The Fiscal Response to Intergovernmental Transfers in Less Developed Areas of the United States

Abstract

PpTHE GROWING dependence of the local public sector on intergovernmental aid and the current interest in new forms of aid to be directed to the development of slower growing regions, such as Appalachia, make an increased knowledge of the relationship between these intergovernmental grants and the actions of the local public sector of particular importance. Have these intergovernmental grants increased or decreased the activity of the local public sector? Is there a discernable difference in the impact of federal as opposed to state aid and in the impact of the programs among individual states? One method of measuring the effect of aid programs would be to consider the relationship between these transfers and expenditure levels.' In this paper, however, the focus is on the impact upon the proportion of locally received income disbursed to the public sector or local fiscal effort. Consideration of this particular relationship is useful because of the interest centered on local fiscal effort in the literature on intergovernmental relations. As intergovernmental aid is only one of the several factors which should bring about changes in the level of local fiscal effort, multivariate regression analysis is used to estimate the impact of all these factors. Before considering the details of the multivariate analysis, a review of the nature of the expected relationship between the local fiscal effort and intergovernmental transfers is useful. For lack of a better model let us assume that local governments complement the operation of the private market in providing goods which the private market cannot effectively handle. Attacking the problem in this framework means that the effect of an increase in intergovernmental transfers on fiscal effort can be thought of as the result of a combination of three factors: (1) the marginal evaluation by the community of the benefits of public consumption versus private actions concerning present or future private consumption and work effort or leisure, (2) the degree of legislated controls and restrictions over the use of transfers imposed by the donor jurisdiction, and (3) the institutional structure. Any community has available to it a package of state and federal aid programs. Some of these programs are tied to expenditure levels or require local matching as a prerequisite for participation. community is able to purchase an additional amount of a specific public good at a discount. actions of the community will reflect both an income and substitution effect. If the community chooses to increase its consumption of the cheaper public good, it will have to raise its fiscal effort. Other aid programs fall into a category of income grants that are not encumbered by matching provisions. It would seem reasonable to assume that a community would spend part of this additional income on public goods. In the process of making the remaining income available for private uses local fiscal effort as defined in this paper must be reduced. This means that aid has some positive effect on public expenditures, but some of the aid is used as a substitute for local charges. If more than one type of public service is being provided, adjustments may take * author is Assistant Professor of Economics and Research Associate in the Bureau of Business and Economic Research at the University of Maryland. This research, undertaken while the author was at the University of Pittsburgh, was supported by Area Redevelopment Administration Technical Assistance Grant No. Co-6042. Computations performed at the University of Pittsburgh Computation Center were partially supported by National Science Foundation Grant No. G-11309. author is indebted to Professors Harvey Brazer, George Break, Jerome WVells, George Green, and Alarina v. N. Whitman for their helpful criticism, and to William Duffy for his assistance in collecting data. 1 For some recent direct estimates of the effect of intergovernmental grants on the expenditures of specific types of jurisdictions see Edward F. Renshaw, Note on the Expenditure Effect of State Aid to Education, Journal of Political Economy (Apr. 1960), 170-174; S. Sacks and R. Harris, The Determinants of State and Local Government Expenditures and Intergovernmental Flows s of Funds, Nratio,tal Tax Jouirnal, (MIarch 1964), 75-85; and George A. Bishop, Stimulative versus Substitutive Effects of State School Aid in New England, National Tax Journal (June 1964), 133-143.