Federal Aid Biggest Source of Revenue for States

May 5, 2009— -- In a historic first, Uncle Sam has supplanted sales, property and income taxes as the biggest source of revenue for state and local governments.

The shift shows how deeply the recession is cutting. Federal stimulus money aimed at reviving the economy and a sharp drop in tax collections have altered, at least temporarily, the traditional balance of how states, cities, counties and schools pay for their operations.

The sales tax had been the No. 1 source of state and local revenue since the mid-1970s, according to the Bureau of Economic Analysis. Before that, property taxes were the primary source. That changed in the first three months of 2009.

Federal grants -- early stimulus money plus conventional federal aid -- soared 15 percent in the first quarter to a seasonally adjusted annual rate of $437 billion, eclipsing sales taxes, which fell 2 percent.

The dominance of federal money is set to expand dramatically this year because tax collections are sinking while the bulk of federal stimulus aid is just starting to arrive.

"This money isn't manna from heaven. It comes with a price," says Indiana state Sen. Jim Buck, a Republican. He worries that the federal money will leave states under greater federal control and burden future generations with debt.

Nick Johnson, a state finance expert at the liberal Center on Budget and Policy Priorities, says the federal aid is well-timed.

"This has more to say about the severity of the recession than anything else," he says. "Congress stepped in on a temporary basis to help states."

The federal government plans to provide about $300 billion in extra aid to state and local governments over the next two years, mostly for health care, education and transportation projects. State and local governments spend about $2 trillion a year, and the federal government is now paying about 23 percent of those costs.

States are counting on tax collections rebounding by 2012, when stimulus money starts to run out.

The early flow of stimulus money helped lift total state and local revenue by 1.6 percent in the first quarter compared with a year earlier despite a 2.9 percent drop in total tax collections. Spending rose 1.5 percent.