Fiscal Substitution in Spending for Highway Infrastructure: Working Paper 2021-13

By Sheila Campbell and Chad Shirley

In this working paper, the Congressional Budget Office provides estimates of how much state and local governments that receive federal grants for highway capital projects substitute that funding for their own spending on highway capital. We find that state and local governments reduce their own per capita spending on highway capital by 26 cents for an additional dollar of annual federal formula grants; that finding is toward the lower end of a broad range of estimates in the existing literature. The rate of substitution decreases as state and local governments run larger deficits, such that, all else being equal, those governments spend more of their own funds on highways when federal grants increase. In response to grants provided under the American Recovery and Reinvestment Act, state and local governments increased their own spending on highway capital relative to what they would have spent otherwise. Requirements in that legislation that states maintain planned levels of spending on highways or face reductions in future federal aid may have contributed to that positive relationship between grants and spending.