Full text of The Southwest Economy : May 1990

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THE FEDEltt\L RESER"I: HANK

or OAI.U\S

School
Finance
Reform
in Texas

\IAY 1990

"IFe bold thattbe slale's school
[illallcillg system is nei/her[illallciaffyefficiellt 1I0r efficient intbe
sense ofprovidillgfor a 'gel/eraf
diffusion ofkllowledge' statewide,
alld therefore that it violates (Micle
VII, SectiOIl 1 ofIhe T(!.:l..-as
COI/Slilll/ioll. "

111e Supreme Coun of Tex;]s
Edgewood lndepelldclII
Scbool Disllict/J_ Kirby
7n S.W. 2d 391 (Texns 1989, p. 397)
With these words, Texas' highest
court nlled the st;lte's school finance
system unconstitutional and ordered
reform by May 1, 1990. The court found
that disparities in loc;]l property values
led to unacceptable differences in
revenues derived from property taxes
(Cban 1). For example, in 1985
Highbnd Park Independent School
District 050) wised 38 percent more
revenue per pupil with a property tax
nne one-third thnt of Wilmer-Hutchins
ISO. In a system acceptnble to the court
Udistricts muSt have substantially equal
access to simihlr revenues per pupil at
similar levels of tax eITon" (Edgewood,
p.3%).
In addition to requiring state monies, reforming educational funding has
the potential to change the face of
prima!}' and seconda!}' education in
Texas. [n Texas, like in many other
stales, comrol of primary and secon-

da!}' education has been left largely in
the hands of local school districts. Incrensed state funding could reduce
local school district control. In choosing
the vehicle for refonning educational
funding, the state legislarure will determine how much control local school
districts will retain.
111e state legisblUre, in two special
sessions this spring, is examining options for reform. -nle legislature has
several slr:ltegies [0 consider-full state
funding, foundation programs or gunrantee programs_ In the 1970s and early
1980s, the highest courts of six statesArkansas, California, Connecticut, New
Jersey, Washington and Wyomingrequired their respective states to make
Chart 1
Disparities ot School District Values, 1985
(Property Value Per Pupil by School
Districts by Quintile)
Property Value
Dollars per pupil
1,200.000

1.110.862

1.000.000

800.000

000.000

400,000

"-,,;;;;;=====

This document was digitized and made available by the Federal Reserve Bank of Dallas' Historical Library (FedHistory@dal.frb.org).

school finance more fair. Today,
C;difomia and Washington rely on full
state funding, Ark:tnS;IS and Wyoming
finance their schools with foundation
programs, and Connecticut and New
Jersey use guarantee programs. l
SChool Finance Strategies

Full State Funding. Under full Sl.1te
funding. the state collects the school
taxes and then redistributes them to the
school districts. The Slate may assume
complete financing responsibility for
the schools, or it may take responsibility for a basic program and leave
enrichment :tctivities to local school
districts. The st:tte mayor may not
direa the way in which school districts
use state funds. Chart 2 illustrates
school district revenues per pupil under
a full state funding program that allows
for local enrichment.
Foundation Programs. A foundation program selS a minimum standard
for per-pupil expendilUre.s in the st:lle,
If a school distric!'s revenues are less
than the standard, the state makes up
the difference-even if the school
district is using the lowest possible tax
rate. If a school district's revenues
exceed the st:md:Hd, the state takes no

action. When the standard is set high
enough, expenditures become roughly
equal :tcross the state because only a
few wealthy school districts choose to
spend more th;m the foundation level
(Char13).

Under a foundation program, much
of the cost of education can fall on the
state government because the program
assures school districts a specific le\'el
of funding reg:trdless of their tax rates.
That gives the school districts incentive
to choose the lowest possible tax rate.
In some states, the legislature established minimum local lax rates to
prevent local school districlS from
shifting responsibility for funding to the
state government.
Chan 3
SChool Financing

under a Foundation Program

...........

Chart 2
SChool Financing
under Full Siale Funding with Enrichment

...........

B Local

• Slale

t:3 Local

•

$taw

FI.Wlds
F\IfId$
FundS
Poor SdloCIl Ooslricls WNlIhy SdloCIl 0isDiI;ts
F1nis

Guarnntce Programs. A guarantee
program selS a guaranteed level of
funding for each tax rate that the local
school district chooses. Under a
guarantee program (sometimes known
as a guaranteed lax base), the state
conSlnlctS a hypothetical t:IX base for
each school district based on the
number of students in the district, Tax
rates are decided by local school
diSlricts. In the case where a district's
actual t:lX base is lower than the
hypothetical base, the state makes up

the difference between actual tax
revenues and t:1X revenue that the
district would receive if it had the
hypothetiC'Jllax base (Cbar14). St:ttes
often set upper limits on the revenue
they will guarantee. In the case where a
district's actual tax base is greater than
the hypothetiC'dl tax base, the state
might take no action, or, in a process
known as rec:apwre, the state might
claim the difference between actual tax
revenues and ta." revenue that the
district would receive if it had Ihe
hypothetical tax base,
Choosing a School Finance Strategy
[n choosing their strategy, Texas
legislators will consider several criteri:t.
The}' must satisfy the coun. They will
also consider how their program affects
the quality of primary and secondary
educalion in Texas, how much it costs
the laxp:1}'Crs and ilS effect on local
school district control.
Satisfying the Court. The Texas
Supreme Court set bro.1d guidelines for
satisfactory refonn. 'I1le public school
system mllSt efficiently prOVide a basic
program that leads to a geneml
diffusion of knowledge. TIle coun
found that m(."Cting this criterion
requires a financing system in which
there is ~a direct and close correlation
between a district's t:lX effort and the
educational resources available to it"
(Edgewood, p. 396). Nonetheless,
satisfying the coon does nOl: require
equal expenditure per pupil. l11e coon
specifically allows communities to
supplement the efficient system with
enrichment funds if those funds are
derivL,,<1 solely from local tax rcvenues.~
With sufficiem funding, ;111 tllf(."C of
the financing strategies probably would
satisfy the court. l'u1l state funding
would satisfy the coun's requiremenlS if
the basic program provided by state
funding leads to a general diffusion of
knowledge and any enrichment funds

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Chart 4
School Financing under Guarantee
Program without Recapture
Ool~

per plJpjI

• Slatel::l Local
Funds
Funds

POOl SC:hoal Districls

Ii Slale
Funds

0 Local
Fuods

Weahhy School Dislrlc:ls

come from local tax revenues. Similarly,
foundation or guarantee progl"3m
would satisfy the coun if the minimum
le\'cl of funding or the gual"3ntee was
set high enough to provide the basic
progl"3m 3cceptable to thc coun. If lite
gual'3ntee is sel high enough to
discourage most school districts from
spending more than the maximum
guar.lOteed ;101ount, the legislature also
might ;\Void the problem of defining a
general diffusion of knowk.'Clge.
Costs. All of the progl'3ms ;He likeI}'
to increase both state funding and total
spending on education. Full Slate
funding that pro\·ides at leaSl 53,500
per Sludent for b:lsic progl"3ms each
year could COSt Tex.:lS taxpayers an
estimated 511 billion annually, all of
which would be funded through the
state govemmem. A similar foundation
progl"3l11 would cost Tex:ls taxpayers
Sil billion annually with at least 56
billion fund{."{lthrough the state
government. A similar guarantee
program without recapture would cost
Texas taxpayers somewhat less than
511 billion annually wilh about 55';
billion funded through lhe Slate government. Enrichment programs would :tdd
to local e.>;pendilures.
;t

Including enrichmcnts, total
spending on primary and secondary
educ:ltion in Texas is likely to be
gremcr with full state funding of the
basic progr:llll than with a foundation
progr:ml because full state funding is
likely to lead to greater enrichment
spending th:tn a foundation program.
W'ith full Slate funding. local school
districts need nOl fund the basic
progl"3m locally before they can offer
enrichment programs, whereas lhey
must with a found:ltion progr:tm.
Full stale funding is also likely to be
more costly than a gual"3ntee program.
\'\Iith full st:l1e funding, school districts
would have no incentives to holel their
costs below the state-funded Icve1even if they could mect their go:l1s with
less money. Under the gual'3ntee
progl"3m, school districtS will ha\'c an
incemi\·e to hold lheir costs down. nle
guarantee program preserves a closer
relationship bclween district costs and
1000ltaxes.
A foundation program is likely to be
more costly than a guarantee progl"3lll
as well. Under the foundation progr;llll,
some school districts are likely to
receive more funding than necessary 10
support their basic programs. "l11ese
excess funds could not be used on
supplemental enrichment progl"311lS
because the fund5 would not be
derived from 10C31 tax effort as the
coun requires. AlIhough the guarantee
could encourJge some propeny-poor
school dislricts to spend heavily on
education, other school districts
probably would spend less Illoney than
the gual"3mec.
\Xlith recapture, a gual"3mee progl"3m
might rcquire lillie or no state funding,
blll recapture SL"CIllS politically infeasible in Texas because it would
require a transfer of funds from
taxpayers in school diSlricts with high
property \'alues. Even without recapture, a guarantee program is likel}' 10
require less Slate funding than a

found1tion progr:.lm. School districts
have an incentive 10 shiflthe burden of
school finance to the state under:1
fOllnc!:ltion progr:tm, bUl a guar:llltee
progl"3m does nOt have such an
incenti\·e.
Full state funding requires more
state funds than either a foundation or
gual"3ntee program. With either of the
latter progl"3n'lS, local fund5 contribute
to the basic program.
The mo:.l e.xpensive progl"3m may
nOi be the best. Research shows that
the connection between eduC:llional
expenditures :lOd studem achievement
is we:lk (See Ibe box lilled "More Mom!)'
May Not Me(lll Belfer &llIcmioJl ').

Local Control, Incentives and
Quality. State funding could shift the
control of primary and secondary
edlle:ttion in Texas from local school
districts toward the state government.
Greater Slate control could enhance or
lessen education:d quality in the state.
In Minnc.-sot3, state funding has been
used 10 fOSIer competition bel\veen
school districts with the hope of
improving quality. Parents are given a
choice of schools in competing
districts. J
Without a similar open enrollment
program in Texas, maintaining some
degree of control at the local school
district would be desirJble. Economists
ha\'c found 111:11 public spending is best
h:llldled :11 the level of government
where the primary benefits are received." Although the benefits of
primary and secondary education spill
acros.'i school district lines, they are
primarily local. Local control allows
school districts to meet local needs :lnd
gives e:tch community :1 gre:ner voice
in the kind of education it will provide.
Full state funding of basic progrJms
would greatly reduce local school
district control over Ihe sizc of lile
school budget. Local school diSlricts
would be Iimiled to detennining the
le\·el of their enrichment programs.

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Full st:lte funding could :llso reduce
local control o\'er Ihe distribution of
resources within :I school distriCi. Once
the legis1:JlUre sets Ihe level of funding
for IxlSic progr.lnlS. it is likely to direct
how those funds must be spent. In
doing so, the legishllUre may mandate
programs that do not meet the needs of
individual school districts.
Compared to full slate funding, :1
foundation program could more
severely limit a local school district's
control over the size of iL~ budget. A
foundation program would inhibit
enrichment spending in all but the
w(.-althiest school diSlrlas. A distriCi that
r.Jises cnough funds to offcr enrichments would lose its Slate funding. To
raise funds for its enrichment progranlS.

a district also would ha\'e to raise
sumaent funds from IOC-.Jltaxes to
cover the b:JSic education.
A guarantee progrJm would
preserve control for loell school
districts. Under guarantee programs,
indh'idual school districts would choose
the level of funding consistent with the
educ:ltion:ll objectives th:lt Illeet their
own community standards.
Conclusions
All three finance stratcgies-full
state funding, a foundation program
and a guarantee program-<ould be
modified to satisfy the coun. All of the
programs will increase total spending
on primary and seoond1ry education in

More Money May Not Mean Better Education

Texas. Nonetheless, the programs differ
in costs and the degree of local control
that they :lllow.
Full state funding is lhe mOSl: COSIly
and could severely limit local school
district control over the size :md
distribution of educatiomll funds, A
foundation l'rogmlll that is likely to
satisfy the coun would limit local
control to enrichment spending and
would discourage school districts frolll
offering enrichments. A guarantt..'e
program that would satisfy the coun
would be the least costly and would
preserve local school district control
over the size and distribution of the
school budget.
-Lori L Taylor
See Richard G. salmon. Christina
D:lwson. Stephen B. lawton, and
l'hom.1s L Johns, compilers :lnd edilors,
Public School Finance P1'ogm/lls ofthe
Unlled Sttl/es and canada,

Underlying the coun's disple:Jsure wim school finance in Texas is the notion
that a general diffusion of knowledge re<luires a geneml diffusion of money.
1\'I:llly economists strongly disagree. Professor Eric J-1anushek of the University
of Rochester analyzed 65 studies that examined the relationship between
expenditures per pupil and student :lchievement. After adjusting for family
characteristics, only 13 of the 65 studies indicated that incre:lsing expenditures
Significantly increases student achievement. Surprisingly, three of the 65 studies
indicated that increasing expenditures significantly decreases studel1l achie\'ememo Thl:: remaining studies found no rel:ltionship between expenditures and
achievement. I
Increasing expenditures has the potential to increase achievement if funds
are allocated effectively, but man}' popular strategies for improving the schools
are generally ineffective. I'roft..>ssor I-Janushek's analysis 31sa demonstr:ltes that
the programs school districts tend to fund with additional school moncysm.1l1er class sizes. higher teacher salaries, more experienced teachers. or more
teachers with advanced degrees-have no systematic effect on studem achie\'c-memo TIle research does not imply that teachers are unimponam to student
achievement. Instead, it indicates that current measures of h_'acher qU:llity--their
experience and education-scldoO\ differentiate good teachers from bad ones.
Increasing the number of teachers or the salaries of current teachers would be
ineffecti\'c in a system that relit..>d on these poor measures of quality when
making decisions about hiring. firing and promotions.

/986-87.

Blacksburg, Va.: American Education
Fin:lllce Association and Virgini:l Polytechnic Institute and State Unh·ersity.
1988, p. 4.
1
"I11e coun did not define the [cnllS
bn~'lc or CllriC/)lIIelll progr:llllS. A basic
progmlll proVides education in the
fundamental subjects essential for a
general diffusion of knowledge. An
enrichment program provides funds for
:lthletics and illSlruction in supplementary subjects.
S Similar progranlS are possible
without sL1te funding if the parents'
choices are limited to schools within
their school dislJiet.
4
See Wallace E. Oates, Fiscal Fcdcmlism, New York: Harcoun Br:lce
Jovanovich. Inc., 1972.

lIanushek.l~ric A. (1986), "The Economics of Schooling: Production :llld
Efficiency in Public Schools," jOlll7la! of EcollOlllic litem/lire Vol. 24, No.3,
Pl'. 1141-77.

I

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Economic Commentary
Genie 5bol1
Vice President, FinaJ/ciallnell/sl1y Studies

Federal Reselw Bank ofDallas

Challenges for
Southwestern Financial Institutions:
Resolution and Beyond
During the past decade the financial industry in the Southwest has undergone a dramatic restructuring. This restructuring
results in part from the broad-based changes in market conditions, technology and the regulatory structure that have had an
impact on financial institutions nationwide. Beyond these

changes, the bst fOUf years brought the financial industry in
the Southwest the most severe financial losses since the Great
Depression.
A new financial landscape is emerging as the process of resolving these troubled financial institutions continues. The
combined effect of the many failures, liquidations and assisted
and unassiSted mergers th:n have occurred at banks and thrifts
throughout the region has resulted in large-scale industry
consolidation, 111is consolidation may benefit the surviving
institutions, panicularly in lowered operating costs. The
recapitalization, using bOth public and private funds, has
improved the overall capacity of the Southwestern financial
industry 10 finance economic activity in the region, which will
benefit the Southwest economy.
Despite these improvements, the magnitude of the recent
b:mking and thrift difficulties raised several compliclltions that
will innuence the near-ternl operations of financial institutions.
First, concerns persist that the large inventory of nonperfanning real estate assets at the insolvent thrifts and elsewhere
wj)J reduce the asset values of the solvent competitors of these
institutions, The high concentration of problem assets and
uncenainty regarding the timing and method of their sale may
be depressing underlying real estate values. Second, troubled
real estate assets :llso complicate the resolution process
because regulatory elTons to resolve the problem assets at the
troubled institutions can place the unassisted institutions at a
competitive disadvantage relative to the newly recapitalized
firms. The negotiated assistance packages tend to include
provisions that remove the negative impact on earnings from
troubled assets. whereas unassisted competitors of these
assisted firms must continue to finance their nonperfornling
:lssets or independently raise sufficient capital to cover
markdowns.

111ese issues are particularly troublesome for the Southwest,
which has many financial institutions with high concentrations
of troubled real estate assets and milny troubled financial
institutions that will require resolution. Nearly 50 percent of
the thrifts in Texas and Arizona are insolvent, and thus will
require some fonn of resolution during the next few years. In
addition, many banks that h:lve already been resolved in the
region can have an impact on the operations of those unassisted institutions. Despite these problems, effons to resolve
problem institutions must continue. Delays would only
increase the ultim:l\e COSt of resolution.
The sweeping changes currently reshaping the financial
landscape will challenge both flnanchd institutions and
policymakers :IS we proceed with the resolution process and
move forward in the changing financial structure. These
unique and changing times increase the need to stay abreast of
market developments and regulatory changes.

...

In all effol1 10 address tbe issues tbat cOlljrom
financial i/1Slillllions, the Federal Rese/w Balik ojDallas
mid Southem MetlJodisl Unillersit)' are sponson'Ilg an
open-fomm discussion. 77)e one-day conference,
"SontIJweslem Bankillg in the 19905: Resolution and
Beyond, .. is scheduledfor May 16. Sessions wiJJjealllre
preselltmionsjrom bankillg leaders, real estate iU-pel1S
and regulatol}' represelltalives, along with alldience
pal1icipalioll. Maill lopics ine/llde managing throngIJ tlJe
resolution, IIJe reglllatolyjrameworkjor tlJe 1990s 'md
markel strategies beyond tbe resolution. Pat1icipants can
e:.>.pect a rigorous and il/jonnative discussion oj l1Je Ilew
OpPO'1111lities and polential pitfallS facing tbe SOIllIJtvestem financial illdllSlry.

This document was digitized and made available by the Federal Reserve Bank of Dallas' Historical Library (FedHistory@dal.frb.org).

SOUTHWESTERN
BANKING

China in Texas' Top 10 Export Markets
Despite U.S. tmde embargoes imposed in the wake of the Tiananmen Square
massacre, China continues 10 open its economy to foreign tmde and to show great
interest in purchasing Texas-made goods. China is one of TeX3S' lOp 10 expon
markets. In 1988, trade with China contributed 5659 million to the state economy.
Chinese imports from Texas comprise only 2.4 percent of the IOlal value of Texas

exports, compared with 3.3 percent for Taiwan and 30 percent for Mexico. China
tends 10 rely on Texas-made goods when its production requires levels of technology
:md capilal intensity that China lacks. That is, China imports high-capital, high-skill
prodUt1ion from Texas and makes Jow-capital, low-skill products for itself. Chinese
purchases from Texas consist primarily of chemicals and allied products, but the
country also is a major market for Texas agricultural products and industrial computer machinery.
Overall, chemicals rank third in Chinese impon volume. Chemicals have long
been Texas' principal world expon product, accounting for about 27 percent of
Texas' world expons in 1988. China uses Texas chemicals to produce agricultuml
lmd manufaetured goods, as the country allempts to increase its agricultural production by adding chemical nutrients to the soil.
China is also expanding its aUlpm of consumer goods. China is the world's largest
imponer of polyolefin, often used in making anificial fibers, and Texas is China's
primary source of this chemical. Because of Texas' role in chemical production, the
Chinese have moved their petrochemical buying office from Beijing to Houston. In
1988, Texas expaned nearly 5337 million of chemicals 10 China, representing about 5
percent of the state's total chemical expons.
So far, however, China's attempts to use Texas-made chemicals in crop production have not made it agriculturally self-sufficient. The country sometimes relies
heaVily on food imports, many of which come from Texas. For example, 1988
brought large increases in the counlJ)"s need for cereal grains. In 1988, Texas
expaned 5182 million in agricultural production from Texas to China, compared with
only 517 million the year before. Texas' agricultural exports to China in 1988 represented about 9 percent of its total agricultural expons.
China's third major interest in Texas products, industrial machinery and eqUipment, occupies a far smaller share of the state's expons of such products than
chemicals do. [n 1988, China's attempts to introduce more efficient productive
processes included the purchase of more than $77 million of industrial and computer
machinery that was exponed from Texas. Chinese purchases represent about 1.7
percem of the state's total expons of these prooucts. Texas also sem China $19
million in measuring, analyzing and control instruments, and 56 million in noncomputing electric and electronic equipment.
In sum, Texas' proouetive capacity and China's proouct needs make trade
beneficial for both panies. Texas has technology and capital-intensive proouctive
capacity. China nOt only lacks them, but also is likely to lack them for some time.
-David Hanna

in tbe 1990s:
RESOLUTION & BEYOND

Aconference spolISored by
TIte Federal Resen'e Bank ofDallas and
The Center for the Stud)' of
FinanciallllstilUtions and Markets
Edwin L. Cox School of Business
Southern Methodist Unil'ersity
Panel discussions will include the rcsolulion
of troubled real eslale assets, opponunities
and pitfalls that may result from
the sale of these assets,
the regulatory framcwork of the
199Os, and market strategies
in light of these issues.
Datc: Wednesday, Ma)'16, 1990
Time: Begins 8:30 a.m. Ends 4:30 p.m.
Place: Hughes-TriggAuditorium,
Southern Methodist Unil'ersitj'
Fee: $150 per person
For More Information Contacl:
Tara Barrett, (214) 651·6222

SOUTHWESTERN
BANKING
i1/ tbe 1990s:
RESOLUTION & BEYOND
Jf }'Ou wish 10 register carl)', complete this fonn
and return hto the follOWing address with your
check for $150 per person 10 Southern
Methodist Unh·ersity.
(Please print all infonnation.)
Name'

-'

Organitalion'

7be Southwest Ecollomy is published six times annually by the Federal Reserve
Bank of Dallas. The views expressed are those of the authors and should not be
attributed to the Federal Reserve Bank of Dallas or the Federal Reserve System.
Anicles may be reprinted on the condition that the source is credited and a
copy is provided to the nesearch Department of the Federal Reserve Bank of Dallas.
77)(1 SOlltbwestl:COllomy is available without charge by writing the Public Affairs Department, Federal Reserve Bank of Dallas, Station K, DaJlas, Texas 75222, or
by telephoning (214) 651-6289,

----'

Address,

-'

Phonc

-'

Mail to:

External Affairs
Edwin L. Cox SChool of Business
Southern Methodist Unil'crsity
Dallas, Texas 75275

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