The Rehabilitation Act, as amended, sets out a formula for distributing VR grants to states and territories. Through this formula, a portion of the funds appropriated for the VR program are distributed to states based upon the grant allotment they received for fiscal year 1978. States’ 1978 allotments served to ensure that no state experienced a funding decrease when the formula was revised through a 1978 amendment to the Rehabilitation Act. Of the remainder of the funds, one-half is distributed based upon states’ general population and a factor that compares their per capita income to the national per capita income, and the other one-half, according to their population and the square of the per capita income factor. The larger a state’s population, the more funds it will receive. Conversely, the higher a state’s per capita income compared to the national level, the lower its allotment will be. The squaring of per capita income increases its influence on a state’s allotment. However, the formula mitigates the effect of per capita income for states with very high or very low per capita income levels by setting upper and lower limits. Ultimately, the final allotment for a state cannot be less than 1/3 of 1 percent of the total amount appropriated, or $3 million dollars, whichever is greater. In fiscal year 2008, the minimum allotment was $9.5 million, and 6 states were allotted this amount. See appendix II for further information on the funding formula. The Act requires states to share in funding the costs of the VR program. Specifically, the Act sets the federal share for the funding of a state’s VR program at 78.7 percent. As a result, in order to receive their full federal allotment, each state must contribute at least 21.3 percent of the funds for their VR programs. In cases where states do not meet this matching requirement, the unmatched federal funds are redistributed to other states near the end of the fiscal year. The Act also calls for annual funding increases to the VR program, overall, to be minimally pegged to the increase in the Consumer Price Index for All Urban Consumers (CPI-U). However, funding changes for an individual state may differ from the change to the CPI-U in any given year because state allocations are, ultimately, determined by the funding formula. In redistributing the funds, Education currently gives priority to those states that did not receive an inflation-adjusted increase over their prior year’s allotment. Under the VR program, state VR agencies are to provide vocational rehabilitation services for individuals with disabilities—consistent with the individual’s strengths, resources, priorities, abilities, interests, and informed choice—so that they may prepare for and engage in gainful employment. To do so, state agencies provide a variety of services to individuals such as job placement assistance, medical treatment, postsecondary education, occupational training, and assistive technologies. Individuals may be eligible for VR services if they have a physical or mental impairment that constitutes or results in a substantial impediment to employment, and if they need VR services to prepare for, secure, retain, or regain employment. According to the Rehabilitation Act, if state VR agencies determine that they will not have enough funding to serve all eligible individuals who apply for services, they may state the order in which they will select individuals for services. Agencies using such an “order of selection” process must develop criteria for ensuring that individuals with the most significant disabilities will be selected first for services. The current VR funding formula does not include factors for rewarding agency performance; however, pursuant to the Rehabilitation Act, Education evaluates state VR agencies’ performance using a set of performance indicators. These indicators are designed to assess how well the agencies are helping individuals obtain, maintain, or regain high- quality employment and, also, how well they are ensuring that individuals from minority backgrounds have equal access to VR services. The Rehabilitation Act gives Education the authority to reduce or suspend payments to a state agency whose performance falls below a certain level and fails to enter into a program improvement plan or to substantially comply with the terms and conditions of such a plan. The VR funding formula does not achieve equity for beneficiaries—the individuals likely to be served by the VR program—for two reasons. First, it does not recognize differences among states in the size of their populations potentially needing VR services. Second, it does not account for state differences in the costs of providing those services. By targeting funds based on a state’s general population, the formula assumes that the proportion of people needing services is largely the same from state to state. In fact, as shown in figure 1, the proportion of the general population that is working-aged and has a disability varies across states, from 5.6 percent (in New Jersey) to 12.8 percent (in West Virginia) in 2007. See appendix III for information on disability rates in each state. In effect, the formula treats alike any two states with similar population sizes, irrespective of the size of their working-aged disability population. For example, New Mexico has a slightly greater population than West Virginia (2.0 million and 1.8 million, respectively), and, therefore, would receive more funding under the current formula (all other things being equal) than West Virginia. However, working-aged people with disabilities comprise nearly 13 percent of West Virginia’s population, compared to 8.7 percent in New Mexico. By not factoring in state disability populations, the formula does not account for West Virginia having over 60,000 more working-aged people with disabilities than New Mexico. Education officials and one expert we spoke with speculated that the formula’s use of per capita income might serve to target funds to states with higher rates of disability since people with disabilities have, on average, lower incomes. We found some correlation between states’ disability rates and their per capita income. As such, per capita income is, at best, an imprecise measure of states’ disability rates. The funding formula also fails to account for differences among states in the cost of providing VR services. Focusing on average wages and rents in each state, we estimated that the cost is 13 percent below the national average in Idaho, for example, while it is 13 percent above average in Massachusetts. This means that Massachusetts would need to pay $1.13 for the same set of services that Idaho could purchase for $0.87. By not taking into account cost differences, VR allocations purchase fewer services in states that have higher costs. See appendix IV for a table of our estimates of state cost differences. Also, see appendix I for information on how we estimated state service costs. Not accounting for state differences in both disability populations and cost of services results in a substantial variation in the amount of services that states are able to purchase per person with a disability, from a low of $83 in Connecticut, to a high of over three times as much—$277 in North Dakota. Figure 2 shows estimated state VR allotments, per working-aged person with a disability, based on fiscal year 2008 funding, adjusted for differences in costs of wages and rents between states. See appendix V for a state-by-state listing of VR grant allocations and cost-adjusted allotments per person with a disability. While proper measures of need and cost are important for both beneficiary and taxpayer equity, the VR funding formula lacks equity for state taxpayers, in particular, because its measure of a state’s ability to contribute to the VR program is limited to per capita income and does not include all potentially taxable resources. Per capita income is based on the personal income in a state, including income received by state residents in the form of wages, rents, and interest income. However, using only this measure excludes certain categories of corporate income that are not received as income by state residents. For example, the formula does not factor in corporate income that is retained by corporations for investment purposes, which could theoretically be subject to state taxation through corporate income taxes. The formula also excludes business income received by out-of-state residents, such as dividends, that are potentially taxable by the state. Although states may differ in their decisions about whether to tax these resources, the measure used in a funding formula to compare states’ ability to finance a program should capture all possible revenue resources and should not be affected by an individual state’s fiscal decisions. Treasury’s Total Taxable Resources provides more comprehensive data on the amount of resources that are potentially taxable in each state. Comparing states’ per capita income with their total taxable resources shows that, for most states, the two measures are similar. However, the formula’s use of per capita income particularly understates the taxable resources in certain states and overstates it in others (see figure 3). For example, the ratio of per capita income to total taxable resources per capita is 0.80 in Alaska, which suggests that the use of per capita income in the formula understates Alaska’s taxable resources by 20 percent. The formula’s use of per capita income especially understates the taxable resources in energy-exporting states, such as Alaska and Wyoming, and in states with numerous corporate headquarters, such as Delaware. The lack of precision in using per capita income is accentuated by the squaring of the per capita income factor in the formula. See appendix VI for a comparison of per capita income and total taxable resources in each state. Also, see appendix I for a more detailed explanation of our analyses of per capita income and total taxable resources data and appendix II for a detailed explanation of the current formula. In fiscal year 2008, 27 percent of federal VR funds were distributed to states based upon the amount of funds they received for fiscal year 1978. This provision of the formula served a purpose when the formula was last revised, in 1978, to ensure that no state experienced a funding decrease. However, most disability experts we spoke with considered this provision outdated and no longer an appropriate factor for distributing VR funds.