States Grow More Dependent on Federal Funds

More than five years ago I warned about how the states are growing dangerously dependent on money from the federal government:

These state–federal joint ventures create a number of problems. They make it difficult for voters to hold the President, Senators, Representatives, state legisla­tors, and governors accountable. If New York spends more on Medicaid, is that because New York voters demanded that their state government expand Medic­aid or because the voters gave the federal government a mandate to expand the program nationwide? If New York voters want to restrain state spending, should they turn to Albany or Washington? Blurred responsibilities between states and the federal government also make it easier for lawmak­ers to sneak government-growing bills in under the voters’ radar.

Since then, a lot has happened. We have been through a very tough, protracted recession that has taken a toll on government budgets. In response to the recession, Congress passed the American Recovery and Reinvestment Act (ARRA), in part to replace shrinking state tax revenues.

There is a lot to be said about the macroeconomic errors associated with the ARRA. From a state viewpoint, though, the greatest problem is that the bill contributed to their dependency on the federal government. In other words, as we crawl out of the recession the problem with state fiscal independence that I pointed to almost six years ago is even more acute today.

According to the 2013 State Expenditure Report from the National Association of State Budget Officers, the 50 states took $516.2 billion from the federal government in 2012, a full 9-percent drop from the all-time-high $567.5 billion in 2011.

It is a very rare phenomenon that states reduce their consumption of federal funds. In this case it is easily attributable to the end of the temporary increase that came with the ARRA. But that does not mean that the dependency on federal funds has reached a turning point: in 2013 states received an estimated $528.1 billion, a 2.3-percent uptick from 2012.

This increase is more important than it may at first seem to be. The estimated amount for 2013 is very close to what it would have been if during the recession Federal Aid to States had increased at its historic pace of approximately six percent per year. In other words, as we slowly exit the Great Recession the federal government continues to grow its state-bound spending at the same pace as it did in the years between the Millennium Recession in 2000-2002 and the outbreak of the Great Recession in 2009.

It is noteworthy that this means the federal government has continued to increase spending lavishly in one of its most important spending programs. But more important is the fact that this steady growth in cash from Uncle Sam has further eroded the fiscal independence of state governments:

• In 2008 states got 26.3 percent of their total funds from Federal Aid to States;
• In 2010 that dependency had increased dramatically to 34.8 percent;
• In 2013 Federal Aid to States constitute an estimated 30.9 percent of state funds.

Despite the end of ARRA funds, states are clearly more dependent on the federal government now than they were in 2008. (The dependency rate for Wyoming in 2013 is an estimated 27.3 percent, ostensibly a state record. A later blog will analyze Wyoming specifically and what lies behind this number.) One reason for this is actually in itself a piece of good news: from 2008 to 2013 the part of their spending that the states pay for themselves has grown at a historic low of 1.6 percent per year.

In fact, 10 states actually spent less of their own funds in 2013 than in 2008. The three most thrifty were Georgia (-5.5 percent per year on average), Vermont (-3.7 percent) and Nevada (-3.1 percent). By contrast, the three states with the fastest average in-state funded spending growth were North Dakota (16.9 percent per year on average), Illinois (9.6 percent) and Wyoming (7.9 percent).

We should, again, keep in mind that the numbers for 2013 are estimates and could change as NASBO processes final data for the year during 2014. However, NASBO’s estimates usually do not fall far from actual data. Therefore, the message of growing federal dependency among states is worth taking seriously.