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A debate over the Obama administration's education policy is playing out in a school district south of Portland, Oregon. The district has rejected $2.5 million in federal funds. The money would have gone toward performance-based bonuses for teachers.

Rob Manning, from Oregon Public Broadcasting, explains what happened. [POST-BROADCAST CORRECTION: This report mischaracterizes the leeway the Department of Education has in determining how Teacher Incentive Fund grants can be spent. The law authorizing the fund specifically says the money must go to teacher performance bonuses in low-income schools.]

ROB MANNING, BYLINE: The Teacher Incentive Fund is meant to reward results. And Oregon City actually applied for the money it's now turned down. The Feds offered $2.5 million for teacher bonuses based on evaluations and their students' test scores. The school district had actually been working on those issues before it got the grant. When Education Secretary Arne Duncan visited Oregon earlier this month, Oregon City teacher Mike Haliski complained about the grant's rules.

MIKE HALISKI: It takes a federal mandate that I believe has been handed down by the administration and says, now that you've used all this time to develop this really teacher-inclusive process, take these monies and apply them this specific way.

SECRETARY ARNE DUNCAN: I totally hear what you're grappling with.

MANNING: Duncan told the gym full of educators that he wanted his department to be less bureaucratic and to support innovation, but he made no promises.

DUNCAN: I don't know the specific answer, but I would love to continue the conversation, see if there's some flexibility there.

MANNING: It turns out, there wasn't. Oregon City wanted to put the money into a shared fund, possibly for teachers' continuing ed. After Duncan's visit, there was some back and forth but ultimately, the administration said it wanted direct bonuses for teachers. The Department of Education also wanted to restrict the funds to schools with lots of low-income students, which would have excluded half of Oregon City schools.

(SOUNDBITE OF A CLASSROON)

UNIDENTIFIED TEACHER: All right. So listen carefully. Shh...

MANNING: This elementary school, for instance, isn't poor enough. Oregon City Teachers' Union President Nancy Noice teaches here. The one solution Feds proposed was that employees hand their bonuses back to the district. But Noice says that didn't seem workable.

NANCY NOICE: We look at it and I think, OK. I've been cut 15 days, my salary has been frozen on top of that, so it's actually a huge decrease in my salary. My benefits have been cut. I would get a bonus check and now, the district wants me to give that back.

MANNING: Noice says a team of administrators, teachers and staff ultimately couldn't agree on a workable solution. But she admits it was tough to turn down the money.

NOICE: Heartbreaking. Heart-wrenching. It was a difficult decision either way.

MANNING: Noice says she's already heard from lots of people in Oregon City, many of them saying the district should not have turned down the money. But she says others were skeptical of performance-based pay, and applaud the union and school district for saying no.

As for the $2.5 million, the Department of Education is seeing if there's another school district in Oregon that wants the money and will play by its rules.

For NPR News, I'm Rob Manning in Oregon City.

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