If you're seeing this message, it means we're having trouble loading external resources on our website.
If you're behind a web filter, please make sure that the domains *.kastatic.org and *.kasandbox.org are unblocked.
The federal government distributed about $721 billion (about 16 percent of its budget) to states and localities in fiscal year 2019, providing about one-quarter of these governments’ total revenues. About 61 percent of those funds were dedicated to health care, 16 percent to income security programs, and 9 percent each to transportation and education, training, employment, and social services (figure 1).
The federal government distributes grants to state and local governments for several reasons. 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 states and localities incentives to undertake additional spending benefiting neighboring jurisdictions or the country as a whole.
Over the past 50 years, the composition of federal grants has shifted dramatically. For example, federal grants for health care programs were less than 20 percent of the total until the 1980s.
There are two main types of federal grants. Categorical grants are restricted to a narrow purpose, such as providing nutrition 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. Less common are grants targeted to redistributing resources across jurisdictions, such as the General Revenue Sharing program that ended in 1986.
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 awards. In addition, grants may require states and localities to contribute their own funds (matching requirements) or maintain previous spending despite the infusion of federal cash (maintenance-of-effort requirements).
A recurring question with federal grants is how they influence state and local behavior. Research finds that states and localities substitute federal dollars for some of their own spending. However, magnitudes vary and in some cases federal grants may “crowd in” rather than crowd out state and local dollars. (See, for example, Gramlich and Galper (1973), who found that $1.00 of unrestricted federal aid stimulated $0.36 in state and local spending, $0.28 in lower state and local taxes, and $0.36 in higher fund balances or saving. However, other research has found evidence that federal dollars stimulate more than the expected state and local spending response. Some early “flypaper effect” research may have mistaken matching as lump-sum grants or overlooked maintenance-of-effort requirements. Other explanations include tacit understandings between federal appropriators and grant recipients about how recipients will respond to federal money (Chernick 1979; Knight 2002). See also Leduc and Wilson (2017).)
Beyond grants, the federal government also subsidizes state and local governments by allowing federal income taxpayers to deduct state and local taxes already paid (up to a $10,000 cap in 2018 through 2025 under current law) and by excluding bond interest from taxable income. The value of these subsidies was about $44 billion in forgone dollars to the US Treasury in FY 2019 (JCT 2019).
Updated May 2020
Money plays a key role in the federal government’s relationship with the states. Congress gives money to the states, for example, but stipulates how this money should be used in order to force the states to cooperate with federal policies.
Federal Aid to the States
Since World War II, states have come to rely heavily on federal money. Likewise, the national government has also relied on the states to administer some federal policies, a practice called fiscal federalism. The term grants-in-aid refers to the federal government giving money to the states for a particular purpose. There are two general types of grants-in-aid:
- Block grants: Money given for a fairly broad purpose with few strings attached.
- Categorical grants: Money given for a specific purpose that comes with restrictions concerning how the money should be spent. There are two types of categorical grants:
- Project grants: Money states apply for by submitting specific project proposals
- Formula grants: Money given to states according to a mathematical formula
Example: When the Republicans retook Congress in 1994, they changed many federal grants into block grants. Instead of giving money to states to buy textbooks or repair schools, for example, Congress gave states blocks of money to spend on education in any way the states saw fit.
Federal Pressure on the States
The federal government uses a number of tactics to compel states to follow its policies and guidelines. Congress can order states to comply but usually applies pressure more subtly by threatening to withhold funds from disobedient states.
Example: When the federal government decided to raise the drinking age to twenty-one, it denied certain highway funds to states that opted not to comply.
Mandates
Sometimes the federal government orders states to do certain things, such as obeying housing laws or environmental regulations. These demands are called mandates. An unfunded mandate is one for which the federal government provides no money. For example, the federal government has required state and local governments to live up to the Americans with Disabilities Act without providing money to make buildings accessible to handicapped people. State governments resent unfunded mandates because they drain state coffers.
One way for Congress to pass mandates is to impose regulations and standards on state and local governments. In the past, Congress has forced state governments to meet certain environmental standards, for example. Scholars call this practice regulated federalism.
Preemption
Because of the supremacy clause, all laws passed by the national government take priority over state and local laws. The national government, then, can override state laws if it can demonstrate a compelling national interest; this practice is called preemption.
Horizontal Federalism
Horizontal federalism refers to the ways state governments relate to one another. States often compete or cooperate on many different issues, from environmental policy to economic development. One state, for example, may lower its tax rate in order to attract businesses away from other states. States have a great deal of leeway in how they behave toward one another.
Did you know you can highlight text to take a note? x
In order to continue enjoying our site, we ask that you confirm your identity as a human. Thank you very much for your cooperation.
In order to continue enjoying our site, we ask that you confirm your identity as a human. Thank you very much for your cooperation.