Working paper series // Federal Reserve Bank of Boston 08-1
This paper designs a new equalization-aid formula based on fiscal gaps of local communities. Using conceptual analysis and simulations with Massachusetts data, the authors illustrate the tradeoffs that policymakers face in deciding on the policy variables in the formula and lay out several general guidelines for setting up these variables. When states are in transition to a new local aid formula, the issue of whether and how to hold existing aid harmless poses a challenge. The authors show that previous studies and the formulas derived from them give differential weights to existing and new aid in filling the gap and hence effectively treat communities receiving greater amounts of existing aid more favorably than communities receiving less or no existing aid. As a fairer alternative, the authors propose a new approach that considers existing and new aid within a consistent framework by taking account of both in filling the gap. In addition, unlike previous research that focuses only on a single year's new aid distribution, the authors simulate the dynamics of aid distributions over multiple years and examine their evolution over time. The authors further provide and compare several possible solutions to addressing the possible tradeoffs between short-term and long-term goals. Although the proposed aid formula is designed for municipal aid and tailored to Massachusetts, the authors note that foundation aid formulas for education implicitly treat existing aid in the same way and suggest that the framework, principles, and policy recommendations might also be applicable to other states designing new municipal aid formulas.
Formula design state aid formula equalizing aid fiscal equalization