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We build a model where homogeneous workers can accumulate human capital by investing in education. Schools combine public resources and individual effort to generate productive skills. If skills are imperfectly compensated, then in equilibrium students may under‐invest in effort. We examine the effect on human capital accumulation of three basic education finance policies. Increased tuition subsidies may not be beneficial because they increase enrolment but they may lower the incentives for student achievement, hence the skill level. Policies directed at enhancing the productivity of education or making degrees more informative are more successful at improving educational outcomes.

Since the early 1970s, litigation in many U.S. states has led to education finance reform. Over the same period, many states have imposed new tax and expenditure limitations (TELs) on local governments. The imposition of a TEL may alter how local and state education expenditures change subsequent to court‐mandated decreases in spending inequality. Similarly, the effectiveness of TELs in limiting local education expenditures may be influenced by reform. To better evaluate the effects of reform and TELs on education spending, this article considers them jointly and finds that reform has a negative effect on local own‐source education expenditures only in the presence of TELs. In the absence of court‐ordered reform, TELs decrease own‐source expenditure, but the effect is less pronounced than when TELs are present with reform. When both are present, state government spending on education is higher. Also TELs and court‐ordered reform independently increase state government spending on education. (JEL H72, I22)