What types of federal grants are made to state and local governments and how do they work?
The federal government distributes nearly $600 billion, about 17 percent of its budget, each year to states and localities, providing about a quarter of these governments’ general revenues. The bulk of the funds are dedicated to health care (figure 1).
The federal government distributes grants to state and local governments for several purposes. In some cases, the federal government may devolve or share responsibility for a given service or function because state and local governments have better information about local preferences and costs. In others, the federal government may offer incentives to states and localities to undertake additional spending benefiting neighboring jurisdictions or the country as a whole. Less common are grants targeted to redistributing resources across jurisdictions, such as the General Revenue Sharing program that ended in 1986. Over the past 50 years, the composition of federal grants has shifted dramatically. Today, federal grants for health programs, predominantly Medicaid, represent 55 percent of total federal grant outlays, compared with 20 percent in 1980.
There are two types of federal grants. Categorical grants are restricted to a narrow purpose, such as providing nutrition to lower-income pregnant and postpartum women, infants, and children under the Special Supplemental Nutrition Program for Women, Infants, and Children, also known as WIC. Even more restricted are grants limited to specific projects, such as building a highway. Block grants give recipients more latitude in meeting program objectives, such as assisting needy families and promoting work under the Temporary Assistance for Needy Families (TANF) program. States also set TANF eligibility requirements within federal parameters.
Federal grants may also be classified according to how funds are awarded. Formula grants allocate federal dollars to states based on formulas set in law and linked to factors such as the number of highway lane-miles, school-aged children, or low-income families. A prime example is the federal-state Medicaid program, which provides subsidized health insurance to low-income households.
Grants may also be awarded competitively according to specified criteria as in the Race to the Top or Transportation Investment Generating Economic Recovery (TIGER) awards. In addition, grants may require states and localities to contribute their own funds (matching requirements) or maintain previous spending levels despite the infusion of federal cash (maintenance of effort requirements).
Beyond grants, the federal government also subsidizes state and local governments by allowing federal income taxpayers to deduct state and local taxes already paid and by excluding bond interest from taxable income. The value of these subsidies has been estimated at $122 billion in foregone dollars to the US Treasury in FY2016 (Office of Management and Budget, 2016).
Office of Management and Budget. Budget of the United States Government, Fiscal Year 2016, Historical Tables. Table 12.2. “Total Outlays for Grants to State and Local Governments, by Function and Group: 1940–2020.”
United States Office of Management and Budget, Budget of the United States Government, Fiscal Year 2016, Analytical Perspectives, Table 14.1 Estimated of Total Income Tax Expenditures for Fiscal Years 2014–2024.
Congressional Budget Office. 2013. Federal Grants to State and Local Governments. Washington, DC: Congressional Budget Office.
Government Accountability Office. 2012. Grants to State and Local Governments: An Overview of Federal Funding Levels and Selected Challenges. Washington, DC: Government Accountability Office.