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Fiscal Federalism and State and Local Government Finance


Grants-in-Aid. The federal government sends 15% of its tax revenue to state and local ... of Grants. If you are in the role of the Federal Government you can ... – PowerPoint PPT presentation

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Title: Fiscal Federalism and State and Local Government Finance

Chapter 18
  • Fiscal Federalism and State and Local Government

Levels of Government
  • Federal
  • State
  • County (called a Parish in Louisiana)
  • School, Water, Fire, Sanitation District
  • City, Town, Village

  • The federal government sends 15 of its tax
    revenue to state and local governments.
  • Most of this money goes to fund Medicaid and TANF
    programs that states are required to provide.

Fiscal Federalism
  • Fiscal Federalism is the structure of the levels
    of governments in which each level has sources of
    revenues and economic or fiscal responsibilities.

Local Public Goods
Local public goods are goods that create no
rivalry to the good within a certain geographic
  • Examples
  • local streets
  • sewers and sanitation systems
  • parks
  • police protection
  • fire protection

Providing Local Public Goods Locally
  • The benefit of providing local public goods with
    local tax dollars is that the preferences of the
    population using the services can be matched with
    their willingness to pay taxes to receive them.
  • The problem with providing local public goods
    with local tax dollars is that differences in the
    ability to pay between local jurisdictions can
    cause differences in the provision of public
    goods This is sometimes seen as inequitable.

Centralized vs Decentralized Decisions
  • An important problem for a society which goods
    and services should be provided at which level of
  • Are equity concerns more or less important than
    the concerns of matching preferences to service
    levels? For instance, should primary and
    secondary education be provided nationally or

Mobility between Jurisdictions Voting with Your
  • When local public goods are provided in differing
    amounts in different communities, citizens can
    move from one jurisdiction to another to match
    their preferences for local public goods.
  • This concept is called the Tiebout model, in
    which people choose jurisdictions as they choose
    any good. Each jurisdiction provides services
    that come at a price (the tax rate) and people
    can choose how much government to consume by
    choosing where they want to live.

The Global Economy and Federalism
  • The European Union (EU)
  • pushed federalism beyond national borders by
    agreeing to establish uniform regulations and tax
    systems to establish more integrated economies.
  • eliminated border and customs controls between
    member nations.
  • replaced individual currencies with the Euro
  • The U.S.
  • Infrastructure and education have increasingly
    become the responsibility of state and local
  • Tax competition among states often limits their
    ability to raise revenue

Interjurisdictional Externalities
  • Costs or benefits accrue to citizens in one
    jurisdiction that result from the public goods
    choices of another jurisdiction.
  • A suburb with higher taxes to provide better
    parks may provide recreation to more than just
    its own citizens.

The Theory of Taxation with a Decentralized System
  • The Tax Base
  • People being taxed can move to another
    jurisdiction as a result of a tax placed upon
    them. The elasticity of the tax base represents
    this as the percentage change in the tax base
    divided by the percentage change in the tax rate.
  • A new tax can therefore increase overall revenues
    or decrease overall revenues, depending upon
    whether the new tax raises more revenue from a
    new base being taxed than is lost from existing
    taxes because people leave the jurisdiction.

Tax Base Elasticity, Tax Rates and Revenues
Tax Competition and Tax Exporting
  • Jurisdictions attempt to lure residents and
    business to an area by offering them lower tax
    rates or tax abatements. This is called tax
    competition. For example, governments issue tax
    abatements to industries if they agree to move to
    their community.
  • When jurisdictions place a tax on a good that is
    consumed by people who do not live in the
    jurisdiction this is called tax exporting. For
    example, cities place a hotel tax on visitors to
    their communities.

Fiscal Capacity
Fiscal capacity is a measure of a jurisdictions
ability to raise revenue.
Possible Measures
  • Per capita income
  • Per capita retail sales
  • Per capita assessed valuation

Revenue Effort
  • Revenue effort is a measure of how much revenue a
    jurisdiction is collecting relative to how much
    it could collect.
  • It is typically measured as the ratio of the tax
    collections from all sources in a jurisdiction to
    its per capita income.

Interstate Tax Exportation
  • Many state governments do succeed in exporting
    their tax burden to residents of other states.
  • Tax exportation arises in a variety of ways
  • Tax out-of-state input owners who employ their
    inputs in the state
  • Tax goods and services purchased by out-of-state
  • Tax hotels and entertainment activities
  • The federal deductibility of state and local
    income and property taxes from taxable income
    under the income tax amounts to tax exportation.

Governmental Grants
  • Categorical Grants are grants by one level of
    government to another to support a specific
  • Matching Grants are grants by one level of
    government to another that must be matched by the
    receiving government in support of a program.
  • Unconditional Grants are grants by one level of
    government to another that may be used for any
    broad purpose. Sometimes called Block Grants or
    Revenue Sharing.
  • Because money not spent in one area when a grant
    is received can be spent in another, a restricted
    grant may serve unintended purposes. This is
    called fungibility.

Federal Grants in Aid
The Theory of Grants
  • If you are in the role of the Federal Government
    you can
  • provide the good
  • provide local governments with an incentive to
    provide the good themselves with matching grants,
  • provide local governments with the means to
    provide the good with categorical grants or with
    block grants.

Figure 18.1 Political Equilibrium A Matching
Grant Versus a Nonmatching Grant of Equal Value
Impact of a Nonmatching Grant on the Political
  • A nonmatching grant would likely (depending on
    the preferences of the median voter) increase
    both the level of public goods produced as well
    as allow for lower taxes so that more private
    goods could be consumed.
  • Less of the grant is devoted to public goods with
    a nonmatching grant than with a matching grant.

Figure 18.2 Matching Grant
Education Finance
  • What is the proper role of the federal government
    in school finance? The question is one of equity
    vs local control. Because some school districts
    are poor relative to others, a completely local
    system could be seen as inequitable. On the other
    hand, local control of the curriculum is seen as
    important as well.