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Some Potential Incentives of Special Eclucation Funding Practices SUZANNE S. MAGNETTI Although various studies have indicated that special education services are cost-effective for society in terms of the increased lifetime earnings of the students in such programs (Conley, 1973; Schweinhart and Weikart, 1980; Weber et al., 1978), special education is a costly enterprise for local school jurisdictions in the short term. Because of the inability or unwill- ingness of local jurisdictions to assume the costs of these programs, states (and later the federal government) began to provide financial aid for those services to encourage the efforts of local jurisdictions to educate hand- icapped children. State and federal financial aid for special education con- stitutes a substantial portion of local budgets for special education. The manner in which states and the federal government transfer funds to localities for special education services and the conditions placed on those funds may influence the types and amounts of services offered. At a very basic level, the amount of money a school district has available to spend on special education programs affects the quality and coverage of each district's special education program. From a more removed perspec- tive, the multiple tiers of governmental funding (federal, state, and local) and related funding policies for special education programs may create fiscal incentives and disincentives that vary across jurisdictional lines. I would like to thank Donald N. Bersoff, Alonzo Crim, Jerry Gross, William T. Hartman, Richard A. Rossmiller, and Frederick J. Weintraub for their helpful comments on earlier drafts of this paper. 300

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Incentives of Special Education Funding Practices 301 These incentives and disincentives may affect the rate at which children are placed in special education clases. For example, where the fiscal im- plications of counting more children as handicapped are favorable to a school district or school, proportionally larger numbers of children might be classified as handicapped. The panel was concerned with the phenomenon of minority students in the special education population, particularly in classes for educable men- tally retarded (EMR) children, in proportions that far exceed their pro- portional enrollments in the public education systems. A number of fac- tors have been pointed to as contributing in some way to this phenomenon, among them the methods used to fund special education programs. The purpose of this paper is to examine the fiscal incentives and disincentives that may result from state and federal funding methods and, when possi- ble, to relate these to the patterns of minority enrollments in special pro- grams for EMR children. Fiscal incentives and constraints may arise from state and federal fund- ing formulas and policies, state and local perceptions of funding and regulations, the interaction of federal policies with state and local pro- grams and priorities, and the combined use of special education programs for the handicapped and other special-needs programs. In addition, the particular conditions that face a given school district e.g., the relative geographic isolation or population density of the area, the wealth of the tax base of the area, the number of children served, and the availability of resources for handicapped children outside the school system- enhance or diminish the district's reaction to a source of funding. The combination of these interactions and conditions in the state or school district dictates what the particular fiscal incentive of an offer of funds to that jurisdic- tional unit will be. An exploration of all these interactions was not possible within the con- text of the panel's work, but this paper identifies some of the forces con- tributing to fiscal incentives. Certain aspects of special education funding that appear to have had an effect in jurisdictions across the country are ex- amined, e.g., the federal special-needs programs may create incentives to include or exclude children from special education classes. However, this focus on the federal programs is not exclusive; state funding plays a major role in the financing of special education programs. In past research, state schemes for funding special education have been grouped into a few rough categories. The possible effects of each of these categories on the provision of special education services are examined here. In addition, certain potential implications of these funding schemes that may affect the number of children identified and the placement of children with special needs are discussed.

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302 THE FEDERAL SPECIAL-NEEDS PROGRAMS MAGNETTI Three federal funding programs are most frequently mentioned in discus- sions of the fiscal incentives involved in federal policies to place children in classes for the handicapped: (1) the Education for All Handicapped Children Act (20 U.S.C. 1401-1461, known as P.L. 94-142), which creates requirements and provides federal funds for special education programs for handicapped children; (2) Title I of the Elementary and Secondary Education Act of 1965 as revised by the Education Amendments of 1978 (P.L. 95-561) and by the Education Consolidation and Improvement Act of 1981, which funds compensatory education for the educationally deprived; and (3) the Bilingual Education Act of 1978, which funds bi- lingual education programs. Taken together, these three statutes comprise a substantial portion of the federal involvement in special-needs program- ming. Individually and as a group they provide funds and policies that can create inducements to expand or reduce the number of children receiving special education and that can affect the structure and quality of special education programs. THE EDUCATION FOR Ace HANDICAPPED CHILDREN ACT The Education for All Handicapped Children Act (P.L. 94-142) is designed to provide a free, appropriate, public education to all handicapped children in this country. It is a grant-giving statute, allocating funds to states if they agree to meet detailed requirements for identifying, evaluating, and placing handicapped children. P.L. 94-142 potentially affects all handicapped children in this country, but the statute limits the number of children for which it will provide funds to 12 percent of all school-age children in the United States (20 U. S. C. 1411(a)(15~(A)(i)~. ~ For fiscal 1980 the federal allocation for P.L. 94-142 was $804 million (U.S. Department of Health, Education, and Welfare, 1979b), or about $217 per child served. For that same period the states spent an estimated $3.4 billion for special education programs (Odden and McGuire, 1980), a national average of $900-$1,000 per child, although wide variations ex- isted across the states. And, as local governments also contribute to the costs of special education, the federal contribution mandated under P.L. 94-142 appears to be about 15 percent of the total cost of special education programs. Congress imposed a 12 percent ceiling on the number of children that could be served by P.L`. 94-142 based on estimates developed near the time of enactment of the prevalence rates of handicaps in the United States.

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Incentives of Special Education Funding Practices 303 Funds appropriated under P.L. 94-142 are allocated to the states on the basis of the number of children served. The P.L. 94-142 grant to each state increases by an incrementally greater amount for each child counted as served by the state's special education program. The dollar amount of the federal grant to each state is arrived at by multiplying the number of children served in special education programs in the state by the national average per-pupil expenditure for students in kindergarten through the twelth grade. The states are reimbursed a set percentage of this amount (20 U.S.C. 1411(a)~1~.2 For fiscal 1980 the federal contribution to special education was allocated among the states based on a count of 3,709,639 handicapped children served by special education programs. The federal program establishes some limitations on how this money may be spent. State education agencies may retain up to 25 percent of the P.L. 94-142 grant. One fifth of that amount may be used by the state to cover the administrative costs of carrying out the provisions of P.L. 94-142, and the remainder of the state grant may be used to provide sup- port services or direct services to children who are identified as handi- capped but who are not receiving any special education services or are served inappropriately. Federal funds used by a state to provide support or direct services must be matched on a program basis by state funds for the same purpose (20 U.S.C. 1411(c)~. The remainder of the federal grant is distributed to the local-education agencies (LEA) or intermediate units. Each LEA is entitled to an amount that bears the same ratio to the total amount, minus the state's share, as the number of handicapped children served in that LEA bears to the total number of handicapped children served in the state (20 U.S.C. 1411(d)~. This formula does not consider the variations in expenditures necessary to serve particular children. LEAs are not automatically eligible for P.L. 94-142 funds; in the same way that states must make application to the federal programs, LEAs must apply for funds and make satisfactory assurances that programs using that money satisfy the substantive re- quirements of P. L. 94- 142 (20 U . S . C . 1414a. No funds may be distributed to an LEA that is not entitled to at least $7,500 (20 U.S.C. 1411~41(A)), but small districts may consolidate their applications and offer a joint program. Funds provided under P.L. 94-142 can be used only to cover the excess costs of special education and may not be used to reduce previous levels of state or local expenditures for special education (20 U. S.C. 1414~. 2 For fiscal 1980 the authorized reimbursable percentage was 30 percent, but only two thirds of that amount was appropriated by Congress.

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304 MAGNETTI TITLE I OF THE ELEMENTARY AND SECONDARY EDUCATION ACT OF 1965 Title I of the Elementary and Secondary Education Act of 1965, now ad- ministered by the U.S. Department of Education, provides for the largest federal program of assistance to elementary and secondary education. For fiscal 1980 (school year 1979-1980) the total Title I allocation was more than $3 billion (U.S. Department of Health, Education, and Welfare, 1979a). It is designed to meet the special education needs of school-age children by funding special programs of compensatory education for selected groups of educationally deprived children. Educationally depriv- ed children are defined by regulation as ". . . (1) children who have need for special educational assistance in order that their level of educational attainment may be raised to that appropriate to their age, and (2) children who are handicapped" (45 C.F.R. 116a.21. Title I comprises several smaller programs, each having a different target group (i.e., migrants, children in institutions for delinquents, children in institutions for handicapped children, children of low-income families), different grant requirements, and different procedures for counting children. The largest Title I program is directed to children of low-income families. Grants under this program are based on a count of the number of pupils from low-income families, the number of children living in institutions for neglected and delinquent children, and the number of children supported by public funds in foster care. The level of funding per state for this program is computed by multiplying the child count by 40 percent of the average per-pupil expenditure in that state within a range 20 percent above or below the average per-pupil expen- diture in the United States (20 U.S.C. 27111. Like that of P.L. 94-142, Ti- tle I funding is based on a count of children. Under Title I, however, the criteria used to determine which children should be counted in arriving at the size of the grant (e.g., whether they are children of low-income families) are distinct from the reason for which individual children are selected to participate in the program, i.e., to provide compensatory education services to children who are educationally deprived. The other Title I programs have similar funding formulas, although the criteria used for counting children and the ways in which they are counted vary slightly. One section of Title I (referred to as the P.L. 89-313 program) provides funds for the education of children in state-run or state-supported institu- tions for handicapped children (and, under certain conditions, to children who have been in such institutions and have subsequently returned to their local schools). The current method of allocating funds under this program is such that states and localities receive substantially more on a

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Incentives of Special Education Funding Practices 305 per-child-served basis under P.L. 89-313 than under P.L. 94-142. Children who receive services under P.L. 89-313 may not also receive ser- vices under P.L. 94-142, although other children counted under Title I can also be served with funds provided by P.L. 94-142. The federal program also sets certain limits on how Title I money may be used. States electing to participate in Title I programs must file an ap- plication with the Department of Education. Participating states must agree to abide by Title I's no-supplant provision; Title I funds are intended to provide a supplement to regular education, not to supplant funds already available for the education of these children, and states must demonstrate that no state or local money was replaced with the federal funds. States must also demonstrate that comparable state and local funds are expended in Title I schools and other schools (20 U.S.C. 2736~. State education agen- cies administer the Title I program within the state and report to the de- partment. Local education agencies that apply are awarded Title I funds in pro- portion to the number of eligible children in their districts. The LEAs must use those funds in areas with high concentrations of children from low-income families (20 U.S.C. 27321. Within those "target schools," Ti- tle I services should be made available to those children with the "greatest need for special assistance" whether or not they were originally counted as low-income children (20 U. S.C. 2733~. Title I also provides some stimulus for states to develop their own com- pensatory education programs. In addition to the basic Title I grant, the Education Amendments of 1978 created an incentive program that pro- vides a special grant to each participating LEA in a state that offers its own compensatory education program (20 U.S.C. 27211. These incentive grants offer up to an additional 50 percent of the amount of state funds for compensatory education expended in a district. To be eligible for these matching funds, state compensatory education programs must offer categorical funds for the education of educationally disadvantaged children, the funds must be supplemental to other state education funds, and there must be program accountability based on performance objec- tives related to educational achievement (20 U.S.C. 2721~. THE BILINGUAL EDUCATION ACT Through the Bilingual Education Act the federal government provides funds to local school districts and state departments of education for the operation of bilingual programs to assist children of limited proficiency in speaking and writing English (20 U.S.C. 3223~. In fiscal 1979, federally

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306 MAGNETTI funded programs served about 3.6 million students, and federal funds for bilingual education amounted to more than $158 million (about $44 per child served). Grants are funded under the act on the basis of applications from school districts and state education agencies. There is no formula funding (20 U.S.C. 3231~. These grants are available to establish, operate, and im- prove bilingual education programs; to provide supplemental community education activities; to train bilingual education personnel; and to provide technical assistance for the development of bilingual education programs. Grant applications compete for funds on the basis of several broad criteria: the geographic distribution of children of limited English- speaking proficiency, the relative needs of persons in different geographic areas, the relative ability of state or local agencies to provide these ser- vices, and the relative number of persons from low-income families who would benefit from these services (20 U.S.C. 3231~. OUR PROGRAMS Other federal education programs may also have some effect on special- needs populations. For example, school districts eligible for assistance under the Emergency School Aid Act are also entitled to a proportional amount of a second category of aid under the Bilingual Education Act. These grants are made to fund projects designed to meet the "special educational needs of minority group children who are from environments in which the dominant language is other than English" to develop language and cultural skills (20 U.S.C. 3261~. THE STATE ROLE IN FINANCING SPECIAL EDUCATION Historically, public elementary and secondary education has been funded by a variety of federal, state, and local funds, the bulk of these funds com- ing from local sources. The trends of the late 1960s and 1970s, however, showed a gradual reduction in the percentage of education funding picked up by local governments and an increase in the size of the state role; the federal contribution has remained relatively stable at about 8 percent of the total funds expended for elementary and secondary education. By school year 1978-1979, local revenues accounted for less than 50 percent of the cost of elementary and secondary education. The state role in financ- ing education now approaches 50 percent of the cost of education (Odden and McGuire, 1980~. State support for special education also appears to be increasing rapidly. In part, this increase is a response to the federal requirements for special

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Incentives of Special Education Funding Practices 307 education programs in P.L. 94-142, but substantial expansion of special education programs was already under way before the enactment of this legislation. Between 1975 and 1980 the national total of state budgets for special education grew by more than 66 percent (Odden and McGuire, 19801. For fiscal 1978 and fiscal 1979, state funds for special education in- creased by a national average of 16.1 percent (Hodge, 1979), although, of course, state funding varied considerably across the states. It is estimated that for 1980 the states spent more than $3.4 billion for the education of handicapped children. The states have moved to address the needs of other special groups. Following the lead of the federal government in compensatory education (Title I), as of school year 1979-1980, 16 states funded state-run compen- satory education programs. In addition, 6 other states provided sup- plemental support for compensatory education programs as a factor in their general aid formula (Education Commission of the States, 1979b, 19801. In school year 1978-1979, states spent approximately $700 million for their state compensatory education programs. Most of these programs were directed at children who were eligible for the federal Title I program but who were not served by it because of insufficient federal funding. States are also addressing the need for additional bilingual education services; 22 states now offer bilingual-bicultural education programs. In school year 1979-1980, states spent approximately $98.4 million on these programs (Education Commission of the States, 1979a). The state role in funding and operating special-needs programs is large and is increasing. While these issues are beyond the scope of this paper, the expanding role of the states in special education financing puts addi- tional emphasis on the question of taxpayer equity, i.e., the extent to which these services should be paid for with revenue raised at the local level (property taxes) or at the state and federal levels (income, excise, and sales taxes). States have a substantial influence on the number of children reached by special education programs and the content of that education. In particular, the role of a state in financing special education programs for handicapped children affects the number and type of services available to such children. Complex layers of fiscal incentives and disincentives may affect state and federal policy objectives. Among the most important forces influencing these incentives and disincentives are the mechanisms states use to transfer state funds to LEAs for special education. States employ several different types of financing formulas to transfer funds from state coffers to local education agencies. If a state has set aside or budgeted a certain amount of money to be distributed to its LEAs for a particular special education program, the type of financing formula used will not affect the total amount transferred (Bernstein et al., 19761. The

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308 MAGNETTI formula used provides the method for dividing the state appropriation but will not increase or decrease it. The state funding formula is most impor- tant, therefore, not for the total amount of money transferred through its application, since that total may well be fixed by other forces, but for the messages it conveys to local jurisdictions on the relative value of various types of programs and services. The emphasis created by the funding for- mula may influence decisions of the LEA about the nature and quality of individual programs. Besides the funding formula, other constraints imposed by the state to reinforce the program structure, to prevent waste, and to regulate the flow of funds also affect the transfer of funds to local jurisdictions. Thus, for example, states may define handicaps loosely or distinctly, may place ceil- ings on the number of children to be served, and may mandate services and programs. Other constraints imposed on the use of state money may be limits on the number of children to be served by each teacher or on the categories of services or personnel eligible for funding. Cost and program accountability requirements may also be used to regulate funding (Kakalik, 1979~. Because actual or perceived fiscal incentives are depen- dent on the environment in which special education programs operate, it is not possible to determine absolutely what effect a given funding formula has by itself. However, within the separate contexts of the legal, political, social, and educational factors that affect a state's special education pro- gram, the funding formula influences the use of these funds and may also affect future programming. While the incentives and disincentives of various funding mechanisms are best explored within that environment, the basic form and implications of the various funding formulas provide the tools for a more particular investigation. TYPES OF FUNDING FORMULAS Analysts have identified six types of funding formulas for special educa- tion (Bernstein et al., 1976; Hartman, 1980; Thomas, 1973~. In practice, these formulas may be used as they are portrayed here or may be combined to serve the practical purposes of the state. The manner in which a par- ticular state's formula varies from these basic types may be noteworthy and may be a result of particular conditions (e.g., population sparsity) or specific policy decisions. For example, a state is making a definite policy statement about its interest in supplying a basic education to all children with the use of a weighted formula that assigns a greater value to elemen- tary education than to secondary education, even though secondary education costs more. The six types of funding formulas are described below:

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Incentives of Special Education Funding Practices 309 1. Unit. Under a unit financing formula a fixed amount of money is provided by the state for every qualified unit of instructional, administra- tive, and/or other services. For example, a district may be reimbursed a set amount for each special education class. This type of funding formula is designed to cover some or all of the expenditures necessary to the opera- tion of that particular unit, based on an averaged, actual, standard, mini- mum, or prorated expenditure per unit across the state. 2. Personnel. Under a personnel formula the state provides funds to LEAs to cover some or all of the costs of hiring special education staff. The amount reimbursed by the state may be determined by the duties of that staff. For example, under this formula an LEA could receive more for a teacher than for a program aide. 3. Weight. Under a weighted system the LEA is reimbursed an amount equal to the regular per-pupil reimbursement multiplied by a factor or weight that represents the increased cost of the special program. Generally, the weight varies by the type or severity of the handicap, so that, for exam- ple, a district might receive twice the base rate per child for multiply handi- capped children and 1.S times the base rate for hearing-impaired children. 4. Straight Sum. With a straight-sum formula the state reimburses LEAs a fixed amount of money for each handicapped child served. This amount usually varies by type of handicap. For example, the state may reimburse the district $1,000 for each EMR child served and $1,500 for each trainable mentally retarded child served. 5. Percentage. Under this type of formula a percentage of the local ex- penditures for educating a handicapped child are assumed by the state. For example, the state may reimburse a school district 30 percent of the district's excess cost of providing a program for seriously learning- disabled children, of the expenditures incurred for a set unit, or of the cost of necessary special personnel. 6. Excess costs. Under this formula the state assumes full or partial responsibility for the expenditures incurred in educating a handicapped child, above the average costs of a regular education. For the purposes of this analysis, these six types of funding formulas can be further grouped by the characteristic factor on which payment is based. The unit and personnel formulas are resource-based formulas: Payment to local jurisdictions is based on the resources used, and the amount of money paid by the state is regulated at the state level by limits on allowable costs and on the number of children served per unit of pay- ment. The weighted and straight-sum formulas are child-based formulas: Payment is based on the number of children served and is regulated by the costs of special education incurred and the amount of resources used. The

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310 MAGNETTI percentage and excess-cost formulas are cost-based formulas: Payment is based on actual local expenditures, with state limits on the number of children served and the amount of resources used. Each of these funding formulas, in conjunction with fiscal and program constraints and regulations, can affect policies and decisions at the level at which children are directly served and can provide feedback to those same constraints and regulations. The potential incentives and disincentives that these formulas provide in the making of special education policy and local programming decisions are diverse. For the purposes of this study, among the most noteworthy of these incentives and disincentives are those affecting labeling and classification of children, selection of the most ap- propriate program, class size, and support for placing children in the least restrictive environment. IMPLICATIONS OF FUNDING ARRANGEMENTS As noted above, the actual effects of a particular funding formula must be considered with reference to other factors that contribute to the operation of a given special education program. These factors vary considerably among the states and, in combination with each state's funding mechanism, create a spectrum of potential incentives and disincentives. An examina- tion of these incentives and disincentives is beyond the scope of this paper; however, the potential effects of the state funding formulas grouped by the characteristic factor on which payment is based have been identified else- where (Kakalik, 1979; Hartman, 1980~. These potential effects should be considered in conjunction with the incentives and constraints of the federal programs and the implications arising from the overlapping coverages of federal, state, and local programs. Resource-Based Formulas Under a resource-based formula (those based on units of service or staff costs) the incentive to overclassify students as handicapped is relatively low: Depending on the state-defined size of a unit, the number of addi- tional students needed to fund an additional unit of services or justify an additional staff member is often relatively large. No funds accrue to the local jurisdiction for the classification of any one child. Nor do these for- mulas require the labeling of children; funding is based on the number of units of service or personnel needed and not the particular labels given to the children. These formulas provide at best rather weak support for systemic resistance to changes in student placements because relatively

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Incentives of Special Education Funding Practices 311 large numbers of students must move in or out of a program to change the number of resource units reimbursed by the state. Among the problems involved with resource-based formulas is that they may encourage maximization of class size as a means of reducing per- pupil costs. This problem can be alleviated by manipulating other factors. For example, if the state sets levels of class or unit size relatively low, and if they are to a large degree funded with state or federal money, resource- based formulas can actually act as inducements to reduce class size so as to provide better services to handicapped children at little cost to the local jurisdiction. If resource-based formulas are based on the unit or teacher of a special class, placement in less restrictive environments is generally discouraged, but if resource reimbursements are defined to include alter- native placement units and support personnel, then consideration of a variety of placements is reinforced. Resource-based formulas may have other consequences as well. Small jurisdictions may not have the minimum numbers of students served to qualify for resource reimbursement. Jurisdictions with too few special education students to receive reimbursement for a given unit or personnel member may have to form cooperative arrangements with neighboring jurisdictions. A state may establish relatively high or low minimum and maximum class sizes and caseloads, but its ability to do so may be limited by the number of resource units it can afford to finance. Child-Based Formulas Child-based formulas (weighted and straight sum) appear to offer the greatest incentive among the types of funding formulas to overclassify children. Under these formulas the reimbursement for expenditures a jurisdiction receives from the state depends directly on the number of children identified as handicapped. When, for example, a jurisdiction's allocation from the state is decreasing, it may feel the need to classify more children as handicapped in order to get the same amount from the state as in previous years. However, local districts will also be increasing their costs by increasing the number of children served. With a weighted formula that gives different weights to different hand- icaps, there is an incentive to classify more children in those categories that have a greater reimbursement rate. With a straight-sum formula, in which each child, regardless of handicap, generates the same amount of money, the incentive is greater to classify more children in the mildly hand- icapped categories and to reduce the number of seriously handicapped children served who require more, and more costly, services. For these

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312 MAGNETTI same reasons the child-based formulas encourage labeling. Furthermore, even under the weighted formula that awards different handicaps varying amounts of money, no allowance is made for the fact that the extent of a child's handicap and educational needs can range widely in any given category; the incentive is to provide children with the lowest-cost program- ming alternative. Of course, many of these problems are not inherent in the formulas themselves and can be adjusted for by regulating the propor- tion of students in the fiscally preferred categories. These formulas do provide a strong incentive to identify previously unserved children, at least in some categories. Child-based formulas also provide an apparent incen- tive to increase class sizes and caseloads as a means of maximizing reim- bursement while minimizing costs to the local jurisdiction. The weighted formulas can provide a financial incentive to remove children from low-reimbursement categories and place them in high- reimbursement categories. This process would be cost-effective to a local jurisdiction only if net costs in the higher categories are lower than those in the lower categories. The weighted formulas can be used to encourage placements in less restrictive environments, however, by means of larger reimbursements, relative to the lower costs, for children in less restrictive settings. On one hand, child-based formulas provide a considerable in- ducement to avoid removing a child entirely from special education pro- grams because that action would result in the loss of a reimbursable entity without reducing by very much the fixed costs of the program. On the other hand, child-based formulas are also cited as providing an incentive to serve children only briefly in the course of a year, or otherwise limiting the services provided to them, to get full reimbursment at a very limited cost. If an enrollment or a one-time count qualifies a child for a full reim- bursement there may be a strong inducement to move that child quickly through a limited program. This problem can be solved by adjusting the formula reimbursement rate to recognize the duration of services for any child. Small districts may have trouble collecting enough state money to sup- port their special education program because reimbursement under these formulas is based on a count of eligible children and not on the costs of the complete program. With a weighted or straight-sum formula, reimburse- ment per child is usually based on the costs of an average class size, and a small district may have too few students to fill an average class. This may encourage some overclassification and mislabeling in small districts. However, states may adjust their reimbursement formula to solve this prob- lem. For example, in some states that use a weighted formula? an addi- tional weight or factor is added to the weight for children from small

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Incentives of Special Education Funding Practices 313 districts to ease the cost burden to these districts. Other states may choose to use the funding mechanism to encourage cooperative arrangements among neighboring small districts. Cost-Based Formulas The cost-based formulas percentage and excess costs reimburse juris- dictions on the basis of expenditures and not on the basis of the resources used or the number of students served. The percentage-based formula may encourage placement in the least expensive program available since local jurisdictions must assume some percentage of the costs of those placements and services. The excess-cost formulas would not appear to create any type of incentive when the state absorbs all costs associated with the special placement. On one hand, however, with the high levels of reimbursement often made with these formulas, there may be some incen- tive to mislabel. On the other hand, a fully funded excess-cost formula would allow jurisdictions to make the best appropriate placement for a child with no thought to cost. From the point of view of state planners, excess-cost formulas without some kind of cost constraints on local juris- dictions are a nightmare. The percentage formulas do provide an incentive for jurisdictions to maximize class size to reduce the percentage that they themselves must pay. A jurisdiction that pays a significant percentage of the costs of a special education program may have additional incentives to reduce ex- penditures by placing students in the low-cost programs and may have disincentives to move children to higher-cost programs. The excess-cost formulas should not create any incentives that relate to class size, program content, or placement decisions, since all the expenditures associated with the special education program are reimbursed by the state. Placements outside of special education classes would not be discouraged by either the percentage or excess-cost formulas because the most restrictive placement would not cost the local jurisdiction any more. Small districts should not be harmed by the excess-cost formulas if the state assumes all the extra costs of providing special education. However, if the state pays only a portion of the excess costs or if reimbursements are limited by minimum class size regulations and constraints on the categor- ies of approvable costs, the ability of small districts to pay for special edu- cation may indeed be curtailed. The ability of small districts to afford a full special education program under a percentage formula depends on whether the reimbursable percentage is high or low.

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314 A COMPARISON OF FORMULAS MAGNETTI Forty-five states use a formula for funding special education programs clearly like one of the three discussed above (Education Commission of the States, 19801. To compare the three formulas and their relationship to disproportionate placements by race and sex, states were classified by the formula used and by geographic region. The means for geographic regions and funding formulas were compared statistically on the percentage of students enrolled in EMR programs, an index of racial disproportion in EMR classes, and an index of sex disproportion in EMR classes. The results are summarized in Table 1.3 There is a statistically significant difference among formulas, both in the average size of the EMR program and the average disproportion by race or ethnicity; there is no significant difference in disproportion by sex. Specifically, states employing resource-based formulas have on the aver- age the largest EMR programs and also the largest minority-white differ- ence in the percentage of students classified as EMR. States using cost- based formulas have the smallest average EMR programs and also the smallest racial differences. There is also, however, a tendency for states in different geographic regions to employ different formulas. For example, more than half the states using resource-based formulas are located in the South or in states bordering the South. These states also have the highest average placement TABLE 1 Relationship of Funding Formula to EMR Placement Rates and Disproportions by Race and Sex Mean Per- Mean Dispro centage of portion by Mean Dis Funding Number of Students in Race or proportion Formula States EMR Classes Ethnicity by Sex Resource-based 13 1.95 0.87 0.44 Child-based 12 1.46 0.40 0.40 Cost-based 20 1.23 0.27 0.39 3The index of disproportion is the log-odds index described in the paper by Finn in this volume. The values in Table 1 are all positive, indicating that on the average a greater percentage of minority students is enrolled in EMR classes than white students, as is a greater percentage of males than females. Statistical comparisons were made by fitting a two-way fixed-effects analysis-of-variance model to the data, using an exact least-squares ap- proach for unequal cell frequencies. All tests were made with ~ = .05.

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Incentives of Special Education Funding Practices 315 rates and the highest minority-white disproportions. Cost-based formulas are in more common use in the Northeast, Midwest, and West, where EMR programs and disproportions are generally lower. When the effects of different regions using different formulas are controlled statistically, no significant differences remain among the three formulas. Thus, it cannot be concluded that any particular funding formula produces certain levels of enrollment or disproportion. The funding approach for special educa- tion services is one of many factors including geographic region, minor- ity population density, and the relative size of the special education pro- gram that varies systematically with the extent of racial disproportion. INCENTIVES IN THE FEDERAL APPROACH TO FUNDING SPECIAL SERVICES4 P.L. 94-142, which is the principal means of channeling federal funds to special education, can be thought of as a civil rights requirement or en- titlement law for handicapped children that also provides some share of the costs of the required programs. The major portion of funding for special education, however, comes from state and local governments. Few estimate that the federal government picks up more than 15 percent of those costs (Hartman, 1980~. Current appropriations for P.L. 94-142 are less than half their authorized level, and future authorizations have been sharply reduced. Yet, on the whole, states, which are loath to lose federal support, accept the federal requirements. The funding provisions of P.L. 94-142 appear to provide some incentive for compliance with the substan- tive and procedural requirements of federal law, although some aspects of the funding provisions may negate the policy aims and priorities expressed elsewhere in the statute. It may be useful to examine the funding structure and the potential fiscal incentives created by the law before attempting to describe the effect of its fiscal provisions on the achievement of its policy goals. P.L. 94-142 employs a straight-sum funding formula a child-based formula to transfer federal funds to local jurisdictions and states. Each state receives a fixed amount for each handicapped child receiving special education. The state is permitted to retain a relatively small, fixed percent- age of this money and transfers the remainder to local jurisdictions in pro- portion to the number of children they serve. The federal formula does not make distinctions in the amount of funds generated on the bases of type or severity of handicap or the cost of the necessary program. 4The following discussion of the incentives created by the federal legislation was drawn largely from Hartman (1980:23-31).

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316 MAGNETTI One of the primary purposes of P.L. 94-142 was to expand special education services to an allegedly large but unknown population of hand- icapped children who were thought to be unserved. Studies conducted for the Bureau of Education for the Handicapped when enactment of P.L. 94-142 was under consideration suggested that about 12 percent of all school-age children were in need of special education services and that states were providing services to only a small proportion of this potential total.5 The straight-sum funding formula complements this purpose and encourages states to identify and serve additional students. This type of formula can also be viewed as supplying a rather strong incentive to overlabel and misclassify students. The incentive is direct: For each addi- tional child served the state will receive an additional fixed amount of money. This incentive applies until 12 percent of the school-aged popula- tion of a state is served the goal embodied in the statute. In other words, the federal government will reimburse a state a fixed amount per child only up to that 12 percent limit. On one hand, this limit may be considered to be the goal of full implementation of the act; on the other hand, it also acts to curb the potential incentive of the funding formula to overclassify children. The straight-sum formula may provide a strong incentive to states and local jurisdictions to identify and serve children in the mildly handicapped categories and to reduce the number or percentage of children served in the most costly programs. For many children who are classified in the mildly handicapped categories and who receive or need only limited ser- vices, the federal reimbursement could cover a sizable part of the costs of the additional services. The level of federal funding may create its own in- centives with respect to the number of children served and the extent of services provided. If the level of federal funding is relatively low, resulting in a small per-pupil reimbursement, local jurisdictions probably would not increase the number of children served and would minimize the costs of educating those children identified as needing services, by maximizing class sizes and limiting the extent of the services provided. The straight-sum funding formula itself creates an incentive to local jurisdictions to provide special education programs at least cost as a means of limiting their expenditures. However, other provisions of the act (e.g., the requirement of individual education plans for each child) should operate to prevent abusive placements in low-cost programs. Placing children in less restrictive educational settings is actively encouraged by 5This figure was based on estimates of the nationwide incidence of various handicapping conditions; there is little hard evidence of what these incidence rates actually are and little agreement on how many handicaps are defined.

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Incentives of Special Education Funding Practices 317 this type of funding; since less restrictive programs are of relatively lower cost, there are positive incentives to local jurisdictions to place children in these programs. This is true only up to a point: Unless a state has reached the 12 percent limit in the number of children it can count as handi- capped, there would be a distinct disincentive to return children to the regular education system. The federal regulations also require that each child served be labeled and counted by category of handicapping condition. These requirements strengthen the practice of labeling and may result in the mislabeling or miscategorization of children. As a general rule, the federal funds can be used only to supplement ex- isting state and local supports for special education services (20 U.S.C. 1413(a)~9~. The emphasis of the federal law is to encourage the delivery of services to all needy children. States that can prove that all children in need of services are served, however, can apply for a waiver of the no- supplant rule. (One way to do so would be to identify as handicapped and serve 12 percent of their school-aged population). If such a waiver is granted, P.L. 94-142 funds can be used by the state essentially as general aid money (Barro, 19781. The federal program may limit the ability of some small school districts to offer special education programs with its requirement that no funds be distributed to districts that are not eligible for at least $7,500 (20 U.S.C. 1411(c)~4~(A)~. The purpose of this provision is to prevent the fragmenta- tion of services. Small districts are permitted to file joint applications for the funding of special education programs. Other requirements of P.L. 94-142 may create additional financial in- centives that are not directly tied to its funding provisions. For example, the use of administrative hearing procedures established under the act adds to the costs of placing a handicapped child in special education. School districts may weigh the costs of a placement requested by a child's parents against the costs of fighting that request through an administrative hearing process. In fact, the opportunity of parents to impose these costs on a school district may be their greatest leverage against the school district. Some states may limit the extent of this leverage and thereby reduce the in- centive of school districts to comply with such parental requests by reim- bursine school districts for all or part of the costs of using the administra five hearing process. Although these implications can be drawn from the funding mechanism and some of the regulations and statutory provisions of P.L. 94-142, federal law does not exist in a vacuum, and the implications for service delivery that appear to exist in P.L. 94-142 must be considered in light of the policies and regulations of individual state laws. The federal statute

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318 MAGNETTI provides a direction or emphasis for state programs to follow, but much of the substance of special education programs comes from states or even local jurisdictions. Many of the implications created by the federal fund- ing arrangement may be blunted or altered by conflicting incentives created at the state level. For example, if a state reimburses a local jurisdiction for only a small percentage of the costs of its program, the in- centives created by the federal funding arrangements will probably have a considerable impact on its decisions about costs and, consequently, ser- vice delivery. If, on the other hand, a state reimburses all the excess costs of a local jurisdiction's program, federal funding arrangements will have little influence. In fact, if state funding is relatively high, local jurisdic- tions should be much more responsive to the incentives produced by the state requirements than they will be to the federal ones (Barro, 1978~. The effect of the federal incentives is also influenced by the interactions of special education programs with other special-needs programs. Several of these programs most notably the federal compensatory education and bilingual education programs are frequently cited as factors that can conflict with or confuse the policies expressed in P.L. 94-142. In part, these interactions are a result of the overlap in the populations served and the services provided between these programs and special education pro- grams. These interactions also are, in part, the result of fiscal incentives that occur in the combined action of these programs. Overlap in program participants exists because each of these programs is designed to serve a discrete group of children, and in reality the target groups are not discrete. For example, a child with a perceptible physical handicap may also need bilingual education services. The target groups as defined by each program are frequently vague and indefinite. This overlap may be important for several reasons. First, some children could be served under two or even more of these programs. Second, since each of these programs is often operated as a "pull-out" program (children served are taken out of the regular class for a portion of the day), children par- ticipating in two or three programs may lose class time in moving from program to program and may receive most of their education outside the regular school environment. As a result, fewer children may receive less core education in the regular class (Kimbrough and Hill, 1981~. One large study undertaken to consider the problems of overlaps in special-needs services and populations found that, although schools frequently at- tempted to prevent duplication of services within the programs, some children did receive services from several programs (Birman, 1979~. Multiple enrollment resulted in some disruption of students' base pro- grams. Multiple enrollments were found most frequently where special- needs programs were nearly fully funded by state and federal funds. In

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Incentives of Special Education Funding Practices 319 jurisdictions where no state or federal funds were available to provide special-needs services, multiple enrollments of any one student were infre- quent. NEW DEVELOPMENTS AND CONSIDERATIONS FOR THE FUTURE Recent economic and political developments indicate that, at least for the immediate future, federal and state governments will have or will make available fewer resources for special education programs. Local school districts must contend with declining enrollments, reduced revenues, and demands for a greater variety of services (Kirst and Garms, 19801. Given these diminished resources, the ability of schools to meet the needs of a diverse population may be considerably strained. In addition, recent developments, at least at the federal level, suggest that not only will the funds going to special education programs be reduced but also that the method through which those funds reach states and local jurisdictions may be altered. In 1981 the Reagan administration announced that it would attempt to consolidate the federal categorical education pro- grams into two block grants. Although the administration-backed Elemen- tary and Secondary Education Consolidation Act of 1981 failed to be passed by Congress, Congress did pass a modified block-grant proposal the Ed- ucation Consolidation and Improvement Act of 1981, which modifies Title I of the Elementary and Secondary Education Act and consolidates most of its other titles (with the exception of the Bilingual Education Act and the Women's Educational Equity Program) into a block grant to the states effective in fiscal 1983. While P.L. 94-142 remained a categorical program, authorization levels for fiscal 1983 and fiscal 1984 were reduced, perhaps presaging an even more limited federal role in the future. The Reagan ad- ministration remains committed to shifting responsibility and control for education programs back to state and local authorities. It argues that block grants are a means of reducing the administrative costs associated with running the large numbers of federal categorical education programs and of increasing the flexibility of state and local governments to meet the ed- ucation demands of their populations. Opponents of block-grant funds argue that such grants would destroy the intent of the categorical programs by eliminating the commitment of funds to the particular populations in need. Most of those populations are minorities and lack the political power necessary to garner funds to meet their particular needs. Coupled with a general decline in federal funds, the consolidation of federal programs into block grants could have a deleterious impact on the disadvantaged, the handicapped, and other minorities.

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320 CONCULSION MAGN ETTI Fiscal incentives that may affect the behavior of a school district are func- tions of the environment of legal, social, political, financial, and educa- tional considerations within which a school district must operate. The ex- tent to which a given activity is more or less costly may influence the choices that school districts make about the number of children classified as handicapped, the types of handicaps identified, the placement of children in regular classes or in special environments, the length of time a child may spend in a special education program, the quality and type of programs and services provided, and the size of classes and support per- sonnel's case loads. Although a description of the funding formula used to transfer special education funds to a local jurisdiction is useful for understanding the financial considerations that may be directing its ac- tions, the funding formula cannot be viewed alone. A variety of factors are at work to create the incentives and disincentives that can affect the nature and quality of special education. For example, regulations and guidelines that define handicaps, describe programs and services, and limit class sizes act as constraints on the funding formula. Other fac- tors such as the level of funding, the history of special education in the jurisdiction, the relationship of education agencies to other government agencies, the interaction of special education programs and such activities as mental health programs and child welfare services, and the activities of special interests also contribute to the fiscal incentives under which school districts operate. Since funding is provided through several federal and state programs, potential fiscal incentives should be considered in light of these various sources of funding. REFERENCES Barro, S. M. 1978 Federal education goals and policy instruments: an assessment of the "strings" at- tached to categorical grants in education. Pp. 229-285 in M. Timpane, ea., The Federal Interest i'' Financing Schooling. Cambridge, Mass.: Ballinger. Bernstein, C. D., Kirst, M. W., Hartman, W. T., and Marshall, R. S. 1976 Financing Education Services for the Handicapped: An Analysis of Current Re- search and Practices. Reston, Va.: The Council for Exceptional Children. Birman, B. F. 1979 Case Studies of Overlap Between Title I and P.L. 94-142 Services for Handi- capped Students. Research report EPRC 26 prepared for the U.S. Department of Health, Education, and Welfare. Menlo Park, Calif.: SRI International. Conley, R. W. 1973 The Economics of Mental Retardation. Baltimore, Md.: Johns Hopkins Univer- sity Press.

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Incentives of Special Education Funding Practices 321 Education Commission of the States 1979a 1978-79 Bilingual Education Survey. Education Finance Center. Denver, Colo. Education Commission of the States. 1979b 1978/79 State Compensatory Education Program Characteristics and Current Funding Levels for Sixteen States. Education Finance Center. Denver, Colo.: Education Commission of the States. 1980 School Finance at a Fifth Glance. Wall chart. Education Finance Center. Denver, Colo.: Education Commission of the States. Hartman, W. T. 1980 Policy Effects of Special Education Funding Formulas. Policy report no. 80-B1. Stanford, Calif.: Institute for Research on Educational Finance and Governance. Hodge, M. 1979 State Financing of Special Education. Unpublished paper prepared for the U.S. Department of Health, Education, and Welfare. Kakalik, J. 1979 Issues in the cost and finance of special education. Pp. 195-222 in Review of Re- search i'' Education. Vol. 7. Washington, D.C.: American Educational Research Association. Kimbrough, J., and Hill, P. T. 1981 The Aggregate Effects ok Federal Education Programs. Report no. R-2638-ED. Santa Monica, Calif.: Rand Corporation. Kirst, M. W., and Garms, W. I. 1980 The Demographic Fiscal arid Political Environment of Public School Finance in the 1980s. Policy Paper No. 80-61. Stanford, Calif.: Institute for Research on Educational Finance and Governance. Odden, A., and McGuire, C. K. 1980 Financing Educational Services for Special Populations: The State and Federal Roles. Working paper no. 28. Education Finance Center. Denver, Colo.: Educa- tion Commission of the States. Schweinhart, L. J., and Weikart, D. P. 1980 Young Children Grow Up: The Effects of the Perry Preschool Program OF Youths Through Age 15. Monographs of the High/Scope Educational Research Founda- tion, No. 7. Ypsilanti, Mich.: High/Scope Press. Thomas, M. A. 1973 Finance: without which there is no special education. Exceptional Children 39:475-480. U.S. Department of Health, Education, and Welfare 1979a Elementary and Secondary Education Act of 1965, P.L. 89-10 as Amended, Title I, Assistance for Educationally Deprived Children, Allotments for Fiscal Year 1980. Table dated March 30, 1979. Office of Education. Washington, D.C.: U.S. Department of Health, Education, and Welfare. 1979b Progress Toward a Free Appropriate Public Education: Semi-Annual Update oil the Implementation of P.L. 94-142: The Education for All Handicapped Children Act. Office of Education. Superintendent of Documents no. 0-631-611/2923. Washington, D.C.: U.S. Government Printing Office. Weber, C. F., Foster, P. W., and Weikart, D. P. 1978 An Economic Analysis of the Ypsilanti Perry Preschool Project. Monographs of the High/Scope Educational Research Foundation, No. 4. Ypsilanti, Mich.: High/ Scope Press.