Everything You Always Wanted to Ask About School Finance But Were Afraid to Ask

How do individual schools get their funds from districts, how do districts get funding from states, and how do states generate revenue for education?

These are little-understood mechanisms, and what’s more, the way we finance schools looks different in almost every community because of statutory structures and local context.

There’s a lot of prognosticating going around about how school budgets will look next calendar and school year due to COVID-19, but the economic shock flowing through the education sector needs to be tempered with some fact checking and clarity. In my previous life, I advised the Texas legislature on public education budgeting and school finance, so I’m here to simplify the complex so education leaders can get a clear and accurate understanding of how funding actually trickles down.

After you read these FAQs, check out the rest of The Looming Financial Crisis? series for key takeaways for school districts, state education agencies, individual schools, charter networks, and more:

  1. Where does most school funding come from?
  2. Where do state dollars for education come from?
  3. What about local dollars? Where do those come from?
  4. Why can’t we predict next year’s school budgets? Shouldn’t school funding already have decreased since many people are out of work and probably not paying income taxes?
  5. What are a few different scenarios you could imagine for schools?
  6. What are the first things to go when a school leader has reduced funds to work with?
  7. Don’t governments have reserves they can lean on during tough times?
  8. If a state or district leader wants to prepare for different possible economic impacts, what should they be doing?
  9. What if I want to get wonky and learn more about this?

Where does most school funding come from?

The first common misunderstanding is about where the bulk of school-level education funding actually comes from: your local community, your state, or the federal government.

The answer is it’s all three, but not the breakdown you might assume. As the chart below shows, funding for education, on average is mostly from state and local governments, about a 50-50 split, with only 8-10% coming from the federal government. It is worth noting that while these proportions of state and local funds are true on average, tremendous variability in how much funding comes from state versus local sources exists between and even within states, depending largely on the structure of state school funding formulas.

The two largest sources of federal funds from the U.S. Department of Education are Title I, which targets funding to schools serving low-income students, and the Individuals with Disabilities Education Act (or IDEA), which supports students with disabilities. In addition to these large programs, the federal government also runs grant programs to support other initiatives including teacher quality, early childhood education, and charter schools. And the federal government heavily subsidizes school meals, which is the largest source of federal funding flowing into schools, through the free and reduced-price breakfast and lunch programs administered by the U.S. Department of Agriculture.

But the bulk of funding that supports educator salaries and benefits, instructional materials for students, construction and maintenance of school facilities, school transportation systems, and all the other core ingredients for school operations are funded from state and local funds.

Where do state dollars for education come from?

Most states get most of their revenue from income and sales taxes. Different states tax different purchases differently (e.g., some states exempt select purchases considered to be basic needs, like food and medicine), and some don’t charge any income or sales tax at all. There are nine states with no personal income tax, but several of those have some other tax source to fill the gap (like Alaska and Texas, which generate significant revenue from the oil and gas industry). Most states have a mix of other taxes and fees they may levy on businesses, tourism, or other specific activities. But across the country, personal income tax and sales tax provide the lion’s share of state tax revenue.

State tax dollars pay for a range of services, with the largest proportion of state investments in most states going to K-12 public education. Beyond K-12 education, significant state spending goes to public higher education systems, health care (especially Medicaid, which is jointly funded from state and federal sources), criminal justice systems (state law enforcement, court, and prison systems), social services (like child protective services and administration of family supports), economic and workforce development, and regulatory functions (like licensing child care facilities or various professional licenses). Many of these functions are also supported with federal and/or local funds. 

What about local dollars? Where do those come from?

School districts get their local revenue almost entirely from property taxes. School districts located in places with taxable property that’s more valuable have greater access to local dollars, compared to a district with lower property values that may be charging a similar tax rate. 

The value of taxable real estate and what counts as taxable real estate varies by jurisdiction. Communities often tax different “types” of property differently. For example, residential property and commercial property are often taxed at different rates or assessed differently in terms of value, often translating to more revenue for communities with more owner-occupied homes compared to rental properties owned by landlords or management companies. If commercial properties are taxed at lower rates or exempted in whole or in part, then areas with more commercial property relative to residential neighborhoods will have a lower tax base, and therefore less capacity to generate tax revenue. Industrial and agricultural property may be valued or taxed differently as well. 

Many states and local jurisdictions offer property tax exemptions as a means of lowering tax burdens for individuals or businesses to encourage certain behaviors. For example, some portion of the value of a house may be exempted if the house is the primary residence of the owner (as opposed to a second home, like an investment property or vacation home), to encourage people to buy houses. Commercial properties may be valued or taxed differently to encourage businesses to locate in a community. Agricultural land may be exempted to support the agriculture industry, which can affect rural taxing jurisdictions in particular. 

The end result is often that the accumulated value of taxable property (the tax base) within a school district is often higher in areas with a high rate of home ownership and higher home values. This means that school districts that serve higher income families (who are more likely to live in those high-value residential areas) can often access more revenue more easily than school districts that serve higher proportions of lower income families. 

This often results in inequitable access to funding from local sources, especially for low-income communities. Some states make up for some of this inequity by adjusting the amount of state revenue a district receives based on its access to local revenue, but not all states do this.

Why can’t we predict next year’s school budgets? Shouldn’t school funding already have decreased since many people are out of work and probably not paying income taxes?

Well, not quite. State budgets, and school budgets, are set based on projections of tax revenue. COVID was an unpredictable event that revenue estimators could not have foreseen, and so the revenue impacts weren’t reflected in the models on which state and local budgets were built. According to the National Council on State Legislatures (NCSL), 33 states project revenue to drop between 1% and 15% for fiscal year 2020, and 39 have projected revenues for fiscal year 2021 to drop between 1% and 30%.

The true impact will only be certain once the sales tax books are closed for the year and  income taxes for 2020 are filed in April 2021. This is one place that will really vary from state to state, based on each state’s mix of revenue sources and the impact of COVID on individuals and businesses. Florida, for example, relies heavily on taxes tied to the tourism industry. Together with reductions in household spending in this very sales tax-dependent state, dollars from tourism have taken a big hit with fewer people going on vacation or traveling, contributing to a substantial projected revenue shortfall.

While there has been massive job loss and staggering unemployment, it’s actually hard to say how much impact this will have on state coffers. For one, the job loss has been concentrated on low-wage workers, who account for a lower share of total income tax revenue, leading some analysts to project that income tax revenues may not be as adversely affected as past downturns might predict. And while sales tax has certainly taken a hit, the jury is still out on the aggregate impact, since services (like haircuts) are often taxed differently than goods (like clothing), and many people have continued spending online during the pandemic. All that internet shopping might at least partially balance out other spending decreases.

This is not to make light of the real hardships experienced by individuals and businesses, nor does it mean there will be little or no impact on the revenue systems that fund vital public systems and supports. The magnitude of impact remains uncertain, and planning for the potential for significant impact to school budgets and other public systems is wise.

What are a few different scenarios you could imagine for schools?

First of all, some schools may already be feeling an impact because they’ve had unexpected costs like buying computers for students, purchasing personal protective equipment (PPE) for staff, or increasing cleaning protocols. Some of these schools may have offset costs with federal dollars through the CARES Act’s Education Stabilization Fund, which my former colleague Sara Mead wrote about in April.

K-12 education is usually the biggest spending category for states, so if states do lose tax revenue and need to make cuts, schools are likely to take a hit. Another large spending category for states is the state’s share of Medicaid, but during a public health crisis, it’s hard to imagine making substantive cuts to healthcare funding. Based on conversations with district leaders, anecdotally, they are expecting cuts anywhere from 5-20% in the next school year because of shifts in state revenue. But we really won’t know for another few months at least.

What are the first things to go when a school leader has reduced funds to work with?

You may notice fewer special programs, fewer non-core offerings to students (like art and music), and larger class sizes. But the fact of the matter is that upwards of 70 to 80% of school budgets fund personnel, so deep cuts often have to translate into reductions in staffing and/or compensation.

The good news is that property taxes tend to be more stable than income tax or sales tax, which means local revenues may be less affected by the downturn. However, dependence on local property taxes also reinforces inequity since districts serving a higher wealth demographic tend to have a wealthier local tax base. So districts serving the highest need communities may be faced with the deepest cuts, if states don’t adjust reductions in state revenue to account for districts’ ability to fill in funding gaps with local revenue.

Don’t governments have reserves they can lean on during tough times?

State savings accounts, which are often called “rainy day funds,” are basically a way for states to put aside cash during good years to have some cushion for the tough ones. Of the 48 states with rainy day funds, 43 have regulations that limit their ability to make withdrawals. Some states require approval by at least 60 percent of lawmakers to access rainy day funds, while other states limit the total amount that can be withdrawn in any year. Because of these limitations, rainy day funds are not always a reliable source of funding. Politics plays a role in these decisions, and the relative appetite of lawmakers to dip into reserve funds varies.

If a state or district leader wants to prepare for different possible economic impacts, what should they be doing?

If state leaders are compelled to make cuts to school funding, they should consider the mix of total funds available at the local level and the profile of students and families served. Flat across-the-board cuts to state spending may be simple from a messaging point of view, and even politically popular as a means of “sharing the pain equally,” but that type of approach often results in extreme inequities that strain the most vulnerable students and communities. A 5% cut in a district that has extremely high rates of poverty won’t be experienced the same as a 5% cut in an affluent community, particularly if the state doesn’t account for any differences in those communities’ access to local funds to shore up schools. An equitable response from the state would take into account student needs and local revenue, and enact a surgical response instead of a blunt one. 

And then once a district gets those state funds, they should do the same. They should allocate resources to the schools within their district while taking into account the needs of students as the primary driver of spending decisions. Most districts don’t approach budgeting from the point of view of students’ needs, but they can. I had a great conversation earlier this year talking about some ways districts can spend their dollars equitably.

What if I want to get wonky and learn more about this?

I’m so glad you asked! I love geeking out on this stuff, and I really just scratched the surface with this post. Here are some suggestions for further reading:

Follow along as we roll out more insights targeting school districts, state education agencies, individual schools, charter networks, and more.

*Indira Dammu contributed research support for this post.