The Long and Winding Road to Local Fiscal Equity in the United States: A Fifty Year Retrospective

Outside the United States, fiscal equity is a common explicit objective for intergovernmental transfers at the central and regional levels, with transfers often having specific equalization targets. In contrast, the United States does not have a comprehensive federal transfer scheme for explicit fiscal equalization but rather employs an array of categorical and block grants, some of which are formula-based while others are project-driven. However, the allocation of many of these grants has equalization effects resulting in the narrowing of fiscal disparities among jurisdictions. Indeed, almost half of federal grants in the United States are allocated to healthcare and another quarter to income security programs. In addition, the largest category of state grants is allocated to school districts using formulae similar to those used in other countries for fiscal equalization by the central government, including the measurement of fiscal capacity and expenditure needs. Few studies have attempted to quantify the extent of equalization achieved with federal and state grants in a manner that would allow comparisons across states and over time. While recently several important studies have been published on fiscal inequities between and within states (e.g., Murray et al., AER 1998), their focus has been narrowed to school districts. In this study we set out to take this literature further by measuring the extent of equalization across local governments in the United States that is implicit in the federal grants system and more explicit in the grants implemented by the individual states. Rather than focusing on specific types of local services, we look at the evolution of per capita resources available to all types of local governments combined. The extent of equalization is measured by the ratio of inequality indices before and after the allocation of grants, following the methodology used in Martinez-Vazquez and Timofeev (JCE 2008). We find that, on average, state grants tend to considerably reduce the within-state inequality but tend to slightly increase the between-state inequality. States showing more equalization are those with less socio-political fractionalization, higher income inequality, less decentralization of revenue, and court-ordered reforms of school financing. The equalizing impact of direct federal grants to local governments has fluctuated over time but all in all it has been much smaller than that of the state grants. Overall, federal grants tend to slightly reduce the between-state inequality but slightly increase the within-state inequality. Because the within-state disparities in own-source revenues have become dominant, the overall level of inequality across local jurisdictions has tended to increase with the allocation of federal grants.