Effect of constraints on Tiebout competition: evidence from a school finance reform in the United States

In 1994, Michigan enacted a comprehensive school finance reform that not only significantly increased state aid to low-spending districts, but also placed restraints on the growth of spending in high-spending districts. While a rich literature studies the impact of school finance reforms on resource equalization, test scores, and residential sorting, there is no literature yet on the impact of such reforms on resource allocation by school districts. This study begins to fill this gap. The Michigan reform affords us a unique opportunity to study the impacts of such reforms on resource allocation in districts located at different points of the pre-reform spending distribution, and we study this both theoretically and empirically. We find that the reform led the high spending districts to allocate a lower share of their total expenditure to support services and a higher share to instruction (relative to the low spending districts). To the extent that instructional expenditures are more productive and contribute to student achievement more than support services expenditures, these results suggest that the reform led to a relative increase in productivity in the high spending districts. This finding is robust in that it continues to hold in each of the seven years after the reform we analyze, is not sensitive to alternative specifications and controls, and survives a series of sensitivity tests. This finding has important policy implications, and this evidence of resource re-allocation by districts facing school finance reforms should be taken into account in the design of any school finance policy.