Rural School Funding News Special Series:
Financing Rural Schools: Characteristics of Strong Rural School Finance Systems

Last Updated: December 21, 2010

This article appeared in the December 2010 Rural Policy Matters.

In this series, Rural School Funding News is reviewing general principles of school finance and sharing information about school funding systems that support rural schools and their unique characteristics and needs. While there are no easy answers to questions about how to fund schools, especially in this economic climate, we hope that these articles will provide you promising practices, ideas for advocacy, and guidelines that are easily transferable in your analysis and work on your own school finance systems.

If you are new to the series, you can review a brief introduction to the subject and discussion of Characteristic 1: A Strong Foundation Formula, here; Characteristic 2: Effective Use of the Judicial System, here; Characteristic 3: Fair Accounting for Cost of Living and Geographic Differences, here; Characteristic 4: Recognition of the Benefits of Small Schools, here; and, Characteristic 5: A Balance of Revenue Sources for Schools, here.

Characteristic Six: Efficiency in the State Revenue System

Advocates for equitable and adequate funding systems cannot ignore the ways through which public money, that is revenue, for schools is generated in their state. It is very difficult to build a strong finance system that supports all schools, including rural schools, on an inefficient revenue system.

Generally, three types of state revenue flow to schools. The first and generally the largest and most important is revenue collected from broad-based state taxes. These taxes, which include personal income and sales taxes, impact almost every citizen in the state and typically provide the bulk of school funding.

A second source of state revenue is special taxes or fees earmarked for schools. This category may include various types of licensing fees or unique taxes levied on specific goods or services with the revenue, or a portion thereof, reserved for schools. This category also includes revenues designated for schools from state lotteries or other legalized gaming in states with gaming programs.

The third category of revenue includes various sources of public funding that are specific to individual states. For example, some states have publicly-owned or managed lands, trust funds, mineral holdings, or other resources that yield revenue designated for schools.

For this analysis we will look specifically at broad-based taxes because all states rely on taxes as a primary method of generating revenue for education.

Three-Legged Stool

Three major categories of taxes make up the bulk of state revenue for schools. Often referred to as a three-legged stool, these revenue sources include sales, income, and property taxes.

Many, although not all, states utilize all three taxes to support schools. In addition, many localities (cities, counties, school districts) also levy one or more of these taxes to generate local revenue to supplement state allocations. This article focuses on state revenues.

The reasoning for utilizing all three sources of revenue for schools can be summed up by three major arguments: 1) taxes should be drawn from as wide an array of sources as possible so as not to overburden any one base or sector; 2) the spread of taxes over a number of bases will ensure greater stability and reliability in the revenue they produce; and, 3) a wider number and variety of revenue streams minimizes any downside economic or social consequences of relying on one type of tax to support public services and functions.

Revenue Fairness

Generally, good tax policy is fair across groups. In other words, fairer tax systems usually peg tax expectations to an ability to shoulder that expectation so that individuals and families in lower-income brackets are not forced to bear heavier tax burdens than better-off citizens. Sales taxes levied on necessities constitute an example of regressive tax that tends to place a heavier tax burden on low-income taxpayers who must spend a higher percentage of their income to meet basic needs than do more affluent taxpayers. Income taxes, on the other hand, especially in states that gradate effective tax rates with increasing income, spread taxation more evenly across the population.

Property taxes are generally the most stable producer of revenue. They are less vulnerable to fluctuations in the economy than sales taxes and less sensitive to up- and down- ticks in employment than income taxes. (The current housing crisis has, however, created a downswing in property-based revenues in some districts.) Property taxes are often collected a year “in arrears,” so revenue is also very predictable. Property taxation is not always fair, however. In many states, large landowners get a property tax “break,” essentially creating higher tax rates on land owned in smaller parcels by resident families and individuals than on land held in large parcels or by corporations or absentee owners.

It should be noted that property taxes are a major source of local revenue for schools. Because property values vary widely, districts located in places with high property values usually get a lot more local funding than do districts in places with low property values, even when those properties are taxed at higher rates. Some states attempt to equalize property yields or adjust state financial aid to schools in order to make up for some of this difference. But in almost all states, differences in local property wealth are a factor in inequities in school funding. 

It is helpful for rural advocates to know the sources of revenue and the proportions of each that fund schools in their state. Advocates need to pay close attention anytime a state considers eliminating or drastically reducing a primary source of revenue. The result of such a shift will almost always mean a shift in tax burden to another source of income. And, it may mean a reduction in revenue for schools or a shift to a less stable or predictable source of funding.

Budgeting Process

States’ budgeting processes can also drive tax and revenue policies, often to the detriment of schools. In many states, the amount of funding schools receive is a function of how much revenue is projected or currently available. In other words, schools are not funded according to what they need to function effectively; instead funding is allocated from revenue produced by existing revenue streams. As economic conditions worsen, the amount available becomes smaller and smaller and drastic cuts are forced on schools with little consideration of how to improve the overall revenue stream or the amount of money it yields.

Making things harder on schools is the fact that the budget process is often the last item on legislative agendas. Schools may not know their allocation for the following year until the late spring.

Establishing a well-reasoned process for determining need and then determining how to fund that need provides more stability for schools than waiting to see how much money is available and then divvying it up. Determining how much funding schools need is a topic that will be addressed in a future installment of this series.

Working on the Revenue Side

A strong, fair reliable revenue system is critical to a good school finance system. Working to improve the revenue equation can be one of the most productive approaches to improving school funding.

But overhauling state tax systems is a also politically controversial undertaking. Approached carefully, however, a bipartisan effort to create a stable and fair revenue system can serve many interests.

Because almost every state has some taxes that are not being collected, tax exemptions with outdated reasoning, or other tax inconsistencies, addressing these issues can be a first step in a longer process of evaluating the state’s revenue system.

Revenue-side work is challenging, but rural advocates have been doing it successfully. If you would like more information on rural education advocacy, contact the Rural School and Community Trust.

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Read more from the December 2010 Rural Policy Matters.