Policy Position

Federal Aid Dependency

in Budget, Taxation, and the Economy

Introduction

Federal funds are tempting, but they create risks for states.  North Carolina is no exception.

First, they leave the state and those who rely on the federally funded programs vulnerable to a federal government shutdown (such as the one in 2013), sequestration and other policy decisions to reduce spending, and other changes in the ability or willingness of Washington to spend.

Second, federal funds remove state authority to set related policies, including sex-segregated bathrooms in public schools, health insurance mandates, the organization of sports teams in universities, and social program reforms.  Federal regulators have final approval of what would otherwise be state and local decisions.

Third, and most importantly, federal funds distort decisions as budget writers and agencies focus on the money instead of the need.  Questions about outcomes go unasked or unanswered if the program substitutes federal money for state appropriations.

As such, local and state officials need to have a better understanding of how much federal money comes into the state and how it is used to pay for personnel, services, programs, and infrastructure.  Only then can they evaluate the costs, benefits, and risks of taking what appears to be “free” money from the federal government.

Obviously, it is not “free money” and should not be treated as such.

In fact, every tax dollar Washington sends to North Carolina is a dollar taken from taxpayers in North Carolina and the other states.  Economists have found that federal subsidies to the states lead to higher state taxes and spending in the long run because the federal “seed money” creates a demand for more government with current and future commitments.  One dollar of federal funding in a state leads to an additional 40 cents in state spending.  That hardly qualifies as free.

Key Facts

  • North Carolina received $20.7 billion from 3,903 federal grants during Fiscal Year 2016-17.  Nearly 80 percent of those funds were in just five areas: Medicaid, food assistance (SNAP and school lunches), student financial aid, transportation, and public schools.  Federal grants reached a peak of $24.8 billion in 2011, an increase from $15 billion in 2008.  This was largely due to expanded unemployment insurance and Medicaid payments, which have since been shrinking slowly.
  • North Carolina received $20.7 billion in federal funds in FY 2016-17, including $17.2 billion in the state budget.
  • Nearly half of federal funds to North Carolina ($9.1 billion) went to Medicaid in FY 2016-17. The next four largest categories (food assistance, financial aid, transportation, and K-12 schools) received $6.6 billion.  All other categories received $4.5 billion.
  • Medicaid spending has continued to rise, and state agencies are looking for ways to save state appropriations by maximizing federal receipts. The legislature’s refusal to expand Medicaid is a step in the right direction.  The decision has made the state less dependent on the federal government.

Recommendations

  1. Limit total spending growth, including federal funds, to no more than the combined rate of population growth and inflation. During the state budget process, budget writers should also establish a process for making a revenue estimate of the amount of federal funds that the state expects to receive.
  2. Review new and existing federal grants to ensure that the funds are used in an efficient and productive way. Many state and local decisions are made simply to use federal money that is available.
  3. Prepare for future reductions in federal funds. Programs that depend on federal funding should begin planning now for the probable loss of federal support due to economic downturns, political changes, and the inevitable increase in Social Security, Medicare, and entitlement program spending.

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