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In 1994, Michigan enacted a comprehensive school finance reform that not only significantly increased state aid to low-spending districts, but also placed significant limits on local discretion over school spending. These limits especially constrained the high-spending districts. This scenario affords us a unique opportunity to study the implications of such reforms on resource allocation, particularly as they differentially affected districts situated at different points of the pre-reform spending distribution. We find that the reform generally led to a negative effect on the growth of instructional expenditure and its share, as well as in teachers per pupil. But these declines were sharpest in the high-spending districts. Interestingly, while trends for shares of administration expenditure as well as administrators per pupil also showed across-the-board declines, these declines were actually the smallest for the high-spending districts. To the extent that instructional expenditures are more productive and contribute to student achievement more than administrative expenditures, these results suggest that loss of discretion acted as a disincentive for districts located throughout the spending distribution. Moreover, this disincentive effect was the strongest in the high-spending districts. These findings have important policy implications and suggest that school finance reforms (or other policies) that place significant restraints on local discretion can lead to unintended disincentive effects, which should be taken into account while devising policy.

Effect of Constraints on Tiebout Competition: Evidence from the Michigan School Finance Reform