Designing formulas for distributing reductions in state aid

Local governments depend on state aid to provide residents and businesses with vital public services, such as education, police and fire protection, and safe public roads. However, in response to the recent fiscal crisis, many states are quickly and deeply cutting local aid. The Congressional Budget Office reported that 22 states reduced aid to local governments in FY 2010, and 20 states have proposed additional cuts in FY 2011. ; States tend to cut aid either on an ad hoc basis or across the board, with every community receiving the same percent aid cut. This paper proposes a new, more equitable approach to distributing reductions in state aid. It develops a framework that distributes reductions in state aid based on underlying local fiscal health whereby communities that are in worse underlying fiscal health and receive less existing aid experience smaller aid cuts. The framework can also apply to aid increases, giving policymakers a single tool to accommodate any change in state aid. ; The paper uses Massachusetts data on unrestricted municipal aid to simulate the impact of the proposed framework. The framework can be used to distribute cuts or increases in school aid or non-school aid, and is potentially applicable to all states.