In this paper, we consider the problem of determining the appropriate method for adjusting state aid to compensate for cost differentials across localities. The feasibility of using cost and expenditure functions to estimate these adjustments is considered. Data from Arizona are used to determine adjustments for districts with at-risk students (students with limited English proficiency or eligible for subsidized lunch). We find districts with at-risk students face higher costs, and we show that failing to account for temporally stable effects of omitted variables leads to inaccurate estimates of cost differentials. We also discuss advantages of using cost functions for determining aid.
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