In these times of fiscal constraint, the State of Iowa is charged with finding new revenue sources to help fund its school districts.

Historically, property tax has been the primary source of locally-generated revenue for public schools. However, school district income tax appears to be growing in popularity as a source of local financing.

In the Summer 2013 issue of Public Budgeting & Finance, Phuong Nguyen-Hoang, assistant professor in the School of Urban and Regional Planning at the University of Iowa, investigates the impact of school district income tax on property tax revenue in the State of Ohio. The data show that increases in school district income tax are not associated with proportionate decreases in property taxes.

Nguyen-Hoang concludes that districts use school district income tax mostly as a revenue supplement rather than as a revenue substitute. With this additional revenue source, school districts can fund academic initiatives without using state aid, federal aid, or local property tax money, which would cause other programs to suffer.

“If school districts raise one source of revenue, in this case income taxes, but still keep property tax revenue relatively stable, this will help them financially,” Nguyen-Hoang says. “School districts left to their own devices will use the money from school district income tax to raise their revenue, not reduce property taxes.”

Since 1981, school districts in Ohio have held the legal option to levy a voter-approved school district income tax.

The district income tax is collected by the state, which then remits the revenue to the taxpayers’ respective school districts, with the state retaining 1.5 percent to cover administrative costs.

Each school district can decide whether to levy the tax and how to spend the resulting revenue, with no restrictions imposed by state law.

Iowa has made income surtax available to its school districts since the 1970s, but the tax is to be used only for initiating educational improvement programs and must be tied to a property tax increase. The tax is collected by the state, not by the school districts.

“The State of Iowa mostly is concerned that school districts and local governments spend too much,” says Nguyen-Hoang, faculty in the UI’s Public Policy Center. “Our research implies that Iowa school districts would be likely to increase revenue even with no restrictions on spending,”

Analyzing school district finance data from 609 Ohio school districts from 1990 to 2008, Nguyen-Hoang and fellow author Justin Ross, assistant professor at Indiana University, determined that increased revenue from school district income taxation results in greater total revenue. Their calculations show that for every one-percent increase in per-pupil income tax revenues, a school district reduces its property tax levy per pupil by only 0.056 percent.

Additional data calculations with observed income-to-property tax ratios show that income tax adopters could have increased between $3.1 and $35.2 in total revenues per pupil if they had raised one more percent of their per-pupil income tax revenues. School districts that adopt income tax have a positive and significant post-adoption trend that allows for property tax levies to be higher than they otherwise would be, peaking around 10 years post-adoption.

Recently, the school district income tax has become a potential instrument in a handful of states, with most states permitting its use only for certain purposes or under particular conditions in order to prevent school districts and local governments from spending too much.

Seventeen states had at least one local income tax jurisdiction (e.g., cities, counties, or school districts) in 2011. In the last 30 years, Iowa, Kentucky, Ohio, and Pennsylvania have permitted school districts to add a residency-based income tax as a revenue instrument. Michigan, Kentucky, and Arkansas have implemented it selectively, and the possibility has been discussed periodically in Indiana, Connecticut, and Georgia.