WASHINGTON -- Using money as bait, President Barack Obama challenged states and school districts Friday to raise their academic standards, improve teacher quality and allow more innovation if they want a chance at roughly $5 billion in new grants.

Obama said the broad goals are to give every child a chance to succeed and to boost the educational foundation of the nation's economy. Yet the "Race to the Top" program is also specifically targeted at expanding reforms the administration wants, such as linking teacher pay to how well students do on tests.

"This competition will not be based on politics or ideology or the preferences of a particular interest group," Obama said in an appearance at the Education Department. "Instead, it will be based on a simple principle: whether a state is ready to do what works."

The president added: "Not every state will win and not every school district will be happy with the results. But America's children, America's economy, America itself will be better for it."

Obama said the states and districts that apply for money will be evaluated by clear criteria, with rewards going to those that adopt strong standards and common tests; that get high-quality teachers in the classroom; and that allow expansions of charter schools, which are public schools that operate with more independence. He endorsed the idea of linking student achievement to teacher pay -- a hotly debated idea in education -- but said it should be just one factor in compensation.

As he has with other domestic priorities, Obama said reforming education has been talked about without enough action for years.

Speaking of the need to improve academics nationwide, he said: "We have no choice. And I'm absolutely confident that we can make it happen."

The $5 billion education fund, part of the economic stimulus law enacted this year, is seen as Obama's shot at revamping schools over the next couple of years.

A state will have to meet a series of conditions to earn points and boost its chances. Some of those conditions are controversial, especially among teachers' unions, which make up an influential segment of Obama's Democratic base.

For example, the administration says it will not award money to states that bar student performance data from being linked to teacher evaluations. Several states, including California, New York and Wisconsin, have such a prohibition.

But there are also elements the unions will embrace; states can earn points by submitting letters of support from state union leaders.

The Obama administration is using the stimulus not only to help schools ride out the recession but to try to transform the federal government's role in education. Education Secretary Arne Duncan envisions the dollars going to perhaps 10 to 20 states that can serve as models for innovation.

The $5 billion fund might not seem like much, considering the stimulus bill provided $100 billion for schools. But the fund is massive compared with the $16 million in discretionary money Duncan's predecessors got each year for their own priorities.

Moreover, the fund has taken on added importance because in many states, the bulk of the stimulus money is being used to fill increasingly larger budget holes, and not for the innovations Obama wants.

A report from the Government Accountability Office earlier this month said school districts are planning to use the money mostly to prevent teacher layoffs.

"Most did not indicate they would use these funds to pursue educational reform," the report said. The GAO is the investigative arm of Congress.

Already, the promise of an extra $5 billion has helped Duncan prod state legislatures to do the administration's bidding.

For example, he warned Tennessee lawmakers they could lose out on the money if they kept blocking a bill to let more kids into charter schools; within weeks, the bill was enacted and signed into law.

"It's amazing the amount of progress, literally, without us spending a dime," Duncan said.

The Education Department will gather public comment on its rules for the $5 billion fund for the next 30 days; applications will be available in October, and the first round of money should be awarded early next year.