Public Economics and Intergovernmental Grants

A brief literature review

Essay, 2016

16 Pages, Grade: A



Public Economics

Intergovernmental Grants

Objectives of Intergovernmental grants

History of Intergovernmental Grants

Impact of Intergovernmental grants


Public Economics

As stated by (Smith, 1776) who is considered to be the founding father of modern economics, economics is the study of the nature and causes of nations’ wealth or simply as the study of wealth. It is the branch of social science that studies economic activities and economic activities usually involves production, exchange and consumption of goods and services. Public economics can be referred as the branch of economics that studies economic policies and the main emphasis of the study is upon taxation. Public economics focuses on answering two questions; how do government policies effect the economy and how should policies should be designed to maximize welfare (Bruich, 2012).

According to (Musgrave, 1939), the public economy is comprised of three functions; stabilization, distribution and allocation. Accordingly, the government should be able to stabilize prices, avoiding excessive inflation and has to ensure full employment. Secondly, the government should see that the resources are allocated efficiently and finally the governments should also ensure socially accepted wealth levels and market access are maintained, if not maintained the wealth has to be redistributed. Apparently by doing this governments can and have to stabilize employment levels, prices, and economic growth.

Intergovernmental Grants

As stated by (Payson, 2014) Intergovernmental grants are direct budgetary outlays that flows from federal government to subnational governments that is flow of grants from federal government to state and local governments and authorities. It is also expressed as the fiscal relationship between the federal government and subnational governments. Intergovernmental grants are one of the dominant revenue sources for subnational governments; state and local governments in most of the developing countries and these grants are very important as they play major role in strengthening public sectors and also to improve the efficiency and equity of local service position and fiscal health of subnational governments (CIESIN, 2012). Intergovernmental grants are used in many countries finance sub-national spending and implement national policies (OECD, 2006). Basically, all countries have Intergovernmental grants with difference in structures and systems, however they serve on the sole aim of strengthening public economy. For instance, in United States, the Intergovernmental grants are paid from federal government to state and local governments.

In Australia, all state government revenues are obtained from transfers from their federal government and in Canada, the federal system makes substantial payments to provincial governments and provincial governments make payments to municipal governments. However in Europe, as it is to abide by European Union the budget is funded transfers from governments of individual countries. In contrast, the transfer of aid’s in America or Canada, moves higher federal government to lower state and local government, but in Europe, payments usually are transferred from lower EU countries towards European Union which is from lower government to higher government. The main of Intergovernmental grants is to deal with budgetary tensions that are presented at different levels of the government (Oates, 2003).

Objectives of Intergovernmental grants

(Oates, 1990) stated that there are three objectives of providing grants to sub-national governments;

- Financing sub-national services and investments - improving sub-national capacity to finance provision of services
- Subsidization -Improving the efficiency by subsidizing services.
- Equalization- redistribution of resources to equalize tax capacity.

The Intergovernmental grant systems works on a system that; the higher level of the government, which can be referred as federal government from the America’s perspective; generate tax revenues in excess of its expenditures and then transferred to state and local governments to finance its budget. Typically, there are two kinds of intergovernmental grants; conditional and unconditional grants. However, in United States of America grants are classified as categorical, block and shared revenues. The dimension of these grants are different by; the range of federal control over who receives the grant, the range of discretion of the recipient and how they use to aid activities and the type, number, detail and scope of the grant program conditions (Dilger and Boyd, 2014) Categorical grants are highly conditional grants which are authorized only for narrowly defined purposes and activities. The legislation generally describes the conditions of the categorical grant and specifies the type of activities to be funded. Categorical grant reserves the power of its usage and federal governments and increases the power of congress in determining how the money allotted to the state to be spent.

The state governments will have no power in determining the usage of categorical grant, unless it’s a block grant. For instance development of roadways or railways, the federal government has an upper-hand in determining the money granted. Categorical grants are further classified into in to nonmatching, matching and cost reimbursement grants. The matching grant instruments require matching funds to be provided by the recipient of the grant. Furthermore, matching grants are classified as open-ended matching and closed-end matching. These are monitored and regulated by federal law. In open-ended matching there will be no limit on the appropriation level at the federal level. It is based on the individual’s eligibility and the state matching requirements for matching open-ended grants which is specified under the federal law which determines the annual commitment of funds for these grant programs (Robbins, 2004).

The grants that comes with stipulated maximum appropriation in a specific fiscal year and specified statutory matching requirement is closed-ended matching grants. In the case of non-matching grants, there will be no requirement of funds to be matched and need not to be provided by grant recipient, however the federal government does stipulate a maximum appropriation level in specific year for each non-matching grant program.

Block grants are the grants that provide a higher functional focus boarder discretion in the use of funds by the grant recipient and they possess an intermediate degree of conditionality (Payson, 2014).Block grants increases the power of the state governments relative to the federal government, because the individual state determines how the money to spent or will spent. However, the federal government rarely issues block grants as because the block grants are broad in scope of its application and the state has a relative high power in deciding the usage of block grant over the federal government. For instance, grant released for the development of law enforcement or community development. Shared revenue is sort of grant where the decision of the usage of the grant is undermined and decided by the recipient of the grant.

In shared revenue, federal government has a low degree of discretion over who is the recipient receiving the grant. The recipients have broader discretion of deciding what funding activities to be carried upon using the shared revenues and also it has limited restrictions and conditions attached to it. In fiscal federalism, Intergovernmental grants play an important and distinctive policy tool that can benefit the government by serving a number of different functions.

General aid to education refers to the provision of grants for the use of SLEAs for the purpose of education only. This grants aren’t been provided by the Federal government, but the subnational state governments provide these general aid to LEAs for two purposes. The main aim of the general aid to education purpose is to strengthen primary education sector and to provide at least minimum educational program even in the event of high local tax rates. This general aid has also impact on the income levels for a state government jurisdiction (Levin, 1983)

According to (Buettner, 2006) intergovernmental grants can be used as an effective tool to elicit certain behavior among recipient governments. The higher federal government can use these intergovernmental grants as a tool to tackle recession by inducing spending by lower level governments with the aim of increasing aggregate demand. When the expenditure of a local or state government surpasses the revenue raising ability of the state or local government, there exist an imbalance between the revenue and expenditure which is referred as the fiscal gap. Such a situation can arise because of improper spending or tax payments are collected at federal level responsibilities to avoid tax competition and tax rate. Intergovernmental grants acts an revenue to fill this fiscal gaps, fund and enable the local or state governments to continue to their expenditure responsibilities. Intergovernmental grant are also required to equalize the fiscal residuals- where there exists a difference between the public services received and the amount of tax levied.

History of Intergovernmental Grants

According to (Canada, 2003) the federal aid and grant system predate the constitution of United States of America and had existed during the period of 1785. Under the Articles of Constitution 1785, it is dated that the congress provided grants for lands during 1785. It also stated that, during late 18th and 19th century, the period of civil war weakened state and local governments and performance. However, federal government came into rescue and offered grants at minimal stipulation that led to sustainable development of states and local governments.

As stated by (Edwards, 2013), the history of federal grants dates back to long history of 1862, where the grant outlays were enforced by The Morrill Act 1862 that provided grants of federal land to develop colleges that mainly emphasized on agriculture education, mechanical and military studies. This particular grant was the grant program with “strings attached”, as it had detail rules for the grant recipients to periodically update, record and submit regular reports to the federal government. Primarily it was the land grants and grants of land sales.

It is stated that around 130 million acres of the federal domain which included lands were granted as a federal grant for the purposed of building public schools, and 4 million acres was granted for developing higher education institutions. Prior to that, during 1816, the states were given a set of grants that provided 5per cent of net proceeds of sales within their boundaries and it had included a stipulation that 3per cent should be utilized for learning purposes which eventually led to the development of university or a college as per the Morrill Act 1862. The sanctions and grants communicated a message that the federal government was prepared and interested to assist state and local governments and communities for the development in terms of performance and education in which national interest existed (Maxwell, 1952). However, during that period of time grants were treated as outright donations as there was existed no matching requirement mechanisms and the government did not have the right to order or advice about the usage of grants and expenditures.

During 1880, the grants and aids were further developed and main focus was kept on the development of education, agriculture, research and development. During this period, the federal imposed conditions and restrictions on the usage of grants to the recipients of the grants. In 1887, the first unified grants of $15,000/year for each states was released which was enforced upon by the Hatch Act 1887 for the development of agricultural research and experiments. It was also warned by the federal government that, failure to spend the grants for broad purposes would lead to cancellation and withheld of grants from the federal to the states and local governments. During 1910, grants were allotted with mechanism of matching systems which are widely practiced today in the United States of America.

It was in the 20th century, financial grants were created with associated with the matching mechanism and conditions. It was the Franklin Roosevelt, President of United States of America, who worked closely with the congress to accelerate the development of grant0in-aid system as a New Deal Program which focused giving grants for social relief, financial reform and economic recovery. President Woodrow Wilson (1913-1921) continued Roosevelt’s use of executive power to strengthen social ills and also stressed about the professionalization of public service and cooperation. During his reign of time, the Wilson focused on developing grants that strongly laid emphasis on development of certain geographical areas, national highways, constructing roads in rural areas, education systems that include vocational training, agricultural skills, industrial skills and home economics. The Federal Highway Act 1916 divided the grants system into three separate grants and were disbursed to states based on selected variables. Based on skills and economics in urban and rural areas, grants distributed. The Federal Emergency Act 1933, was the first grant that stated the express purpose of providing public relief and had a long last impact in history of America.

At reigning time of President Harry Truman (1945-1953), the federal government adopted grants that focused on health and public safety development, agricultural research, and housing. By the end of 1961, the total grant outlays accounted for $6.8 billion and the pioneer for such development was the President Eisenhower grant aids program during 1960 which was the initiative of President Lyndon Johnson’s Great Society initiative focused on the development of urban areas and disadvantaged populations. President Richard Nixon (19740) adopted grant that focused upon improving efficiency, decentralized decision making to all states and localities and restrain program growth.

During (1981-1989) President Ronald Regain made certain changes to the grant-aid-system. The President supported block grants as a mean of disengaging the national government from policy areas. The federal system didn’t exercise much power in spending of state and local governments. During 1990’s the intervention of Supreme Court in grant-aid-system, limited the power of federal government and its influence over the state policy. During the period of President George. W. Bush (1993) grant-aid-system underwent little changes in its programs and features. He tried to consolidate many categorical grants into larger, lower-funded block program, however this was rejected by the congress.

During 1993-2001, National Performance Review (NPR) was introduced by the President Bill Clinton which focused on improving government management and performance. After the Sept 11th terrorist act several considerable amount of changes was done the grant-aid-system by President George. W. Bush (2001), where the establishment of Interagency Working group on Federalism was formed which formulated a new executive order to address accountability in federal aids. The above presented information presents the brief history of federal grants and aid systems of the United States of America. During the fiscal year 2011, the federal government provided a huge amount of $607 billion in form of grants and aids to the state and local governments.

During 2013, annual fiscal federal aid spent was around $600 billion; out of which 300 billion accounted for public health grants. The further report presents the statistics of federal grants and aids to state and local governments for last 10 years;

The below statistics presents the federal grants and assistance state wise (Statistic Brain, 2012)

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Table 1: Adapted from Statistic Brain by U.S.Federal Government Procurement Data System, 2012:

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Table 2: Adapted from Statistic Brain by U.S. Federal Government Procurement Data System, 2012

The below graphical representation presents the federal grant outlays to state and local governments and a share of grants in GDP

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Graph 1: Adapted from Congressional Budget Office, 2012

Impact of Intergovernmental grants

Intergovernmental grants are one of the effective policy tool that focuses on improving the efficiency and performance of state and local governments. Local governments are the subsidiaries of state governments and state governments are the subnational of federal government which regulate and aid governments. State governments are the principal sources of intergovernmental transfers and are done mainly to primary and secondary education. The grants received from federal are utilized to increase program sizes. Higher the amount of grant granted would increase the intensity and size of such programs to increase general own-source revenue (Volden, 1989).

Grants like Medical and Aid to Families with dependent children served as a major financial support for the spending of state and local government on public health and also increased the cash assistance services to low-income households. In 2003, around $132 billion which is about 36per cent of intergovernmental transfers were granted to Medicaid to improvise the health sector of state and local governments.

Federal transfers also support capital expenditures by other governments that focuses on improving infrastructure of state and local authorities. Federal transfers also improvised the functional areas such as transportation, public safety that included security of the states and local, economic development and public health (Wildasin, 2009). According to the stats produced by 1997 census, there are around 90,000 localities which comprises of 20,000 municipalities, 14,000 school districts, 17,000 townships, and 35,000 special districts. For all these localities and communities, state-local transfers acts as a principal source of transferring grants.

According to the study by (Chamberlan, 2013), federal intergovernmental grants has a long lasting effect on state taxes. They argue that $1 in federal aid temporarily stimulates United States spending by $0.76 with only about $0.65 of it ultimately disappearing from the state budget in future years and the remaining $0.11 turns out to be persistent state expenditures financed by state tax revenue indicating positive budget asymmetry. Their study concluded arguing that temporary federal grants to states and local governments have a lasting and unintentional future budgetary consequences. Federal government has higher power for borrowing money than the state or local government. The federal government can borrow money and use it for the development of state and local government which outlines the federal government’s greater ability to stabilize a weak economy.


Excerpt out of 16 pages


Public Economics and Intergovernmental Grants
A brief literature review
University of South Florida  (PG Business School)
Msc Healthcare and Public Administration
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ISBN (eBook)
ISBN (Book)
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662 KB
economics, public economics, policy making, Intergovernmental grants, Public policy
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Murali Mg (Author), 2016, Public Economics and Intergovernmental Grants, Munich, GRIN Verlag,


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