How to best hand out money issues in the design and structure of intergovernmental aid formulas
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How to Best Hand Out Money: Issues in the Design and Structure of Intergovernmental Aid Formulas. Thomas A. Downes Department of Economics Tufts University. Introduction. Importance of aid Federal aid 7.3% of revenues in 1999-2000 State aid 49.5%, largest source since 1978-79

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How to Best Hand Out Money: Issues in the Design and Structure of Intergovernmental Aid Formulas

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How to best hand out money issues in the design and structure of intergovernmental aid formulas

How to Best Hand Out Money: Issues in the Design and Structure of Intergovernmental Aid Formulas

Thomas A. Downes

Department of Economics

Tufts University


Introduction

Introduction

  • Importance of aid

    • Federal aid 7.3% of revenues in 1999-2000

    • State aid 49.5%, largest source since 1978-79

  • Categorical v. general aid in the U.S. context

    • In 1999-2000, categorical aid provided 19% of revenues

    • Categorical share largest for districts with largest shares of “at-risk” students


Goals of this talk

Goals of this talk

  • Issues addressed in talk

    • What are objectives of aid?

    • How do objectives translate into aid formulae and aid programs?

    • What formula is implied by specific aid objective?

    • To what extent do actual formulas deviate from ideal?

    • What are implications of these deviations?


Objectives of aid

Objectives of Aid

  • Fiscal neutrality

    • Motivated by the existence of fiscal disparities – differences among localities in fiscal capacity and in cost of providing target level of public services

    • Has both efficiency and equity rationales

  • Equitable distribution of tax burdens

    • Motivated by desire to eliminate inequities

    • Definition of horizontal and vertical inequities

  • Correct for inefficiencies in provision

    • Result of mismatch of providers and beneficiaries

    • Need to change incentives of providers


Examples

Examples

  • State equalization aid to local school districts

    • Goal ‑ Reduce fiscal disparities

    • Dominant types ‑ Foundation and power‑equalizing

  • Title I Education grants

    • Goal – To provide districts serving significant populations of economically disadvantaged students with the resources to improve the teaching and learning of these students

    • Grants now go directly to most eligible school districts, with grant amounts based loosely on the number children in poverty and on state per pupil expenditures


Classes of grants

Classes of Grants

  • Lump‑Sum grants

    • Aid does not depend on actions of recipient

    • Block grants are an example

    • Most categorical grants are lump sum

  • Matching grants

    • Increased spending by recipient increases aid

    • Open‑ended v. closed‑ended


Designing formulae common issues

Designing formulae: Common issues

  • Starting point: Closing need and effort gap

  • Basic formula ‑ Aj=F ‑ t*Vj (F is per‑capita spending to supply target service level, t* is formula tax rate, Vj is fiscal capacity)

  • Common issues

    • High capacity jurisdictions and recapture

    • Variation in services provided (equal access v. equal outcomes)

    • Multiple determinants of fiscal capacity

    • Cost adjustment ‑ Aj=CjF ‑ t*Vj (Cj is cost index)


Matching or lump sum

Matching or Lump‑Sum?

  • Objective: Fiscal neutrality ‑ Appropriate formula: Lump‑sum

    • Conditions under which fiscal neutrality is achieved

    • Is result horizontally equitable?

  • Objective: Equitable distribution of tax burdens ‑ Appropriate formula: Lump‑sum

    • Operationalizing objective using average tax effort to establish measure of fiscal capacity

    • Will aid improve horizontal or vertical equity?


Matching or lump sum1

Matching or Lump‑Sum?

  • Objective: Correct for underprovision ‑ Appropriate formula: Matching

    • Determinants of the matching rate

    • Killing two birds with one stone ‑ Can matching aid also be used to mitigate locational nonneutralities?

  • Can aid be used to reduce vertical inequities?

  • Tension of objectives


Implementation problems

Implementation Problems

  • Accounting for cost/need variation

    • Ad hoc nature of existing cost adjustments

    • Problem 1: No accepted methodology for estimating cost variation

    • Problem 2: Data issues

  • Measuring fiscal capacity

    • Choice of measure depends on objective

    • Preferred measure: Revenue that would be obtained from applying formula tax rate to available tax bases (Representative tax system)


Implementation problems1

Implementation Problems

  • Recapture

    • Tension ‑ Payments for services v. redistribution

    • Reality ‑ limited recapture

  • Local discretion

    • Local discretion as an impediment to achieving objectives

    • Should discretion be limited?

    • Can discretion really be limited? – The fungibility problem

    • Potential solution ‑ composite aid formulae


Implementation problems2

Implementation Problems

  • Limiting budgetary liability

    • Tools for controlling liability (lump‑sum) ‑ target spending level, formula tax rate

    • Tools for controlling liability (matching) ‑ matching rate, closed‑ended grants

    • Tensions between budgetary liability and objectives

  • Handling transitions

    • Case for hold‑harmless provisions (stability, fairness)

    • Costs of hold‑harmless provisions (failure to achieve objectives, lock‑in of inappropriate aid distribution)

  • Reasons for failure to achieve objectives


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