Designing Formulas for Distributing Reductions in State Aid

Abstract

This paper develops a framework that distributes reductions in state aid based on underlying local fiscal health. Under this framework, the state gives smaller aid cuts to communities that are in worse underlying fiscal health and receive less existing aid. This framework therefore provides a more rational and equitable method of cutting aid than commonly used ad hoc or across‐the‐board cuts. The framework can also apply to aid increases, giving policymakers a single tool to accommodate any change in state aid. We use Massachusetts data on unrestricted municipal aid to conduct policy simulations. The framework can also be used to distribute school aid or non‐school aid, and is potentially applicable to all states.

Keywords: fiscal health, fiscal gap, state aid, aid cut, fiscal equalization

JEL Classification: H70, H72, H73, H77, H83