State aid and student performance: A supply-demand analysis

Using a supply-demand framework, a six-equation model is specified to generate hypotheses about the relationship between state aid and student performance. Theory predicts that an increase in state or federal aid provides an incentive to decrease local funding, but that the disincentive associated with increased state aid is moderated when federal aid is compensatory. Applying the theory to Alabama county school test score data, results suggest that between 62 and 73 cents of the incremental state dollar goes to schools; the rest is absorbed by local taxpayers through incidence shifting, and by the federal government through the compensatory mechanism. Despite these 'leakages', results suggest that increased state aid can improve student performance provided the incremental funding goes to teacher salaries and not to reductions in class size. Poverty reduction or income growth, however, might accomplish the same ends at lower cost.