Fiscal Federalism & the Role of Federal Funds in State Policy

Lesson Transcript
Instructor: Ashley Dugger

Ashley has a JD degree and is an attorney. She has extensive experience as a prosecutor and legal writer, and she has taught and written various law courses.

The New Deal brought about a new form of fiscal federalism, resulting in a change in the roles of federal funds in state policy. Learn about early federalism, the move toward fiscal federalism, and the different forms that fiscal federalism comes in, including grants and mandates. Updated: 10/29/2021

Early Federalism

I'm the mom of three boys. I give each of my sons an allowance, but my sons aren't free to spend the money as they wish. The allowance comes with conditions. I tell the boys what they can and cannot do with their funds. My system is a bit like the relationship between our federal government and state governments. Let's look at how.

The framers of the United States Constitution used federalism, which is a division of power between the federal government and the individual state governments. Each government entity was given responsibility for matters that are best addressed at that level of government. The responsibilities used to be very distinct, with most powers reserved to the states through the Tenth Amendment.

However, federalism has evolved over the course of American history. In the 1930s, the New Deal brought new federal legislation enacted in response to the Great Depression that implemented several programs and policies geared toward reviving the economy. This resulted in the federal government regulating areas it hadn't previously regulated.

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  • 0:01 Early Federalism
  • 1:20 Fiscal Federalism
  • 2:42 Grants
  • 4:54 Mandates
  • 6:38 Lesson Summary
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Fiscal Federalism

The new programs and policies were based on fiscal federalism. Fiscal federalism means that federal funding is allocated to the states with specific conditions attached. Like me with my sons, the federal government controls the state governments through money.

In short, the federal government determines how much money will be given to a state, under what conditions the money will be given, and what the state can do with the money. This means that federal and state government responsibilities are often intertwined, rather than distinct. The states now rely on federal money, and the federal government relies on the states to administer some federal programs and policies. The federal government is now involved in matters such as health care, education, and transportation. These are, historically, state matters.

Fiscal federalism comes in several different forms. Generally speaking, the main categories include:

  • Categorical grants
  • Block grants
  • Revenue sharing
  • Mandates

Let's take a closer look at each of these.


We'll start with grants. Grants in aid refers to when the federal government gives money to the states for a particular purpose. There are two main types of grants in aid.

A categorical grant is federal money given to a state for a specific purpose, with restrictions on how the money can be used. The Head Start Program is an example of a categorical grant. Federal money is given to individual states in order to implement Head Start. Head Start is a federal program that provides education, health, nutrition, and family services to low-income preschoolers and their families. The categorical grant money cannot be used for any other purpose.

A categorical grant works differently than a block grant. A block grant is federal money given to a state for a broad purpose, with few restrictions on how the money can be used. States can decide where and how to use the money. The Welfare Reform legislation, enacted in 1996, uses block grants. Under the law, federal money was given to states. The states then developed and implemented their own plans to move people off welfare and into employment within a five-year period. The states could use the block grant money as they wished, as long as the money was used toward this goal. The states have broad discretion to implement the programs, since the federal government mostly only monitors the progress and outcomes of block grant projects.

These two types of grants can be differentiated from revenue sharing. Revenue sharing is when the federal government gives money to the states with no restrictions on how the money can be used. President Nixon initiated the use of revenue sharing programs in the 1970s, but by 1986 this practice was no longer in use.

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