Fiscal Federalism: Definition, Theory & Examples

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  • 0:00 Definition Of Fiscal…
  • 0:40 Theory Of Fiscal Federalism
  • 1:10 Fiscal Federalism In The U.S.
  • 3:25 Medicaid: Fiscal…
  • 4:20 Lesson Summary
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Lesson Transcript
Instructor: Julia Maypole

Julia has a master's degree in world history and has taught college history and other humanities courses.

This lesson will explain what fiscal federalism is, how it works, and examine a few examples from America's government and history, including a look at one of the largest federal- and state-funded programs: Medicaid.

Definition of Fiscal Federalism

At its most basic level, fiscal federalism attempts to define the division of governmental functions, and the financial relationship between, different levels of government (usually how federal or central governments fund state and local governments).

Imagine a Leave it to Beaver scenario: fiscal federalism might involve Dad (the federal government) making money, then handing it over to Mom (the state government) to distribute as she sees fit based on the needs of the family (the people) to buy groceries, pay the rent, give the kids allowances, go to the doctor, and so on (programs like government housing and health care).

Theory of Fiscal Federalism

The theory of fiscal federalism was originally developed by German-born American economist Richard Musgrave in 1959. Musgrave argued that federal government systems have the ability to solve many of the issues local governments face by providing the balance and stability needed to overcome disruptive issues like uneven distribution of wealth and lack of widely available resources. Musgrave further theorized that federal governments should manage a nation's money from the top and give it to states, who can distribute it locally as needed.

The United States government relies on fiscal federalism. In the United States, there exists a complex and highly bureaucratic relationship between states and the federal government to fund such vital aspects of daily life, as roads, schools, and health care. States can ask for (or be granted) money through federal 'grant-in-aids,' an example of fiscal federalism at work.

Prior to the end of the American Civil War in 1865, state proposals asking for federal funding were routinely shot down or vetoed by presidents for being unconstitutional (the 10th Amendment of the Constitution prohibits the federal government from intervening in state governance). That began to change in the latter part of the 19th Century, as federal funding policies moved further away from strict Constitutional adherence. The realities of operating a country with the size and influence of the United States made co-dependency between federal and state governments necessary, and late 19th century technology, like railroads and telegraphs, made it possible.

Fiscal Federalism in the United States

The Morrill Act of 1862 was the first fiscal federalist legislation in the United States. In it, the federal government allocated 30,000 acres of federal land to each state, allowing them to use the profits of those land sales to build public universities. The federal government intended the Morrill Act to spur the scientific, agricultural, and industrial advancement of the U.S. Some of the universities that came out of the Morrill Act include Cornell University and the Massachusetts Institute of Technology.

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