Chapter 14 Intergovernmental Grants in Theory and Practice Chapter outline 1．The Growth and Decline of Federal Grants 2．Purposes of Grants 3．The Choice of Tools 4．Types of Grants 5．Efficiency and Equity Effects of Grants 6．Matching Grants

Usually that sharing involves a transfer of funds from one level of government to another that is primarily responsible for providing the service. Such transfers are called intergovernmental grants. Grants are a significant expenditure for the federal government and a very important source of revenue for state and local governments.

1.The Growth and Decline of Federal Grants Federal grants are an important source of revenue to state and local governments, although less important now than in earlier periods. State aid to local governments, especially for education, continues to be a major local revenue source in most states. Federal aid has a history of almost two centuries, with major growth occurring in the 1930s and the 1960s followed by some retrenchment in the 1980s and 1990s.

2．Purposes of Grants Among the purposes of intergovernmental grants are vertical and horizontal equalization, correcting spatial externalities, redirecting priorities, and experimenting with new ideas and approaches. ①Equalizing Grants One important function of grants is to balance revenue with service responsibilities both by levels of government and across governments at the same level.

Vertical equalization attempts to correct the difference between the amount of revenue that a government can raise and the amount of responsibility that appropriately falls to that level in a multilevel or federal system. The imbalance between revenue needs and the ability to raise revenue has a horizontal dimension as well.

②Correcting Spatial Externalities The existence of spatial externalities can lead to spending less than the optimal amount by a state or local government if a significant part of the benefits spill over to an adjacent jurisdiction. Grants from a high level of government to encourage the provision of more of such services can correct for this problem.

③Redirecting Priorities Each level of government has its own priorities in terms of the variety and quality of public services to be provided and the externalities to be corrected. Sometimes higher levels of government attempt to override those priorities by mandating local governments to provide certain services.

When the higher level of government simply orders a state or local government to perform certain functions or meet certain standards without offering to pay some of the cost, that order is known as an unfounded mandate. When the services are largely funded and provided by a different level of government, grants can be a tool of persuasion for redirecting priorities.

④Experimenting with New Ideas Grants are a particularly useful device in a federal system because new ideas and programs can be tried out in one or more states or local areas on an experimental basis before being spread to other states if they are successful.

3.The Choice of Tools Grants are just one way accomplishing the objectives of a higher level of government through partnership with other governments. Sometimes direct expenditures are a good alternative, as with student loans and Medicare to provide health services for the elderly. At other times, the incentives can be offered to individuals instead of other governments through tax expenditures. The best choice of a tool depends on the nature of the objective being sought.

4．Types of Grants Grants can be classified in many ways. ①General Purpose or Categorical? A general purpose grant does not put many constraints on how the funds may be spent. A categorical grant must be spent for a designated use. A block grant consists of funds that must be used within a broad category, but the recipient government has a great deal of flexibility about exactly how to spend the funds within that category.

②Formula or Project? A formula grant is distributed according to some set of criteria. They are about 71% of all federal grants. A project grant is distributed according to designated recipients based on competitive applications or legislative discretion.

③Lump Sum or Matching? Grants may be given as a lump sum or may require matching contributions by the recipient government. Matching grants change relative prices and generally have a stronger incentive effect toward the target objective than a lump-sum grant for the same purpose.

④Open-ended or Closed-ended? An open-ended grant obligates the grantor government to fund as many projects, recipients, or governments as meet the stated qualifications. Close-ended grants have a specific budgeted amount that must be rationed among competing claimants through a grant application process, a formula, or some other distribution mechanism.

5．Efficiency and Equity Effects of Grants Equity is served by collecting from citizens in both rich and poor jurisdictions and redistributing a large share of the funds to jurisdictions with higher concentrations of low-income citizens. Efficiency purposes of grants are much more complicated to analyze.

①Indifference Analysis of Grants From the standpoint of the donor government, a grant is more efficient if it directs more resources toward the desired objective. From the standpoint of the recipient government, efficiency means having the freedom to allocation resources in the way that will satisfy the desires of the citizens to whom it is accountable.

②Lump-sum Grants Citizens have increased their consumption of publicly produced goods and services, but not by the full amount of the grant. Some of the increased revenue has come in the form of a reduction in taxes or other local revenue, leaving consumers more after-tax income to spend on private consumption.

③Fungibility and Maintenance of Effort Fungibility is generally regarded by those who spend the money as a good thing, because it gives them more flexibility. But the donor government, or sometimes the citizens, may feel differently about giving them that kind of flexibility. The most common solution to the fungibility problem for donor governments is to impose a maintenance-of-effort requirement. Maintenance of effort is conceptually simple but difficult to administer in practice, particularly for continuous funding rather than a one-time grant.

Figure 14-1 Lump Sum Grant

④The Flypaper Effect The flypaper effect finds that “money sticks where it lands”. That is funds that are sent to the local public sector are spent there while funds that are sent to private citizens via tax relief are largely spent for private purposes, with only a limited amount finding its way into increased local public spending.

6．Matching Grants A matching grant for a particular purpose will change the slope of the budget constraint, because available resources will now support more spending on the target purpose. Such a grant has both income and substitution effects and will have more impact in increasing spending on the target purpose than a lump-sum grant without a maintenance-of-effort requirement.

True-false questions If false, change the statement to make it true. 1. A categorical grant is preferable to a general purpose grant if the primary goal is fiscal equalization. 2. Horizontal equalization refers to grants intended to ensure that citizens have resources to provide the same level of basic services regardless of what city, county or school district they live in.

3. If a grant is fungible, all of the increase in resources will be directed toward the purpose of the grant. 4. A maintenance of effort requirement is designed to make sure that the local government does not replace its own funds with grant funds when it receives a grant. 5. Formula grants are those that invite competitive applications and award money to the best projects.

Answers: 1. F (The opposite is true.) 2. T 3. F (Fungibility means that it is possible to indirectly shift resources to other uses.) 4. T 5. F (Those are project grants, not formula grants.)