This report focuses on the relationship between State aid to education and incentives for the efficient allocation of resources. Following a description of the historical and current manifestations of State aid, an empirical analysis was conducted to study the impact of State aid on several variables. More State aid was found to be associated with (1) higher per pupil expenditures, (2) lower per pupil local revenues, (3) less likelihood to raise funds through local bond issues, (4) lower nonpublic enrollments, and (5) larger average school size. In another phase of the study, incentive features were developed that could be incorporated into State aid schemes. These incentive features were divided into (1) Scale Incentives -- designed to highlight the potential for cost savings through scale adjustment; and (2) Output Incentives which considered two possible goals: maximum output regardless of cost and maximum output per dollar of cost. Penalty factors and incentive payments, singly and combined, were presented as alternative methods to increase efficiency in terms of both scale incentive and output incentives. (Author)