Estimates of State and Local Responses to Federal Grants
Federal efforts to use matching and MOE requirements to encourage states to spend money on various programs have had mixed results. Researchers have often found that state and local governments tend to shift their use of their own funds as federal grants increase; however, the results of different studies are not always consistent. In addition, it is not clear from that research whether state and local governments respond symmetrically to increases and decreases in spending for federal grants. For example, certain studies have found the following:
- Increases in the amount of funding per student provided through Title I grants led to a nearly dollar-for-dollar increase in total spending by local school districts in the first year of that increase in funding; but those increases in total spending were largely offset by reductions in the local contribution to that total within three years. [Nora Gordon, “Do Federal Grants Boost School Spending? Evidence from Title I,” Journal of Public Economics, vol. 88 (August 2004), pp. 1771–1792.]
- Increases in federal highway grants have been partially offset by a decline in state spending of about 50 percent of the increase in federal highway grants; there is some evidence that the share of such displacement has increased over time. [Government Accountability Office, Federal-Aid Highways: Trends, Effect on State Spending, and Options for Future Program Design, GAO-04-802 (August 2004), www.gao.gov/new.items/ d04802.pdf.]
- Federal highway grants crowd out state highway spending. [Brian Knight, “Endogenous Federal Grants and Crowd-Out of State Government Spending: Theory and Evidence from the Federal Highway Aid Program,” American Economic Review, vol. 92, no. 1 (March 2002), pp. 71–92.]
- Increases and decreases in federal aid alike have been associated with a decrease in spending at the county level. [William F. Stine, “Is Local Government Revenue Response to Federal Aid Symmetrical? Evidence from Pennsylvania County Governments in an Era of Retrenchment,” National Tax Journal, vol. 47, no. 4 (December 1994), pp. 799–816]
- In response to cuts in federal grants, aggregate state and local spending fell, but aggregate state and local spending rose as such grants increased.[Shama Gamkhar and Wallace Oates, “Asymmetries in the Response to Increases and Decreases in Intergovernmental Grants: Some Empirical Findings,” National Tax Journal, vol. 49, no. 4 (December 1996), pp. 501–512.]
Thus, drawing broad conclusions about how state and local governments respond to federal grants is difficult. The difficulty arises partly from the wide variety of inter-governmental grant programs, each with its own set of conditions and rules for state and local governments.
In addition, the existing research literature can offer only very limited guidance because most studies examine specific programs rather than a broad set of inter-governmental grants and because researchers are unable to control for other changes that occur simultaneously with changes in grant amounts. [A number of other factors may also make it difficult to reach a consensus on state and local government spending responses to federal grants, including the differing abilities of jurisdictions to raise revenues because of their size or because of legal limits on running deficits. See Shama Gamkhar, Federal Intergovernmental Grants and the States: Managing Devolution (Cheltenham, England: Elgar, 2002).] Moreover, the studies typically analyze changes in intergovernmental grants that are fairly small; the responses of state and local governments to more substantial changes in grants could be quite different.
One reason that matching and MOE requirements may not diminish the ability of state and local governments to use federal grant funds to replace their own revenues is that states can adapt to the provisions of some grant programs in ways that increase the funding they receive from the federal government. For example, states
have been able to increase their federal reimbursements for Medicaid expenditures by using certain inter-governmental transfers or levying taxes on health care providers to offset the matching payments they are required to make. [For an overview of these financing mechanisms, see National Health Policy Forum, The Basics: Medicaid Financing (February 13, 2013), www.nhpf.org/library/the-basics/Basics _MedicaidFinancing_02-13-13.pdf.] That practice may have had the effect of raising federal Medicaid spending by making states’ payments out of their own funds a weaker constraint
on the size of the program. Similarly, local education agencies can measure spending to satisfy the MOE requirement for Title I grants in any given year in one of two ways—on an aggregate spending basis or on the basis of expenditures per pupil. [Department of Education, Non-Regulatory Guidance—Title I Fiscal Issues, Revised (February 2008), www2.ed.gov/programs/ titleiparta/fiscalguid.pdf.]
Implications of Modifying Federal Grant Programs
When considering whether to modify federal grant programs, lawmakers face choices about two key dimensions of those programs: how much federal funding to devote to them and how much federal control to exercise over funded activities. Different choices would have different implications for the federal budget and the way grant programs are implemented. Drawing general conclusions about changes to grant programs is difficult, though, because the features of those programs—their intended purpose, size, and implementation—vary widely.
Amount of Federal Spending
To restrain federal spending or meet other policy objectives, lawmakers could choose to reduce funding for intergovernmental grants. Many federal grants to state and local governments foster investment in both human capital (education and other activities that enhance people’s well-being and productivity) and physical capital (buildings and other infrastructure). Less federal funding for those grants would probably reduce such investments. In particular, the greater the national, as opposed to local, benefits of grant-funded activities, the less likely state and local governments would be to replace the lost federal funding, and thus the greater the net decrease in those investments. Reductions in funding for grants that redistribute resources across jurisdictions could lead to more persistent inequities among communities or individuals because redistribution is a more difficult task for state and local governments than for the federal government. State and local governments could also find it difficult to compensate for lower funding levels during periods of economic weakness for grants that serve as automatic stabilizers. Even if a state’s laws permit borrowing for the purpose at hand, it is likely to be at a higher cost than the federal government would face. More generally, the less that state and local governments share the policy priorities of the federal government, the less they would tend to increase their spending to offset reductions in federal grant spending, especially if there had been extensive federal control over spending those funds. When more of their own funds were at stake, however, states and local governments might implement programs more efficiently.
Conversely, lawmakers could choose to increase funding for federal grants. An increase in federal spending on grant-funded programs would probably not translate into a one-to-one increase in overall spending by all levels of government for such programs. If the benefits of certain grant-funded activities accrued more to the nation at large and less to a given locality, or if state and local governments did not share the policy priorities of the federal government, state and local governments would be more likely to attempt to reduce their own spending on such activities and rely more heavily on the increased federal funding. Such reductions in state and local spending could potentially be mitigated by changes in federal control or by the addition or expansion of matching or MOE requirements. If state and local governments succeeded in reducing the amount of their own funds at stake, they might implement grant-funded programs less efficiently.
Extent of Federal Control
Lawmakers could choose to reduce federal control over funded activities in various ways—for example, by transforming more funding into block grants, removing some of the conditions on spending federal funds, or relaxing matching or MOE requirements. Those changes would have different effects depending on the program involved. In general, however, less federal control would produce efficiency gains to the extent that state and local governments had more information about the expected benefits and costs of projects than the federal government. Less federal control would also facilitate experimentation at the state and local level. If such experimentation was effective, other states and local governments could learn from the results and perhaps adopt similar approaches. Moreover, if people choose to live in a state or locality because of the programs offered, permitting their state and local governments more control over the design of programs could allow for more differentiation between programs that would encourage people to “vote with their feet” and live in states that offer the combination of programs that best suits their circumstances and preferences. At the same time, less federal control would make it easier for states and local governments to adopt practices that do not closely match federal policymakers’ goals. Such reductions in control would tend to decrease net spending on activities with national benefits, as states and local governments shifted funds to activities with more local benefits.
Lawmakers could also choose to increase federal control. The greater the information advantage that states and localities have, the larger the potential loss in efficiency due to more federal control. Reducing jurisdictions’ control over program design, and thereby limiting their ability to differentiate their programs from those of other states and localities, would also limit the potential to learn from policy experimentation and would make it more difficult for people to find the combination of programs that best suits their circumstances and preferences. At the same time, more federal control would tend to increase net spending on activities favored by federal policymakers and would align programs more closely with their aims. Such increases in federal control would also tend to increase net spending on activities with national benefits.