In fiscal year 2011, the federal government provided $607 billion in grants to state and local governments. Those funds accounted for 17 percent of federal outlays, 4 percent of gross domestic product (GDP), and a quarter of spending by state and local governments that year. Over the past 30 years, those “intergovernmental” grants—financial transfers from the federal government that support a wide range of state and local programs—have fluctuated as a share of federal outlays (see figure below). Federal grants for health programs, primarily Medicaid, have grown rapidly, and grants for programs and initiatives not related to health—such as those associated with income security, education, and transportation—have also increased, albeit at a slower rate. In total, the federal government reported outlays in 2011 for more than 200 intergovernmental grant programs, which were administered by 30 federal departments and independent agencies.
Grants to state and local governments can promote economic efficiency in instances when those governments have localized knowledge that would permit them to implement a program more efficiently and effectively than the federal government could but when they have insufficient incentives or funding to provide a good or service—infrastructure, for example—whose benefits extend beyond their jurisdictions. In addition, some grants use the broad federal tax base to redistribute resources among communities and individuals, and certain intergovernmental grants can help stabilize the economy. In some cases, federal policymakers turn to intergovernmental grants to encourage state and local governments to adopt federal policy priorities. Finally, such grants may help foster policy experimentation at the state and local levels that would be difficult to achieve in a single national program.
Federal grant programs offer state and local governments varying degrees of flexibility over the use of grant funds. For instance, block grants provide only broad parameters for using those funds, leaving state and local governments considerable latitude when they make spending decisions. By comparison, state and local governments face more spending constraints on how they use categorical formula grants. For example, certain criteria govern the types of roads that state governments may build or improve using federal highway grant funds. However, among all possible road projects that meet the established criteria, states are typically able to choose which ones to fund. Project grants provide state and local governments the least flexibility over spending, as the use of grant funds is typically limited to the specific project selected. Some grants place additional conditions on recipients that may be closely related to the purpose of the grant—for instance, the requirement that students demonstrate adequate progress for states to remain eligible for certain education grants. Other grants may have more general spending rules, such as those requiring recipients to complete environmental assessments for many federally funded projects.
The federal government allocates grants to state and local governments on the basis of formulas established by law (for block grants and categorical formula grants) or through a competitive process (for project grants). Some formulas are based on historical distributions of grant funds, while others are based on a more complicated set of demographic or other factors relevant to the purpose of the grants. For project grants, federal policymakers set out a list of criteria that will form the basis for evaluating applications from state or local governments. Certain grants to implement education reforms and to construct transportation projects have recently been awarded through competitions.
The federal government can achieve different degrees of control over the amount and predictability of budgetary expenditures for grant programs by making them either mandatory or discretionary programs (see figure below showing how grants are classified by budget function and type of spending) and by making their funding either open-ended or limited for a given period (such as within a single fiscal year). Spending for some mandatory grant programs is open-ended; that is, the relevant agency has unlimited authority to disburse funds as required by the conditions set forth in authorizing legislation. Medicaid, for example, falls into that category. Spending on other mandatory grant programs, such as Temporary Assistance for Needy Families (TANF), may be limited to amounts specified in the authorizing law for a given program. Discretionary grant programs are also limited because they are funded through annual appropriation acts, which set out the maximum amounts that the federal government can commit to spend in a fiscal year for those grants.
Federal grants are typically intended to supplement the efforts of state and local governments rather than supplant them. To that end, many grant programs include matching requirements or maintenance-of-effort (MOE) provisions that require state and local governments to partially pay for a program from nonfederal revenues. Some such provisions may cause state and local governments to spend more on a program than they otherwise would and may constrain their ability to spend their own revenues according to their own policy priorities. Based on the current body of economic literature, the extent to which federal grants supplant state and local spending that would have occurred anyway is unclear. That may be because the wide variety of inter-governmental programs and accompanying rules and conditions make it difficult to draw broad conclusions.
Changes in federal spending on intergovernmental grants could lead to changes in government investment in both human capital (education and other activities that enhance people’s well-being and productivity) and physical capital (buildings and other infrastructure)—particularly if state and local governments decided not to, or were unable to, make other adjustments that would partially offset federal changes. Less federal control over the administration of grant programs could permit state and local governments to find ways to operate those programs in a more economically efficient manner. At the same time, more federal control could make it harder for them to adopt practices that do not closely match federal policymakers’ goals.
Corrected: On April 26, 2013, this document was reposted with a correction to the labeling in Figure 2.