This study empirically tests the notion that consolidating smaller public school districts will save taxpayers money. Multiple regression analyses are employed to analyze the relationship between district size and per-pupil expenditures in the state of Michigan, focusing on the five most recent school years for which data are available.

Based on the model developed for this paper, the most cost-effective size for school districts in Michigan is roughly 2,900 students. Both smaller and larger districts are likely to spend more per pupil, other things being equal. In light of this finding, it is correct to surmise that some Michigan public school districts are probably too small, and others too large, to operate with optimal cost efficiency.

But district size has a more nuanced and less important impact on spending that is often assumed, and the current political emphasis on consolidation of small districts is misplaced. The author estimates that the potential savings from consolidating excessively small districts is about 12 times smaller than the potential savings from breaking up excessively large ones. The maximum total annual savings due to district breakups would be approximately $363 million, while consolidations could save state and local governments at most $31 million annually (note that these are only rough, ballpark figures).

To realize these maxima, it would be necessary to break up every excessively large district into a multiplicity of optimally sized 2,900-student districts and to consolidate all tiny districts into optimally sized districts as well. Some such mergers and breakups would be impractical or impossible. Truly optimal mergers, for instance, could be achieved only in those cases where two 1,450-student districts were adjacent; three 933-student districts were adjacent; and so on. It would actually be counterproductive to merge two 2,000-student districts, because a 4,000-student district would typically spend more per student, other things being equal, than a 2,000-student district.

As a result, the actual savings from pursuing either mergers or breakups is apt to be much smaller than the theoretical maxima given above. It is fair to say, therefore, that neither mergers nor consolidations are likely to bring about dramatic reductions in the roughly $17 billion per year spent on Michigan’s public schools.

If legislators and the governor wish to address the spiraling cost of public schooling, this study points to a far more important factor than district size: the incentive structure of the system itself. The model developed here indicates that public school districts generally endeavor to spend — and succeed in spending — as much as they can.

Specifically, this study compared two alternative theories of school district behavior: that districts spend only as much as they need to in order to fulfill the public trust (the "demand-driven" thesis), or that they spend as much as they can (the "public choice" thesis). Both the ultimately positive relationship between district size and per-pupil spending[*] and the positive relationship between total household income per pupil squared and per-pupil spending compellingly support public choice theory.[†]

In short, public schooling’s incentive structure appears to encourage district officials to maximize their budgets. To improve the efficiency of Michigan’s education system, this problematic incentive structure would have to be replaced with one in which school officials are instead rewarded for simultaneously controlling costs and maintaining or improving quality. This, in turn, suggests the need for incentives similar to those prevailing in the private sector, in which service providers thrive only if they meet their clients’ needs at competitive prices.

The most promising route to higher efficiency in education thus appears to be the injection of market forces such as competition and parental choice. A policy of choice for parents and increased freedom and competition for educators is also consistent with America’s tradition of local and parental control over schooling, something that cannot be said for state-mandated district mergers or breakups.

[*] As discussed later, the checkmark shape of the relationship between spending and district size is consistent with public choice theory because spending rises with district size once a threshold size is reached. The relationship is inconsistent with the “demand-driven” theory, which predicts that spending per pupil should continue to fall as size increases due to economies of scale.

[†] A corollary to this finding is that high district expenditures are not strongly correlated with the high levels of education demand typical in wealthier districts. As explained later in the text, aggregate income per public school pupil squared is not a measure of district wealth and is not strongly correlated with district wealth. Rather, this quantity is a measure of how easy it is to raise per-pupil spending, and it is a very strong predictor of how much money is actually spent. Thus, the ease with which money can be raised is the best predictor of how much money is actually spent, just as expected by public choice theory.