Final answer:
Fiscal federalism is using federal economic power, through spending, taxation, and borrowing, to influence state policies and shape a coordinated national policy, often through mechanisms like federal highway funds that enforce compliance with national standards.
Step-by-step explanation:
The best definition for fiscal federalism involves the use of federal economic power to influence and coordinate policies across state and local governments. This concept is grounded in the practice of utilizing federal government spending, taxation, and borrowing to shape behavior and legislation at the state level. For example, the national government exercises its power through the allocation of federal highway funds, which not only aids in building a national transportation infrastructure but also impacts state policy by tying these funds to state compliance with federal standards like seat belt usage and DUI laws.
Federalism as a system divides power between the national and state governments, with fiscal federalism representing the economic dimension of this division. Changes in the balance of power between national and state governments have been influenced predominantly through legislation and the allocation of federal finances. Moreover, fiscal policies are instrumental for managing the country's budget and overall economic health, evidenced by federal spending within key areas such as national defense, Social Security, healthcare, and managing interest payments on debt.