Making government work, and work for all.

Municipal governments in the United States generate revenues from their own sources (their authority to charge for services and collect taxes); other governments (intergovernmental revenue); and, by issuing debt or borrowing (typically for fixed assets). While frequent attention is paid to federal grants-in-aid, relatively little consideration is given in the intergovernmental finance literature to the state portion of intergovernmental fiscal transfers.

A recent report by the Lincoln Institute of Land Policy provides a deep look at the policies and laws concerning unrestricted state aid to municipalities, and, describes the range of contemporary state grant programs in the 50 states. Also included are additional details on state aid in ten case-study states: Arizona; Florida; Idaho; Illinois; Minnesota; Montana; Nevada; North Carolina; Tennessee; and Wisconsin.

In 2017, state governments contributed $83.8 billion to municipalities’ total general revenues of $491.4 billion (excluding debt), or, approximately 17 percent of municipal general revenues. Most state aid is dedicated to specific functions and purposes, while some state aid is for general or unrestricted purposes.

Unrestricted state aid amounted to 3 percent of total municipal general revenue, or, $15.6 billion in 2017. Yet, states vary widely in the design of unrestricted state aid programs, and, some do not offer unrestricted state aid at all. In fact, in only eight states did unrestricted state aid account for at least 10 percent of municipalities’ total general revenues.

While the design of state aid programs varies, there are three common approaches for distributing funds to municipalities. These common approaches are:

  • origin of taxation or consumption (also referred to as “situs-based”), which effectively means that the state is the collection agent, thereby reducing administrative costs for local governments, and, transfers funds to municipalities;
  • population, which implicitly redistributes funds without regard to the municipality’s or residents’ needs, nor to the municipality’s or residents’ contribution; and
  • equalization or needs-based, which explicitly redistributes funds for the express purpose of  roviding a floor of revenue to each municipality, or, to more equitably distribute resources among all municipalities.

Unrestricted aid programs are also often one of two types: “lump-sum” (which is shared state revenue without regard to the revenue source); and, “tax earmarking” (which is a specific revenue source that is shared with municipalities). Twelve states provide “lump-sum program” support, amounting to $59.35 per capita (median value) to municipalities, or, the equivalent of 2.8 percent of total municipal revenue.

Twenty-six states provided “tax earmarking” support for municipalities in 2017, amounting to $41.28 per capita (median) to municipalities, or, the equivalent of 2.9 percent of municipal revenue. Only 14 states, however, share income and general sales tax revenue with municipalities, and, of those two taxes, it is most common for general sales tax revenue to be shared. Three states (Arizona, Illinois, and Tennessee) earmark both a portion of their income and sales tax collections to municipal governments as unrestricted aid.

Between 2007 and 2017, a time period that included the Great Recession, real, per-capita state aid decreased by 22 percent. Among the 26 tax earmarking states, the median amount of aid decreased the most in the first several years of the Great Recession, between 2007 and 2012, by 10 percent (and remained flat between 2012 and 2017), indicating that declines in aid were mainly attributable to the economic downturn. In contrast, for the 12 lump-sum states, median aid fell more sharply in the 2012 to 2017 period by 11 percent (and declined by 6 percent between 2007 and 2012). This lagged effect suggests that, unlike the tax earmarking states that experienced declines in state aid due to the declining economic position of the state, state governments in lump-sum states took legislative action to reduce state aid.

Read the entire Lincoln Institute of Land Policy Working Paper:

How States Provide Cities with General Revenue: An Analysis of Unrestricted State Aid. Amanda Kass, Michael Pagano, and Farhad Kaab Omeyr, September 2020