Intergovernmental revenue is money that moves from one level of government to another: federal dollars sent to states, state dollars sent to counties and cities, and smaller flows between local jurisdictions. It funds services the receiving government could not easily pay for on its own, and in fiscal year 2022 the federal government alone sent roughly $1.26 trillion in grants to state and local governments. Medicaid, highway construction, school operations, and wastewater treatment all run largely on this kind of money.
The Main Forms It Takes
Most intergovernmental money moves through grants, but how tightly the grantor controls the spending depends on the grant type. A few other mechanisms, like formula-based revenue sharing and payments for tax-exempt federal land, round out the picture.
Categorical Grants
Categorical grants restrict funding to a narrow, specific use. A federal categorical grant might pay for one highway segment or deliver nutrition assistance through the Special Supplemental Nutrition Program for Women, Infants, and Children (WIC). Because the grantor dictates exactly how the money is spent, these grants are the tightest leash a higher government can put on a lower one. They often require the recipient to cover part of the project cost; the Department of Transportation structures most of its programs around cost-sharing, where a stated 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 hand money over for a broad functional area and let the recipient decide how to allocate it inside that category. Temporary Assistance for Needy Families (TANF) is the familiar example: the federal government provides funding for anti-poverty efforts, and states set their own eligibility rules and spending priorities within federal parameters. The flexibility cuts administrative overhead and lets local officials shape programs to local conditions, at the cost of less federal control over outcomes.
Shared Revenues
Some intergovernmental money moves through formula-driven revenue sharing rather than competitive grants. A state might collect a statewide sales tax and return a share 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 weighing 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 still anchors state-to-local transfers for schools and transportation.
Payments in Lieu of Taxes
When the federal government owns large tracts of land inside a county’s borders, that land is exempt from local property taxes. The Payments in Lieu of Taxes (PILT) program, administered by the Department of the Interior, compensates counties for the lost tax base. Eligible lands include those managed by the Bureau of Land Management, National Park Service, U.S. Fish and Wildlife Service, and the U.S. Forest Service. In fiscal year 2025, PILT distributed roughly $644.8 million to more than 1,900 counties across 49 states. Payments are calculated using 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. Federal highway funding is the other major channel, carried mostly by categorical grants that support interstate construction and maintenance.
States then act as intermediaries. They pass federal dollars down to counties, cities, school districts, and special districts, and they also distribute their own tax revenue to localities. For most local governments, state transfers for public education are the largest source of non-tax revenue. The state collects income or sales taxes, runs the money through a funding formula, and sends it to school districts based on enrollment, local property wealth, or both.
Money flowing from local governments upward is minimal. When it happens, it usually involves service agreements rather than broad revenue sharing. A city might pay a county to house its inmates, or neighboring jurisdictions might split the cost of a shared emergency dispatch center. Those arrangements look more like contracts than grants.
How Governments Get Federal Funds
Receiving federal grant money is not automatic. A government has to register before it can apply, and the registration itself takes time.
The first step is SAM.gov, the federal government’s System for Award Management. Registration is free and produces a Unique Entity Identifier (UEI), which every federal award application requires. The process asks for detailed information about the entity and can take up to 10 business days to become active. Registrations must be renewed every 365 days.4SAM.gov. Entity Registration
Once registered, applicants use Grants.gov to find and apply for specific opportunities. An application will not go through if the organization’s SAM.gov registration has lapsed.5Grants.gov. Quick Start Guide for Applicants Formula-based transfers like Medicaid payments and highway funds follow different distribution channels, but competitive project grants almost always run through this system.
Accounting Treatment
Governments that receive intergovernmental funds track them using fund accounting, a system that separates financial resources into pools based on purpose. Intergovernmental revenues with spending restrictions typically go into special revenue funds, walled off from the general operating budget. A federal grant for road maintenance and a state grant for school lunches each sit in their own fund, so an auditor can verify the money went where it was supposed to.
The Governmental Accounting Standards Board (GASB) sets the rules. Under GASB Statement No. 33, grants are classified as nonexchange transactions because the recipient receives resources without providing equal value in return. Revenue cannot be booked the moment it is promised. It is recognized only after all eligibility requirements are met, including qualifying characteristics, time restrictions on when the money can be used, and any conditions the grantor attached. A grant received early for next fiscal year’s work is reported as deferred revenue until that year begins.6Governmental Accounting Standards Board. Summary – Statement No. 33 Financial statements must disclose the source and amount of every intergovernmental revenue received.
The Strings Attached
Spending intergovernmental revenue comes with rules, and the tighter the grant type, the heavier the compliance burden.
Spending Rules and Period of Performance
Categorical grants demand strict adherence to the grantor’s rules about what counts as an eligible expense. Every dollar has to be documented and tied to the approved program. Block grants give more room, but the spending still has to fall inside the broad functional area the grant covers.
Federal grants also carry a defined period of performance, the window between the award’s start date and end date during which the recipient can incur new obligations.7eCFR. 2 CFR 200.1 – Definitions Spending outside that window is generally unallowable, even if money is still sitting in the account. Fall behind on a project, and unspent funds can be lost when the performance period closes.
The Single Audit Threshold
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, conducted under the Uniform Guidance at 2 CFR Part 200, examines financial integrity and compliance with each federal program’s specific rules. Entities below the $1,000,000 threshold are exempt from the federal audit requirement, but records must remain available for review by the federal agency, any pass-through entity, and the Government Accountability Office.8eCFR. 2 CFR 200.501 – Audit Requirements
Maintenance of Effort
Many federal programs include a maintenance of effort (MOE) requirement that prevents governments from swapping their own dollars out for federal money. An MOE provision requires the recipient to keep spending at least a baseline amount of its own funds on the program as a condition of continued eligibility. Under federal education programs, for example, 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.9eCFR. 34 CFR 299.5 – What Maintenance of Effort Requirements Apply to ESEA Programs Falling below the threshold can mean reduced funding or a requirement to repay what was received.
What Happens If Funds Are Misused
Penalties for misspending intergovernmental revenue go well beyond returning the money. Federal agencies can recover misspent funds administratively and debar the entity from future federal awards. Civil penalties are available under the Program Fraud Civil Remedies Act and the Civil False Claims Act, with per-claim penalties and damages up to three times what the government lost. Criminal prosecution under the False Claims Act carries a maximum sentence of five to eight years of imprisonment for knowingly submitting false statements or claims. Even noncompliance short of fraud can trigger repayment demands and tighter scrutiny on every future grant, which is a serious problem for a small city or county that depends on intergovernmental revenue for a third or more of its budget.