The Efficiency of Equity in Local Government Finance

For generations, debates over what level of government should pay for local government services — most notably school funding — have boiled down to a simple pair of assumptions. Having the state or federal government pay for services promotes equality across rich and poor areas, but prevents local tailoring and thereby reduces citizens’ choice sets. Economists call this an equity-efficiency tradeoff — centralized funding promotes equity but undermines efficiency. This Article argues that this presumed tradeoff is not as stark as generally thought, as it ignores important and underappreciated reasons that centralization promotes choice and thus efficiency. Specifically, more centralized funding helps people live where they prefer to live, unburdened by artificially needing to pay more for services in poor jurisdictions with large numbers of impoverished households who can pay little for services themselves. This insight should not only shift the scholarly debate on the equity-efficiency trade-off, but also supplies important, real-world payoffs for debates over school funding and similar programs. Put simply, centralized funding promotes equality and, by promoting choice, also efficiency.The Article does not merely make a theoretical argument; it also empirically tests the claim using natural experiments across the country in centralizing state funding for schools. The Article finds large efficiency benefits. The results also show that more centralized financing has encouraged people to move back to central cities, suggesting a second, hidden efficiency benefit to more centralized financing: it promotes the positive externalities associated with central city living. The Article thus suggests that centralized funding is one of the rare policies capable of garnering the support of both sides of the aisle, something that could fundamentally reshape not just academic debates over fiscal federalism, but also education policy and urban living going forward