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Estimating permanent and transitory income elasticities of education spending from panel data

  • Schmidt, Stephen J.
  • McCarty, Therese A.
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    We use a twenty-one year panel of data to examine the role of past income and aid, and expectations of future income, in regressions explaining state and local education spending. We show that simple estimates of the elasticity of spending with respect to financial resources are not robust to specification changes because the variables are non-stationary over time, causing inconsistent estimation of model parameters. Estimation in first differences (or equivalently, in growth rates) solves the time-series problems and produces robust estimates of the model's parameters. We then show that current spending by states responds to changes in expected future income. This explains why using fixed effects in simpler models reduces estimated income elasticities; fixed effects partially capture permanent income effects on spending. Estimates of lagged income are significant when used in models that do not explicitly model the expectations process, but present and past aid both have no effect on education spending. Models with structural assumptions about expected income produce estimates very similar to simpler models which include lagged information on income as a control variable. We conclude with recommendations for estimating models when only cross-section data or only short panels are available.

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    Article provided by Elsevier in its journal Journal of Public Economics.

    Volume (Year): 92 (2008)
    Issue (Month): 10-11 (October)
    Pages: 2132-2145

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    Handle: RePEc:eee:pubeco:v:92:y:2008:i:10-11:p:2132-2145
    Contact details of provider: Web page: http://www.elsevier.com/locate/inca/505578

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    1. Harris, Amy Rehder & Evans, William N. & Schwab, Robert M., 2001. "Education spending in an aging America," Journal of Public Economics, Elsevier, vol. 81(3), pages 449-472, September.
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    5. Therese A. Mccarty & Stephen J. Schmidt, 2001. "Dynamic Patterns in State Government Finance," Public Finance Review, , vol. 29(3), pages 208-222, May.
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    8. Goldhaber, Dan, 1999. "An Endogenous Model of Public School Expenditures and Private School Enrollment," Journal of Urban Economics, Elsevier, vol. 46(1), pages 106-128, July.
    9. Michelle T. Bensi & David C. Black & Michael R. Dowd, 2004. "The Education/Growth Relationship: Evidence from Real State Panel Data," Contemporary Economic Policy, Western Economic Association International, vol. 22(2), pages 281-298, 04.
    10. Shadbegian, Ronald J., 1999. "The Effect of Tax and Expenditure Limitations on the Revenue Structure of Local Government, 1962-87," National Tax Journal, National Tax Association, vol. 52(n. 2), pages 221-38, June.
    11. Aronsson, Thomas & Lundberg, Johan & Wikstrom, Magnus, 2000. "The impact of regional public expenditures on the local decision to spend," Regional Science and Urban Economics, Elsevier, vol. 30(2), pages 185-202, March.
    12. Ronald J. Shadbegian, 1999. "Fiscal Federalism, Collusion, and Government Size: Evidence from the States," Public Finance Review, , vol. 27(3), pages 262-281, May.
    13. Murray, Sheila E & Evans, William N & Schwab, Robert M, 1998. "Education-Finance Reform and the Distribution of Education Resources," American Economic Review, American Economic Association, vol. 88(4), pages 789-812, September.
    14. Reza Baqir, 2002. "Districting and Government Overspending," Journal of Political Economy, University of Chicago Press, vol. 110(6), pages 1318-1354, December.
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