Intergovernmental revenue is money that moves from one level of government to another inside the U.S. system, flowing between federal, state, and local jurisdictions to fund services the receiving government could not easily pay for on its own. In fiscal year 2022, federal grants to state and local governments alone totaled roughly $1.26 trillion, which makes these transfers one of the largest funding mechanisms in American public finance. The money pays for Medicaid, highways, public schools, wastewater systems, and much more.
The defining feature is that the government sending the money usually keeps some control over how it gets spent. How much control depends entirely on the type of transfer.
The Main Types of Transfers
Categorical Grants
Categorical grants are the tightest form of intergovernmental funding. The money can only be spent on a narrow, specified purpose. A categorical grant might fund a single highway segment or deliver nutrition assistance through the Special Supplemental Nutrition Program for Women, Infants, and Children (WIC). Because the grantor dictates the use down to the line item, these grants give the higher government the most leverage.
They also frequently require the recipient to chip in. The Department of Transportation, for instance, builds most of its programs around cost-sharing, where a set percentage of the total project cost must come from non-federal sources.1U.S. Department of Transportation. Understanding Non-Federal Match Requirements
Block Grants
Block grants cover a broad functional area and let the recipient decide how to allocate the money within it. Temporary Assistance for Needy Families (TANF) is the standard example: the federal government funds anti-poverty efforts, and states set their own eligibility rules and priorities inside federal parameters. Administrative overhead is lower and programs can be tailored to local conditions, at the cost of less federal control over what actually gets done.
Shared Revenues
Some money moves through formula-driven revenue sharing rather than through competitive grants. A state may collect a statewide sales tax and return a portion to cities and counties based on population or local tax effort. The federal government once ran a general revenue sharing program that distributed aid to nearly 39,000 state and local governments using formulas weighted by revenue capacity, tax effort, and population.2U.S. Government Accountability Office. Revenue Sharing Formulas – An Assessment and Framework for Further Research That specific program ended in the 1980s. Formula-based distribution remains the backbone of state-to-local transfers for education and transportation funding.
Payments in Lieu of Taxes
Federal land inside a county’s borders is exempt from local property tax, which can hollow out the tax base in rural western counties in particular. The Payments in Lieu of Taxes (PILT) program, run by the Department of the Interior, compensates counties for that lost revenue. Eligible lands include those managed by the Bureau of Land Management, National Park Service, U.S. Fish and Wildlife Service, and U.S. Forest Service. In fiscal year 2025, PILT distributed roughly $644.8 million to more than 1,900 counties. Payments use per-acre rates, population ceilings, and offsets for other federal land-related payments the county already receives.3Congress.gov. The Payments in Lieu of Taxes (PILT) Program: An Overview
Where the Money Actually Flows
The biggest stream runs from the federal government to state governments. Medicaid dominates it. Total Medicaid expenditures, including federal matching funds, account for roughly 30 percent of average state budgets, making it the single largest intergovernmental program in the country. Federal highway funding is the other major channel, delivered mainly through categorical grants for construction and maintenance.
States then act as pass-through entities, sending federal dollars down to counties, cities, school districts, and special districts. They also distribute their own tax revenue to those same local governments. For most localities, state transfers for public education are the largest single source of non-tax revenue: the state collects income or sales tax, runs the money through a funding formula, and sends it to school districts based on enrollment, local property wealth, or both.
Money moving upward, from local governments to states or the federal government, is minimal. When it happens, it usually reflects a service agreement rather than a grant. A city might pay a county to house its inmates, or neighboring jurisdictions might split the cost of a shared dispatch center. Those arrangements look more like contracts than the grant programs that define federal-to-state and state-to-local funding.
The Strings Attached
Accepting intergovernmental money means accepting rules about how it can be spent, when it can be spent, and how the spending has to be documented. The tighter the grant, the heavier the compliance load.
Eligible Uses and Period of Performance
Categorical grants require strict adherence to the grantor’s list of eligible expenses. Every dollar has to be tied to the approved program and documented. Block grants leave more room, but spending still has to fall inside the functional area the grant covers.
Federal awards also carry a defined period of performance, the window between the start date and end date during which the recipient can incur new obligations.4eCFR. 2 CFR 200.1 – Definitions Spending outside that window is generally unallowable, even if the money is still in the account. A government that falls behind on a project can lose the unspent balance when the performance period closes.
Single Audits
Any non-federal entity that spends $1,000,000 or more in federal awards during its fiscal year must undergo a single audit or program-specific audit. The audit is conducted under the Uniform Guidance at 2 CFR Part 200 and checks both financial integrity and compliance with each program’s rules. Entities that spend less than $1,000,000 are exempt from the federal audit requirement, though their records must remain available for review by the awarding federal agency, any pass-through entity, and the Government Accountability Office.5eCFR. 2 CFR 200.501 – Audit Requirements
Maintenance of Effort
Many federal programs include a maintenance of effort (MOE) requirement to stop recipients from swapping their own dollars out for federal ones. An MOE provision requires the recipient to keep spending a baseline amount of its own money on the program as a condition of continued eligibility. Under federal education programs, a school district’s combined state and local spending per student in a given year generally cannot drop below 90 percent of what it spent the prior year.6eCFR. 34 CFR 299.5 – What Maintenance of Effort Requirements Apply to ESEA Programs Falling below the threshold can mean reduced funding or a demand to repay part of what was received.
What Happens If the Money Is Misused
Penalties for misspending intergovernmental revenue go well beyond returning the money. The federal government can pursue administrative, civil, or criminal remedies depending on how serious the violation is.
Administratively, agencies can claw back misspent funds and debar the entity from receiving future federal awards. Civil penalties under the Program Fraud Civil Remedies Act can reach $5,500 per false claim, with assessments up to twice the claim amount. The Civil False Claims Act allows penalties of $5,500 to $11,000 per false claim, plus damages of up to three times the government’s loss. Criminal prosecution under the False Claims Act carries a maximum sentence of five to eight years for knowingly submitting false statements or claims.
Even short of fraud, audit findings that flag noncompliance can trigger repayment demands and heavier scrutiny on every grant that follows. For a small county or city where intergovernmental revenue makes up a third of the budget or more, losing access to federal funding is not a paperwork problem. It’s a threat to basic services.