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In Thrall to D.C.

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In Thrall to D.C.

The pandemic has worsened states’ dependence on federal largesse. Autumn 2021
Economy, finance, and budgets
Politics and law

Washington, D.C.’s Covid-era extravagance risks deepening a malign long-term trend: the federal government’s escalating presence in state budgets. Excessive federal involvement in state finances is an overlooked cost of the pandemic that undermines federalism and corrodes the political and financial structures of the American system.

Washington has long provided direct funding to state and local governments, but its backing expanded considerably over the past year and a half. While the federal decision to buttress many sectors of the economy—including state and local governments—may have been prudent during the early, uncertain days of the pandemic, the large outflow of federal dollars to states has proved excessive, especially as state budgets have generally outperformed initial expectations.

Yet new “relief” packages keep getting drafted. President Biden’s fiscal 2022 budget accelerates the outflow of federal dollars, boasting $1.1 trillion in federal grants and other outlays to states, local governments, tribal entities, and territories. That’s an increase of 6.9 percent from the estimated $1 trillion in fiscal 2021—itself a whopping 25.4 percent increase over the $829 billion in fiscal 2020.

The trend predates the pandemic. Over the last few decades, all states—with two or three exceptions—have become increasingly reliant on federal funds. According to National Association of State Budget Officers (NASBO) figures, federal dollars constituted just under one-third of all state expenditures in 2020. That’s a considerable increase from 1991, when the share was 23.7 percent. Given the massive rise in federal outlays to states proposed in Biden’s budget, this figure may climb as high as 40 percent in fiscal 2022, assuming that total state expenditures grow at historical rates.

Not all states rely equally on federal largesse. Thirteen saw the federal share of their total expenditures rise by more than 10 percentage points between 1991 and 2019; another eight joined this group in 2020. New Mexico (18.4), Florida (17.1), Alaska (15.6), and Montana (15.1) led the pack in 2019. Despite this tremendous growth, Florida and Alaska have managed to remain below the top ten states most reliant on the federal government. New Mexico (41.1 percent) and Montana (40.3 percent) persistently rank among the most dependent on federal dollars (though Montana’s very small budget likely explains much of this), alongside Arizona, Indiana, Louisiana, and Mississippi—each depending on Washington to cover at least 40 percent of their expenditures.

Medicaid makes up the largest share of federal outflows to states. Medicaid spending peaked at 58 percent in 2019 before falling to 55.3 percent in 2020, given new Covid-related spending. Indeed, federal Medicaid dollars grew by more than 500 percent over the past three decades, reaching $405 billion in 2020, from just $61 billion in 1992. For perspective, this increase equals the entirety of federal dollars given to states in 2004. The increase in Medicaid’s share occurred despite nearly all categories of federally funded expenditures expanding by two to five times over this period.

After Medicaid, approximately 20 percent of federal dollars goes to a mixture of programs, including children’s health insurance, unemployment insurance, public health, child-welfare programs, and others that are lumped together in NASBO’s data set. An additional 12 percent supports K–12 and higher education. Both these categories have grown more than 300 percent in nominal dollar terms since the early 1990s.

A “let no crisis go to waste” attitude drives the intrusion of federal dollars into state budgets. The ratio of federal dollars to state spending tends to rise in fits and starts, with large increases occurring during or shortly after recessions. Accelerated growth in federal dollars offsets recessionary weakness in state revenue, pushing the overall share of federal dollars upward. The ratio tends to fall as the recession fades but never declines to its previous level, maintaining a new plateau that tends to be slightly lower than the recessionary peak but higher than the previous plateau.

This time, the federal role may not shrink at all. In contrast to previous recessions, state revenue remained relatively stable throughout the coronavirus recession. In previous downturns, the spike in the ratio owed to both weakness in state revenue and an increase in federal support; this time, it owed almost exclusively to the latter.

A decline in the ratio probably won’t come from a large increase in state revenue—meaning that if the share of federal dollars in state budgets is to shrink meaningfully, the federal government must pull back. That appears unlikely. As Biden’s budget proposal notes, “Since much of this budget authority [for federal aid to states and local government] will outlay in future fiscal years, the increase in outlays in 2022 is considerably smaller and then will increase over the next couple of years.” The administration’s propensity to splurge will only worsen this dynamic.

The costs to the nation and the taxpayer of such spending are obvious, but the ramifications for states themselves often go overlooked. Some see states as beneficiaries of such a relationship: Why would governors and state legislatures reject free money? But federal dollars have become an irresistible temptation for states, deepening the patron-client relationship. With each recession, states depend more on Washington. Those dollars are easy to come by in a crisis and too hard to relinquish once the trouble subsides.

The arrangement undermines federalism, vitiating the principle of state control. Indeed, the precise purpose of many of these federal grant programs is to encourage states to expand government by entering new policy areas—a trend that began in earnest in the 1960s, when the federal government sought to implement policies that it was constitutionally unable to enact itself. Washington has effectively altered local priorities by offering financial sweeteners.

This dependency reduces policy innovation and experimentation, creating a stale uniformity likely to show its brittleness in new circumstances. Policy competition among states encourages the development of successful ideas by allowing states to learn from others’ experiences. It also helps residents understand the differences among policy environments and allows them to choose according to their preferences—either at the voting booth or by migrating to other states.

Policy standardization also deepens partisan conflict by nationalizing policy matters. When local needs can be met only by the federal government, state and local policies become subject to the whims of whichever party controls Congress or the White House. States are left exposed to the uncertainty of national political winds, raising the stakes of a national politics already marked by polarization and an unhealthy media environment. States can no longer be disinterested neighbors but must resort to combat to determine who controls the levers of power in Washington. This trend distracts from important policy needs and contributes to a fractious political culture.

Reducing the federal role in state budgeting would be a positive step toward reaffirming state prerogatives in a federalist system. Less reliance on federal dollars would promote a healthier policy ecosystem in which states can account for local circumstances in policymaking. If the federalizing trend continues to expand, however, it will count as another hidden cost of Covid.

Photo: Greg Meland/iStock

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