Intergovernmental transfers are transfers of funds from one level of government to another. This may be to fund general government operations or for specific purposes.
Local revenue is greatly enhanced by various forms of state aid, which may include sharing a portion of state revenue from various taxes, giving grants, reimbursing for prison expenditures or payments in lieu of taxes. According to the Lincoln Institute of Land Policy, states contributed between 30 and 40 percent of total municipal revenues in 2002. But, some of these revenues are for purposes beyond the annual operating budgets of local governments, such as highway funds. Over the last 20 years, NLC estimates that the states' share of annual operating revenues for municipalities was 20-25 percent.
Although the federal government does not provide a significant amount of funding to local governments (only about 5 percent of general municipal revenue), it has other ways of increasing local revenue or reducing local costs. This includes establishing federal tax exemptions that reduce municipal borrowing costs. Federal tax exemptions for local property, sales and income taxes encourage homeownership and consumption of goods and services, thereby increasing municipal revenue from local sales, income and property taxes.
In addition, federal aid reaches municipalities in the form of grants. Federal grants come in two forms: block and categorical. Block grants are allocated according to a predetermined formula that dictates how much money a locality can expect to receive, depending on quantifiable factors like population, housing density or health indicators. Cities that apply for block grants must use funds from a preapproved broad functional area such as community development, but generally have few restrictions on how it is spent. One example is the Community Development Block Grant administered by the U.S. Department of Housing and Urban Development that supports housing and economic development activities. Cities that receive categorical grants may only spend the money on specific projects and must usually supply a matching portion of the funds. Categorical grants, which are the most common form of federal aid, are awarded based on merit or a stated formula. Medicaid and the Food Stamp Program are two examples of categorical grants issued to states, Medicaid being the single largest source of federal revenue to the states.