Federal Grants:

Design Improvements Could Help Federal Resources Go Further

AIMD-97-7: Published: Dec 18, 1996. Publicly Released: Dec 18, 1996.

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Pursuant to a congressional request, GAO examined the federal grant-in-aid system from the perspective of fiscal impact, focusing on the extent to which the federal grant system succeeds in: (1) encouraging states to use federal dollars to supplement rather than replace their own spending on nationally important activities; and (2) targeting grant funding to states with relatively greater programmatic needs and fewer fiscal resources.

GAO found that: (1) for the most part, the federal grant system does not encourage states to use federal dollars to supplement rather than replace their own spending on nationally important activities; (2) grants are unlikely to supplement completely a state's own spending; (3) GAO's review and analysis of economists' most recent estimates of substitution suggests that every additional federal grant dollar results in less than a dollar of total additional spending on the aided activity; (4) with the responsibilities of states increasing in the federal system, some observers may view this substitution as a legitimate means of providing states fiscal relief and budgetary flexibility; (5) the Congress has various criteria available to address how such relief should be allocated among the states; (6) GAO's analysis of the extent to which the fiscal relief provided by grants is allocated to states with relatively greater programmatic needs and fewer fiscal resources indicated that federal aid is not targeted to offset these fiscal imbalances; (7) GAO's analysis also suggested that the practice of placing constraints in grant formulas to assure all states a minimum amount of funding has contributed to this lack of targeting; (8) these fiscal substitution and targeting results reflect the way in which most of the 633 federal grants GAO examined are designed; (9) a majority of the 87 largest grant programs did not include features to encourage states to use federal funds to supplement rather than replace their own spending; (10) a number of strategies for increasing the fiscal impact of grants are available to the Congress, depending on the value the Congress places on this goal relative to other grant goals and objectives; (11) grant redesign is one strategy for reducing substitution or targeting fiscal relief to states with greater fiscal stress; (12) in redesigning grants, the Congress would need to consider how best to balance grant restrictions needed to reduce substitution against possible decreases in state budgetary flexibility and discretion; (13) if states do not share the federal government's programmatic objectives, high levels of substitution may occur even after design changes; (14) alternatively, the Congress could decide that particular programs no longer represent the best use of scarce federal resources, which would free up budgetary resources that could be used to reduce the deficit or invest in more promising programs; (15) like the first strategy, grant spending cuts also involve tradeoffs; and (16) depending on the size and area of the reductions, states would incur varying degrees of budgetary stress and might face the prospect of increased state taxes, cuts in state programs, or some combination of both.

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