The federal government provides grants to state and local governments for their transportation infrastructure. State and local governments use some of those funds to replace funds that they would have provided for such investment.
By Sheila Campbell (CBO)
Each year, the federal government invests in expanding and improving the country’s transportation infrastructure. Much of that investment takes the form of grants from the federal government to state and local governments. In its work, CBO has estimated that state and local governments use some of those federal grant funds to replace some nonfederal funds that would have otherwise been used for such investment. Though the economics literature has often provided evidence that such fiscal substitution does occur for investments in highways, less agreement exists around the amount of that substitution.
How Is the Presence of Fiscal Substitution Relevant to CBO’s Work?
The federal government spent about $80 billion on transportation infrastructure in 2014, and state and local governments spent close to $300 billion. Of those spending totals, about three-fourths of the federal amount was for capital investment (spending to expand or improve facilities), whereas almost half of state and local spending was for capital investment. Much of that federal spending took the form of grants to state and local governments, and some of it is expected to replace investment that state and local governments would have undertaken on their own. Understanding the extent to which that substitution occurs is helpful to CBO in considering how federal spending affects the economy.
What Is the Evidence of Fiscal Substitution in the Economics Literature?
Attempts to estimate the extent of fiscal substitution of federal investment in transportation infrastructure have focused on highways because that is where most federal transportation investment goes. Researchers have found evidence that state and local governments reduce spending on highways from their own funds as federal grants increase. For an increase of $1 in federal grants, most estimates suggest, state and local governments would reduce spending on highways from their own funds by between $0.20 and $0.80.
Why Are the Findings So Varied?
Several explanations could account for the wide range of estimates of fiscal substitution. Studies rely on different dependent variables: state highway spending, state and local highway spending, and state capital spending on highways. The periods examined in the studies vary, and programs may have undergone changes that altered how states implemented them. In addition, researchers adopted different strategies to address concerns about federal grant funding and state and local spending being endogenously determined.
What Extensions to the Fiscal Substitution Literature Could Be Useful to CBO’s Understanding of How Much Investment Occurs From Federal Grants?
Several possible extensions to the fiscal substitution literature would further clarify the conditions under which substitution is likely to occur and how other factors influence that effect. State and local governments may adjust their own spending on capital projects or operations and maintenance in response to federal highway grants. The fiscal condition of state and local governments and their relation to national economic conditions also are likely to affect substitution. In addition, federal spending changes could be permanent or temporary, large or small, and increases or decreases, each of which could have implications for state and local spending responses. The effects of federal grant programs could be compared with those of other federal programs that subsidize investment in transportation infrastructure.
How Applicable Are Highway Fiscal Substitution Estimates to Other Transportation Modes?
Patterns of funding and decisionmaking authority differ between highways and other modes of transportation, suggesting some caution in applying highway results to other modes. Mass transit is most similar to highways in that spending is shared between the federal government and state and local governments and because decisionmaking generally rests with the state or local government. The federal government has a more direct role in decisions about aviation and water transportation infrastructure, whereas rail relies heavily on the private sector.