How Best to Hand Out Money: Issues in the Design and Structure of Intergovernmental Aid Formulas
Thomas A. Downes and Thomas F. Pogue
In 1998-99, U.S. Federal aid to state and local governments totaled 270.6 billion USD, comprising 18.9% of general revenue for states and localities. In that year, intergovernmental aid was the single most important source of local revenue, with 31.7 billion USD flowing directly from the Federal government to localities and 296.3 billion USD being transferred from state to local governments (Governments Division, U.S. Census Bureau, 2001). These numbers understate the importance of Federal aid as a revenue source for local governments. For example, Federal aid for school lunch and special education is channeled through the states, as is a portion of aid under the Title I program. The U.S. Census Bureau reports such aid as intergovernmental aid from state to local governments.
The quantitative importance of intergovernmental aid makes clear the need for documenting the goals of aid programs, understanding how, in an ideal world, those goals translate into aid formulas, determining the degree to which, in practice, the formulas for aid programs deviate from ideal, and characterizing the economic and social effects of deviations.
In this article, we discuss some of the central issues that analysts confront as they cope with these four tasks. In the next section of the article, we discuss four objectives of aid that are commonly cited in the economics literature. Then, to provide context for our discussion, we present a commonly-used aid formula and use this formula to introduce essential concepts and terminology. We then explain how specific aid formulas can be rationalized as means of achieving one or more of the commonly-cited objectives. After offering a few examples of how the goals of prominent formula aid programs can be linked to one or more of these objectives, we close by discussing implementation problems facing policy makers attempting to construct aid formulae to accomplish certain objectives.
Intergovernmental aid; fiscal capacity; lump-sum grants; matching grants.