less property-wealthy districts, however, need significant help from the state to reach the minimum.

The state fills the gap between what the district is expected to provide and the predetermined minimum, as indicated with a dark blue bar.

Minimum funding per student Local contribution and State Contribution

In some cases, districts may not get any foundation funding, because they can meet or exceed the spending minimum on their own. As you'd expect, districts that raise less from local sources get more state funding.

Of course, property taxes are not always the same across districts. What happens when districts make different decisions about their local contribution?

In our example, districts are required by the state to have a minimum 1 percent property tax, but they can opt to tax up to 1.4 percent.

Minimum funding per student Local contribution and State Contributions

We've modeled what would happen if every district taxed at a higher rate. Critically, the state's contribution remains the same regardless of the district's property tax rate, so any increase in funding comes from the district's local tax base.

As you'd expect, the property-poor districts don't get much additional funding by raising the property tax, but property-wealthy districts can raise a lot more. Still, every district is exceeding the minimum at this higher tax rate.

Using the sliders and buttons to the right, you can model what happens as districts change their property tax rates. Changes make a bigger difference for the property-wealthy districts, though the property-poor districts will never be far above the $10,000 threshold.

Minimum funding per student Local contribution and State Contributions - Property Tax Rate

This approach to funding can mean that the property-wealthy districts spend more per student than the property-poor districts. However, it also ensures that every district has at least $10,000 per student. That is, as long as the state can afford its contribution.

But what if a state isn't able to fulfill its commitment to districts? Here, we've modeled what would happen if a state, facing a budget constraint, was forced to lower the minimum funding level to $6,000 per student. The curve is more pronounced now, with the property-wealthy districts far outspending the property-poor districts.

Minimum funding per student Local contribution and State Contributions - Property Tax Rate

Foundation funding can minimize differences in spending across districts when states can afford to provide large grants. Since that is not always the case, however, some states use additional mechanisms to try to account for differences in districts' property wealth.

Guaranteed Tax Base: States Balance Local Contribution

Some states' formulas equalize not just access to a minimum level of funding, but also the revenue generated at a given tax rate. This approach, sometimes called power equalization, allows each district to tax and spend as if it had the same local property tax base, thereby eliminating the inequities that foundation funding can produce.

Minimum funding per student Local contribution and States Contributions - Property Tax Rate

The guaranteed tax base approach promises districts a consistent amount of money for their tax effort. Rather than ensuring a minimum overall funding level, the state instead commits to providing a minimum amount for each percentage of property tax regardless of how much district tax revenue is actually raised by that tax.

In our example, the state guarantees each district $6,000 per student per 1 percent tax. This means that in a district where that tax rate yields $1,000 per student, the state will contribute $5,000. At a 1 percent tax rate, this looks similar to the foundation funding model, with all but the most property-wealthy districts spending $6,000 per student.

At a higher tax rate, however, the pattern changes. Whereas with a pure foundation grant, the more property-rich districts exceed the minimum by more than their property-poor counterparts, with a guaranteed tax base, all except the most property-rich districts exceed the minimum by the same amount. That is, a 0.2 percent increase in property taxes generates the same financial boost in almost every district, regardless of the tax base.

Minimum funding per student Local contribution and States Contributions - Property Tax Rate

Districts that could previously only raise small amounts of revenue from property taxes can now raise substantially more with the guarantee that the state "match" their effort.

Property-poor districts now have an incentive to raise local taxes, since each additional dollar of local money raised yields more money from the state.

This model also ensures that all but the wealthiest districts remain relatively equal. Because the state guarantees $6,000 per student per percent property tax, districts that tax at the same level will always have the same amount of money per student.

Of course, the districts that don't need a state contribution can still raise well above the minimum-but some states have found a way to control for this, too.

In both the foundation and guaranteed tax base models, some districts do not receive any state aid because their property wealth per student is higher than the minimum level established by the state.

Minimum funding per student Local contribution and States Contributions - Property Tax Rate - Recaptured Amount

Some states let the districts keep these funds, but other states choose to "recapture" this revenue by setting a cap on spending for these unaided districts (indicated in yellow). For example, in our power equalization model, we can decide that any local funds raised above $6,000 are recaptured by the state.

In any state funding model, however, there's a risk to using recapture.

Those living in a property-wealthy district may have preferences for high spending on education. Under recapture, additional dollars in property taxes would not go to local students, and property values in the district may decline as a result.

Minimum funding per student Local contribution and States Contributions - Property Tax Rate - Recaptured Amount

(In our model, districts can keep state funding above the minimum, but not local revenue.)

If the state relies on recapture to fund redistribution to property-poor districts, the state may be forced to lower the recapture threshold year after year to continue to raise the same amount of money.

Minimum funding per student Local contribution and States Contributions - Property Tax Rate - Recaptured Amount

With the lower recapture threshold, property values may decline even further, causing a downward spiral of decreasing thresholds for recapture and subsequent decreasing property values.

Because guaranteed tax base formulas can dramatically change incentives for districts, states that use a guaranteed tax base model sometimes use it in combination with a foundation grant, matching dollars spent above a minimum foundation amount.

Centralized School Finance: States Control Local Contribution

So far, we've seen that states can either guarantee a minimum level of adequate spending or guarantee a minimum tax base for property-poor districts. In each case, districts have some leeway to choose property tax rates to raise required local funding.

Minimum funding per student Local contribution and States Contributions - Property Tax Rates

Some states have opted for a different path. Rather than trying to outspend rich districts or equalize property values, some states have essentially centralized their school finance system. The state assigns a standard property tax rate for all districts. In return, it guarantees roughly the same per student amount across districts.

In our example, the state sets a standard payment of $10,000 per pupil, and each district pays a required 1 percent tax.

This model looks like a foundation grant, with the state guaranteeing a certain amount of funding, but with the centralized model, districts can't raise more than the minimum amount.

Just like in the other models, states that use the centralized school finance model have to decide how to treat districts, like our richest district, that can raise more than the standard payment using a 1 percent tax. The state could grandfather in such districts, either temporarily or permanently, or the state could recapture surplus funds.

Accounting for Student Need
In this interactive, we've highlighted three methods states use to distribute state funding to school districts. Although these methods are often tied to property wealth, in many states, the districts with the neediest students are not the ones with the lowest property wealth. In part because of this, most states use additional mechanisms to deliver more funding to districts that have more need, either through the formula or outside of it.

For example, many states "weight" students when running their formula, assigning more weight (and therefore more dollars) to students from low-income backgrounds or to students with special needs when calculating the amount of funding guaranteed by the state. States may also use categorical funding, assigning dollars specifically for certain programs or for spending on specific students.

Because states can provide revenue through other mechanisms, the proportion of state funds distributed through a typical formula grant vary substantially. For example, Arizona and North Carolina distribute roughly 98 percent of total state funding through their formulas, yet Connecticut distributes 38 percent of funding this way, and South Carolina distributes just 24 percent of its funding through a formula.

Whether relying heavily on a funding formula is good for schools and students depends on the state and its goals; there is no one-size-fits-all approach to school funding. States have different aims, different obstacles, and different students, and so must choose the combination of approaches that works best given the situation.

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