Exceptional Proff 612

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Introduction

Topics to be covered include:

· Federal Budget Deficit and Military Spending

· Types of Governmental Grants

· Rationales for Governmental Grants

· The Price and Income Effects

· The Flypaper Effects

In Lesson 7, we will discuss Government expenditures and specifically grants. The process of awarding grants begins with locating the places where the grant money will be of the best use. State and local governments and communities apply for grant money to grant-awarding agencies to help with public service projects that they cannot fund entirely by themselves. There are three main types of grants: matching, categorical, and general (block) grants. In addition to providing services, grants stimulate the economy through fiscal equalization, price and income effects, and the flypaper effect.

As you have seen in previous lessons public finance is a complicated system. In order to balance the discussion last week on revenues, we will look more closely at expenditures this week. To start, please review the USASpending site . This site is part of our Government’s effort to become more transparent. The site gave links specifically to the expenditures for 2016 so you can more fully explore them, but please take time to explore the whole site. It will be very helpful in bringing together the concepts we have studied so far. You will note that spending for the National Defense is one of the top three expenditures.

Federal Budget Deficit and Military Spending

Recent political debates over solutions to the federal budget deficit and the ending of the past decade's wars in Afghanistan and Iraq have put defense and military spending on the chopping block.

· Does the American public support such a policy choice?

· Are Americans more or less supportive of defense and military spending than they were prior to September 11, 2001?

The article “Support for Defense and Military Spending” (2015) reviews academic, independent, and media polls to address these questions. The authors find that contemporary levels of support for defense and military spending remain above "normal levels" between 1960 and 2000, and that although Americans are still opposed to cutting defense and military spending, they are more likely to support such cuts as a solution to the federal budget deficit after 2007 (Corman et al., 2015, pp. 166-180).

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US Department of Defense (DoD) procurement and maintenance costs have risen considerably faster than economy-wide inflation over the last several decades. This outcome has occurred in large part because decision-makers within this agency have demanded more complex, better-maintained systems over time. In their paper “Defense inflation: What has Happened, Why has It Happened, and What can be Done About It?” Keating and Arena (2016) argue that defense inflation is likely to abate when resourcing levels no longer accommodate these demands. Defense inflation should be viewed partially as a symptom, not just as a cause, of increased defense spending (Keating & Arena, 2016, pp. 176-183).

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Although each of the expenditure categories could be a lesson on its own, we will move into an area that impacts governments at all levels – grants.

Types of Governmental Grants

One of the leading issues of political contention where budgeting is concerned is the distribution of grants, the government’s method for funding ideas and projects for the purpose of providing services to the public and stimulating the economy at the same time. Federal grants can be placed into three categories: matching, categorical, and general (block) grants (Dilger & Boyd, 2014, pp. 1-4).

Matching Grants

Matching grants involve a government entity (federal, state, or local) putting up a share of the funds for a grant in exchange for another entity (a community group or lower level of government, for instance) putting up the rest.

The concept of a matching grant is simple: state and local governments identify public projects and designate funds to pay for these projects. Groups within the community that wish to develop these projects draft proposals and apply for grants to fund them. If accepted, the local government will match the community contribution to the project. Generally, the government will provide half or two-thirds of the community groups providing the rest, but other levels of funding can be used as well. The community group may contribute labor or donated materials to help match the grant in addition to money, so groups that have time but not money to fund a project can apply for these grants. On the community level, tree plantings and constructing or restoring parks and playgrounds are common examples of projects that may use matching grants (Blake, 2005).

Categorical Grants

The next category, categorical grants , are federal funding for limited, restricted public purposes where recipient state or local governments usually must meet some type of matching requirement. About 90 percent of all federal grants are categorical grants. These grants can either be open-ended with no limit on the grant amount or closed-ended with a fixed upper limit. Categorical grants can be further divided into two types: project grants and formula grants. In both types of categorical grants, federal money redistributed with a grant must be dedicated to a specific program or use.

To receive a project grant, states and/or localities must submit applications and compete for the grant. Detailed forms must be completed and extensive documentation supplied concerning the state or local government’s proposed uses of funds. After the deadline has passed, the federal department or agency awarding the grant evaluates the competing proposals and makes a final decision on how the grant money will be awarded. The U.S. Department of Education runs a number of project grant programs for classroom innovations, core programs, and special education, and the Environmental Protection Agency (EPA) also offers several for research and pilot programs.

General (Block) Grants

The third type of federal grant, general (or block) grants , can be used for a wide range of projects and services. Block grants have been a part of the American federal system since 1966.

Block grants are used by the federal government to provide state and local governments funding to assist in addressing broad purposes. These may include community development, social services, public health, or law enforcement. Legislation generally details the extent of the program, but state and local governments are provided far greater flexibility in the use of the funds. There are also fewer administrative conditions to meet under block grants than under categorical grants. In 2014 there were 21 currently funded block grants, which totaled about $50.8 billion. This amounted to less than 10 percent of total federal grant assistance (Dilger & Boyd, 2014, p. 1).

Matching Grants

Rationales for Governmental Grants

Governmental grants are normally distributed by higher-level governments (e.g., federal and state governments) to lower-level ones (e.g., local governments and community groups) to account for the costs of delivering these public services. These grants internalize spillover benefits or costs. Two principles are relevant for understanding why government grants are necessary.

· SUBSIDIARITY

· The principle of subsidiarity means that the lowest levels of government should deliver governmental services because they understand consumer-voters’ demands and needs the best. Lower levels of government can monitor the preferences and demands of taxpayers more closely than higher ones, and thus can provide the services their residents want more effectively. The principle of subsidiarity leads to evolution toward more democratic governments and more government accountability. The quantity and quality of governmental goods and services will better match the preferences of a community’s residents.

· CORRESPONDENCE

· The principle of correspondence is satisfied when governments serve a set of individual residents who consume their goods and services. Based on this principle, the governmental jurisdictions can prevent problems that occur when beneficiaries of goods and services do not pay for them. When individuals make decisions on how they would like private services rendered there is no distortion, while public goods and services generate external benefits. Police and fire protection services, for example, benefit residents outside the community that delivers the services. Thus, these services need to be delivered by higher-level governments so that resources are not misallocated. Usually, the tradeoff between these two principles involves having governments large enough to avoid cost or benefit spillovers but small enough to provide uniform desired amounts of public services to local residents.

· FISCAL EQUALIZATION

· Another rationale for governmental grants is fiscal equalization across jurisdictions as the second rationale for IGR grants. For example, consider two communities with different levels of property tax bases. If they are to provide the same level of public services, the community with the lower tax base will be faced with a higher property tax rate or higher tax effort. If higher-level governments intervene, they can raise revenues through their tax systems and redistribute them to communities with lower tax bases. This is most evident between inner-city communities and the suburbs of those same cities. Some federal grant formulas even include equalizing elements. If grants with formulas favor states and localities in greater fiscal need (in terms of poverty rates or per capita income, for instance), they can address fiscal disparity across the states and localities.

The principle of subsidiarity means that the lowest levels of government should deliver governmental services because they understand consumer-voters’ demands and needs the best. Lower levels of government can monitor the preferences and demands of taxpayers more closely than higher ones, and thus can provide the services their residents want more effectively. The principle of subsidiarity leads to evolution toward more democratic governments and more government accountability. The quantity and quality of governmental goods and services will better match the preferences of a community’s residents.

The Price and Income Effects

Government grants produce effects on both prices and incomes in recipient governments. After all, their secondary purpose is to stimulate the economy in addition to funding public goods and services. When the price of a certain product drops, it means that the product with a lower price is less expensive than other goods, which gives the customer an incentive to purchase it instead of a competing product. This effect is called the price effect . When price decreases, demand increases. The principle of the price effect can be applied to the analysis of fiscal impacts of government grants. If these grants reduce the price of services delivered by the recipient governments, the grants generate primarily price effects.

Categorical and matching grants tend to increase local expenditures more than lump-sum grants of the same size do. These expenditures do not increase more than the grant amounts, although some funds may be diverted to other categories of expenditures. However, these types of grants have reported a stronger impact on the spending of recipient governments than those paid in lump sums.

There are a couple of reasons why these grants are also often more stimulative than open-ended. There are a couple of potential reasons for the anomaly. Closed-ended categorical matching grants were heavily used for services that state and local governments usually do not provide or may include maintenance efforts as introduced above. Demand for the aided services is also likely to be higher than those of the services receiving open-ended categorical grants, and this might also explain the higher-than-expected impacts.

When consumers’ incomes grow, their purchasing power increases and they are likely to demand a product or service more even if it is not less expensive. This is known as the income effect . When the government grants only increase the wealth of the governments that receive them, income effects may be observed. The residents in the recipient governments might increase their demand for the public service that government grants support.

The Flypaper Effect

Money Sticks Where it Hits

Most findings have shown that the economic impacts of grants given in lump sums are greater than the impacts produced by increases in residents’ incomes. For instance, a one-dollar increase in the latter typically increased local expenditures by about five to ten cents, while a one-dollar increase in a lump sum grant increased local expenditures by about 25 to 50 cents, a phenomenon known as the flypaper effect . In other words, “money sticks where it hits.”

Fiscal Illusion

The flypaper effect is a complicated and controversial concept. Research on the topic has found that the fiscal impacts from grants are much higher than those from personal income. One possible explanation is the theory of fiscal illusion: Local residents perceive that these grants reduce the marginal cost of service deliveries by the governments that receive them. If local governments spend $100 per resident for providing a public service and receive a $30 per resident grant to provide that service, the local government will pay only 70 percent of the cost of that service. Residents might equate the reduction in the cost with a decrease in their tax price, leading to a similar effect from matching grants by reducing tax prices through decreasing marginal costs of service deliveries.

Control of Information

The political process can also produce the flypaper effect. Budget-maximizing bureaucrats can control information about grants and induce voters to approve taxes for desired services while simultaneously spending the grant funds. In this case, the grant funds will significantly increase the spending for the services. Legislators whose districts value the public services provided the most are willing to spend more federal money on these services, and they are likely to make the winning offers for grants. The result is a positive correlation between the grants awarded and the spending by the jurisdictions that receive the grants.

Criticisms of the Flypaper Effect

Competing theories have pointed out errors in the flypaper effect. Agencies awarding grants are likely to distribute grant funds to recipient governments that are likely to spend the largest amount of local funds; thus, these lump-sum grants are essentially matching grants that simply have a more stimulative effect on the economy. Recipient governments bid for the right to provide services using federal grants by offering to share their costs. Donor governments select governments to receive grants until their budgets are exhausted to the point where marginal contributions are equal to the marginal benefits of the services provided by the recipient governments. Recipient governments with the highest bidding price will provide more services and receive more aid.

In addition, as a jurisdiction’s income levels rise, the cost of the public service delivered by the jurisdictions might decline. Especially high-income communities might rely more greatly on private educational services than those provided by the government, thus reducing the burden on the government. Demands for public education will rise with incomes, but at the same time, their costs will be reduced because education services are partially delivered by private educational services. This will partially reduce the cost of service delivery by the governments. Accordingly, supply curves for the service will make a shift that will increase the educational service quantity and expenditures. This leads to higher expenditures for the public services provided.

Conclusion

Reflection:

· Which types of grants do you feel are most beneficial to communities? Which grants are the most fiscally responsible?

· What importance do you place on the economic benefits of grants?

Government expenditures are often part of the political debate that we have seen is part of the budgeting process. As you explored the USASpending site on expenditures you saw many headings that you see daily in the headlines – defense spending, social security and others. Moving to the specifics of government grants we found a variety of types and uses. If you watch your local and state carefully you will see these utilized for many purposes ton include education, infrastructure, and revitalization.

References

Blake, A. (December 23, 2005). Matching Grants. Retrieved from http://depts.washington.edu/open2100/pdf/3_OpenSpaceImplement/Implementation_Mechanisms/matching_grants.pdf

Corman, J., Harris, K., Levin, D., Shulte, J., & Shanks, B. (2015). Support for Defense and Military Spending. Public Opinion Quarterly, 79(1), 166-180. doi:10.1093/poq/nfu091

Dilger, R. J. & Boyd, E. (July 15, 2014). Block Grants: Perspectives and Controversies. Congressional Research Service. Retrieved from https://fas.org/sgp/crs/misc/R40486.pdf.

Federal Emergency Management Agency (FEMA). (2018). FEMA Reports. U.S. Department of Homeland Security. Retrieved from https://www.fema.gov/

Federal Emergency Management Agency (FEMA). (2018). Welcome to the Assistance to Firefighters Grant Program. U.S. Department of Homeland Security. Retrieved from https://www.fema.gov/welcome-assistance-firefighters-grant-program

Keating, E. G., & Arena, M. V. (2016). Defense inflation: What has happened, why has it happened, and what can be done about it? Defence and Peace Economics, 27(2), 176-183. Retrieved from https://doi-org.ezproxy2.apus.edu/10.1080/10242694.2015.1093760

U.S. Department of Education. (2018). Student Loans, Grants, Laws, and Data. WhiteHouse.Gov. Retrieved from https://www.ed.gov/

U.S. Environmental Protection Agency (EPA). (2018). About EPA, Environmental Topics, and Laws and Regulations. Retrieved from https://www.epa.gov/

USA Spending. (2018). Budget Functions. USASpending.Gov. Dun and Bradstreet, Inc. Data. Retrieved from https://beta.usaspending.gov/#/