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The Flypaper Effect

The Flypaper Effect. Phuong Nguyen-Hoang, University of Iowa John Yinger, Syracuse University April 2019. The Flypaper Effect. Outline

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The Flypaper Effect

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  1. The Flypaper Effect Phuong Nguyen-Hoang, University of Iowa John Yinger, Syracuse University April 2019

  2. The Flypaper Effect Outline • A flypaper effectexists if inter-governmental aid has a larger impact on the demand for public services than does an equivalent amount of household income. • To study this phenomenon, we look at: • The Concept of Demand for K-12 Education • The Role of Intergovernmental Aid • Education Demand Models • The Bradford/Oates Equivalence Theorem • The Education Cost Function • Empirical Estimates for New York • The Causes of the Flypaper Effect 1/36

  3. The Flypaper Effect The Concept of Demand for K-12 Education • School districts vary enormously in the amount they spend per pupil and in the performance of their students, as measured, for example, by test scores and drop-out rates. • Most studies of this variation have two steps. • First, individual households have a demand for K-12 education. Households with higher income, for example, tend to demand better quality public schools, all else equal. • Second, school quality is determined by a collective choice mechanism—voting—instead of by individual household decisions. 2/36

  4. The Flypaper Effect The Concept of Demand for K-12 Education, 2 • The standard approach to voting is a median voter model, in which the voting outcome is determined by the voter with the median income and the median tax price (on which more in a minute). • Complexities include: • Renters may not care about school quality, since higher school quality means higher rents. • Unobserved demand factors may influence sorting into locations. • School officials have a role to play because they set the agenda. • Parents have a role to play because they monitor school officials. 3/36

  5. The Flypaper Effect The Concept of Demand for K-12 Education, 3 • We use a median voter model. • We include percent renter as a control variable. • We use school district fixed effects to account for the unique features of each district, including unobserved, time-invariant demand factors. • We include cost and efficiency indexes, to be explained later. • This model has high explanatory power. 4/36

  6. The Flypaper Effect The Role of Intergovernmental Aid • State aid is a key source of K-12 education spending. • The Census provides data only for independent school districts. • Many districts, including Syracuse, are dependent, that is, they are departments in a city government. • McGuire, Papke, and Reschovsky (Handbook of Education Finance and Policy, 2nd Edition) estimatethat for all schools in 2010-11: • Local sources provided 43.1% of revenue for all K-12 schools, • Local property taxes supplied 82.1% of this local revenue, • States provided 44.1% in the form of intergovernmental aid, • The federal government provided 12.5%. 5/36

  7. The Flypaper Effect The Role of Intergovernmental Aid, 2 • State and federal aid push out a school district’s budget constraint. • Recipient districts may spend the money on their K-12 programs, • Or they may use it to provide property tax relief. • Our research estimates these effects. • States need to know the impact of their aid programs. 6/36

  8. The Flypaper Effect Education Demand Models • Now define for a district Y = median income Z = non-school, non-housing spending R = annual cost of owner-occupied housing t = effective property tax rate V = median house value E = spending per pupil A = intergovernmental aid per pupil = property value per pupil (including business property) 7/36

  9. The Flypaper Effect Education Demand Models, 2 • The median household budget constraint is: • The district budget constraint is: • Solving the second equation for t and plugging it into the first yields: • The amount the median voter must pay for another unit of E is: • This is the tax price, which is the price of E in a median voter model. 8/36

  10. The Flypaper Effect Education Demand Models, 3 • So a simple education demand model with A and tax price (the most common model in the literature) is: where F is the flypaper effect. • But the median voter’s adjusted income is (Y+A), so this form is wrong. The appropriate nonlinear form is: 9/36

  11. The Flypaper Effect The Bradford/Oates Equivalence Theorem • Bradford and Oates (AER 1971) show that aid (A) and income (Y ) are not equivalent to the median voter. • The impact of A on a voter depends on the voter’s tax price. • If A is devoted to tax relief, e.g., $1 of aid per pupil only saves the median voter $ . • A flypaper effect, now f, should compare equivalent A and Y, so our estimating equation becomes: 10/36

  12. The Flypaper Effect The Bradford/Oates Equivalence Theorem, 2 • Voters care about performance, not spending. • We model this in two ways. The simplest adds marginal costs (MC) to the tax price and assumes AC=MC (=constant returns to quality scale): • The second method allows non-constant returns, but requires cost–function estimation. • We bring in NY property tax exemptions, which lower tax prices. • The tax price is multiplied by (1 – X/V), where X is the exemption. • This amount varies across district and across time. 11/36

  13. The Flypaper Effect The Education Cost Function • An education cost function indicates best-practice spending required for a given student performance level: C = C{S}. • We estimate a multiplicative cost function, which allows us to estimate economies to quality scale—which are identified by the coefficient of S. • We observe education spending, which is cost multiplied by inefficiency (or, as we model it, divided by efficiency): E{S} = C{S}/e, where e falls between zero (totally wasteful) to one (best practice). • In this context, inefficiency includes any spending that devoted to educational objectives other than S. • If S covers math and English, spending on art and music is inefficient. • Inefficiency also reflects pure waste, but waste and spending on objectives other than S cannot be separated. 12/36

  14. The Flypaper Effect The Education Cost Function, 2 • Because inefficiency reflects the demand for student performance measures other than S, we can model efficiency using a constant-elasticity demand framework, with price and income elasticities. • Moreover, we can identify the MC term, which is part of the tax price in the demand equation, by differentiating the cost function. • With non-constant returns to quality scale, this MC term is a function of S, so we have S on both sides of the performance-based demand model. • Given our functional form assumptions about efficiency, however, we can solve this model for S to eliminate this endogeneity. • Our approach also estimated the impact of district traits, such as percent college graduates, on district efficiency, presumably through voter monitoring of school officials. 13/36

  15. The Flypaper Effect Results for New York • We have data on school districts in New York State, excluding NYC, for 1999 to 2011. • The data set includes a student performance index (S), expenditure per pupil (E), state aid per pupil (AS), federal aid per pupil (AF), median homeowner income (Y ), median house value (V ), median tax share, percent of housing that is owner-occupied, teacher salaries, enrollment, and student traits, among other things. 14/36

  16. The Flypaper Effect Results for New York, 2 • We calculate flypaper effects, f, for several versions of this model. • The best model results: • State aid flypaper effect: 12.4. • An increase in aid worth $1 to the median voter will have the same impact on spending as a $12.4 increase in the median voter’s income. • Federal aid flypaper effect: 29.4. • These results imply • $1 of state aid per pupil leads to a $0.15 increase in spending per pupil and a $0.85 decrease in local taxes. • $1 of federal aid per pupil leads to a $0.28 increase in spending per pupil and a $0.72 decrease in local taxes. 15/36

  17. The Flypaper Effect ed - Basic Results 16/36

  18. The Flypaper Effect Results for New York, 4 • Some scholars have suggested the aid and income are endogenous in a demand model—even with fixed effects. • Tiebout bias could lead to a correlation between annual income and the error term. • Communities with certain time-varying demand traits might be able to lobby for more aid. • We instrument for income (county income multiplied by previous year’s ratio of district to county income) and aid (total state aid in state multiplied by the previous year’s ratio of district to state aid). • The instruments pass the relevant tests, but the results hardly change at all; fixed effects (and controls) appear to be sufficient in this case. 17/36

  19. The Flypaper Effect What Causes the Flypaper Effect? • Scholars have proposed many explanations for the flypaper effect. • Some are based on data problems, such as omitted variable bias, which do not appear to arise with our data. • Others are twists to a standard median voter model. • We review six of these theories and find evidence to support only one (at least in the demand for local education). • Flypaper effects appear to reflect the behavioral economics concept of “framing.” • The magnitude of flypaper effects also appears to be influenced by the “salience” of the B/O adjustments. 18/36

  20. The Flypaper Effect Framing • The literature on behavioral economics includes several versions of “framing.” • The version we use is linked to “mental accounts.” Dollar flows that are linked to a particular mental account tend to stay in that account. • We have several tests to see if mental accounts are at work. • The most interesting involves the No Child Left Behind Act, which was implemented in 2003. • To understand this test, one must look a little bit more carefully into our performance-based model. 19/36

  21. The Flypaper Effect Cost/Efficiency Equation • As indicated earlier, we do not observe e, but we can model its determinants. • The key point about e is that it is inevitably linked to a certain set of outputs; districts efficient in delivering math and reading may not be efficient in delivering art and music. • It follows that e is determined, in part, by the demand for outputs other than the ones in our output index, S. • And this demand depends, in turn on income, tax price, and state aid. • Thus, our analysis leads to a second flypaper effect, which reflects the impact of state aid on the demand for educational outputs other than those in S. 20/36

  22. The Flypaper Effect Flypaper Effects and NCLB • The key element of NCLB was to encourage schools to focus on math and reading. • This caused a shift in a district’s priorities toward the outputs in our performance measure, which includes math and reading tests, and away from unspecified other outputs. • Hence, we would expect the funds in the mental account for local public education to shift toward S. Because intergovernmental aid flows into this account, this shift should show up as an increase in the flypaper effect for S and a decrease in the flypaper effect for unspecified other outputs. 21/36

  23. The Flypaper Effect Flypaper Effects and NCLB, 2 • This analysis is incomplete, however, because shifts of this type might not involve mental accounts at all. • We test for this by looking for differences in the impact of voter income on different educational outputs. • Income is not in the mental account for local public education, so the framing hypothesis predicts no change in the relative impact of income on the two types of output. 22/36

  24. The Flypaper Effect Flypaper Effects and NCLB, 2 • The evidence is consistent with framing. • As shown in the following graphs, the state and federal aid flypaper effects follow exactly the predicted pattern. • As shown in the following table, we find no significant change in the relative income elasticities in the two equations (demand and cost/efficiency). • And for both flypaper effects and income effects, the expenditure model (which, in effect, is an average of the other two) falls in the middle. 23/36

  25. The Flypaper Effect First year of NCLB 24/36

  26. The Flypaper Effect First year of NCLB 25/36

  27. The Flypaper Effect 23.1/17.3=1.34 12.6/15.6=0.81 55/12.9=4.26 47.6/22.1=2.15 15/27=0.56 18/29=0.62 26/36

  28. The Flypaper Effect Flypaper Effects and Rebates • Anotherepisode is the introduction of the STAR rebates in 2007-2009. • From 2007 through 2009 the STAR exemption was supplemented by a rebate, which boosted the exemption to X(1+d), where d is the (varying) rebate percentage. • The state passed the rebate program after school budget votes for 2007. • As a result, rebates should affect school budget votes only 2008 and 2009. 27/36

  29. The Flypaper Effect Flypaper Effects and Rebates, 2 • The algebraically equivalent rebates and exemptions were delivered through different administrative mechanisms. • The exemptions appeared on a homeowner’s property tax bill, which is part of their mental account for public education. • The rebates arrived as a check in the mail, which makes them unlabeled income with no special connection to education. • Our hypothesis is that this difference in framing leads to a difference in voter behavior. • By this hypothesis, the pre-rebate specification still applies in the rebate years and the estimates of the flypaper effects will be the same in the rebate years as in the surrounding no-rebate years. 28/36

  30. The Flypaper Effect Flypaper Effects and Rebates, 3 • To test this hypothesis, we first compare two models: • The “rebates as price” (RAP) model assumes that voters treat the rebates in 2008 and 2009 as part of their STAR tax share, leading to an aid term (A/Y)(V/)(1-X/V-dX/V) for these two years. • The “rebates as income” (RAI) model assumes that voters treat rebates as income, so that income in 2008 and 2009 equals regular income, Y, plus t(dX), where t is the effective property tax rate in a voter’s school district. • The aid terms are (A/Y)(V/)(1-X/V) for the two rebate years. • Davidson and MacKinnon specification tests support the RAP model—and the framing hypothesis. 29/36

  31. The Flypaper Effect Flypaper Effects and Rebates, 4 • Second, we determined whether the estimated flypaper effects are different in the rebate years and the surrounding years with no phase-in, rebates, or recession. • In all six cases (three models, state and federal), our post-regression tests find no significant difference between the rebate-years estimates and the surrounding-years estimates. • These results support the framing hypothesis. 30/36

  32. The Flypaper Effect Salience • The significance of the B/O correction in our estimates implies that, to some degree, voters are aware of and respond to the fact that a low tax price lowers the value to them of intergovernmental aid. • We hypothesize that the extent of this awareness, and hence the estimated flypaper effect, depends on the salience of the tax-price correction. 31/36

  33. The Flypaper Effect Salience, 2 • This hypothesis predicts a lower flypaper effect (corresponding to a higher awareness of the correction) in the years when STAR was implemented and the STAR component of tax share was highly publicized. • We find some evidence for this: The smallest flypaper effects for the performance model arise in 2000, he first year of STAR. 32/36

  34. The Flypaper Effect Conclusions • A reliable estimate of the flypaper effect associated with state aid to education requires a model that accounts for • The nonlinearity of aid in a voter’s budget constraint. • The Bradford/Oates equivalence theorem. • Variation in the cost of education across districts. • Variation in efficiency across districts. • The possibility of non-constant returns to quality scale. • The role of property tax exemptions (if applicable). • District fixed effects. 33/36

  35. The Flypaper Effect Conclusions, 2 • The flypaper effect for state aid to education falls between 12 and 14. • In other words, it would take a 12 to 14 dollar increase in median homeowner income to have the same impact on the demand for education as $1 of appropriately weighted state aid for education. • The appropriate weights in this context include the B/O adjustment: Voters recognize that the higher their tax share, the greater the value to them of $1 of state aid. • The flypaper effects for federal aid are much larger, between 29 and 35. 34/36

  36. The Flypaper Effect Conclusions, 3 • We also find evidence consistent with the view that flypaper effects reflect households’ use of mental accounts—a type of framing—to simplify their financial decisions. • We also find evidence that the magnitude of the flypaper effect is affected by the salience of the factors that determine the B/O correction; more salience leads to a lower flypaper effect. • Once salience and framing are taken into account, the range in estimated annual flypaper effects is from 11 to 23 for state aid and 21 to 62 for federal aid. 35/36

  37. The Flypaper Effect Conclusions, 4 • Policy makers concerned with the impact of their aid programs on recipient governments should be aware of the flypaper effect. • In the case of public education, intergovernmental aid (properly weighted) has a much larger impact on education spending than does the same amount of voter income. • Intergovernmental aid has a larger impact on spending (and on student performance) in school districts with higher tax shares. • For example, $1 of aid will have a larger impact on spending in a largely residential district than in a district with a huge shopping center, all else equal. • A state policy changing local voters’ tax shares alters the impact of state aid on education demand. New York’s STAR program, for example, lowered voters’ tax shares and therefore lowered the impact of existing state aid programs on the local demand for education. • The flypaper effect may be altered by a state’s actions: • Policies that frame tax shares as part of a voter’s mental account for public education or that lower the salience of these tax shares raise the magnitude of the flypaper effect—and hence raise the impact of aid on school district spending. 36/36

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