The Effects of State Fiscal Relief

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I. INTRODUCTION

One important component of American Recovery and Reinvestment Act (ARRA) is state fiscal relief. Through August 28, $38.4 billion had gone to states in the form of fiscal relief, with most of that total ($28.1 billion) coming through a higher Federal share of Medicaid spending. As Table 1 shows, state fiscal relief constituted a crucial portion of the early part of the stimulus – nearly two-thirds of the spending and a quarter of total ARRA stimulus (that is outlays plus tax cuts) through the second quarter of 2009 came in the form of state fiscal relief. 1

Table 1: Total ARRA spending and tax relief by category

State budget relief was especially important because states, which normally must end the year with a balanced budget,2 experienced budget gaps of up to 20 percent of their general funds at some point during the 2009 fiscal year. 3 In response to these gaps, states were already raising taxes and reducing spending by the time the ARRA was passed. These actions not only placed further burdens on families already suffering from the recession and cut important services, but also directly contributed to the worsening of the downturn. The aid to states appears to have helped prevent large tax increases and cuts to government social programs and services that otherwise would have taken place.

All states have received substantial support. The ARRA was designed to provide greater support for states hit harder by the recession. For example, it further increased the Federal component of Medicaid spending in states that have experienced especially large increases in unemployment. Moreover, because Medicaid is a means-tested program, an increase in Medicaid funding naturally provides more funds to states where more workers are unemployed. 4 And indeed, fiscal relief per capita has on average been greater in states that had higher unemployment rates at the time the Act was passed.

Since there is ample evidence that increases in government spending and reductions in taxes help slow economic downturns, there is every reason to think that the state fiscal relief has been one force helping to move the economy from recession to recovery. But, we have little direct evidence that specifically concerns the economic effects of state fiscal relief. For example, there has been little research concerning the macroeconomic effects of the 1972 State and Local Fiscal Assistance Act or the $20 billion state fiscal relief package in 2003. In this report, we therefore look at the effects of state fiscal relief in more detail.

Simply asking whether states that have received more ARRA funds have generally performed better has an obvious problem: on average, states that were "sicker" may have received more "medicine." For example, the ARRA further increased the Federal component of Medicaid spending in states that have experienced especially large increases in unemployment. Moreover, because Medicaid is a means-tested program, during recessions states that lose the largest number of jobs tend to see a relative increase in the number of their residents eligible for Medicaid. These states would therefore tend to receive more funds from the Federal government. Thus, a finding that states that had received more ARRA funding had greater economic problems would not be evidence that fiscal relief causes economic problems; it would just be evidence that the relief was well targeted.

This report describes how it is possible to mitigate this problem by focusing on a part of the Medicaid relief to states which resulted from decisions prior to the recession. We then describe the institutional details of the Federal Medicaid funding. Finally, we present results for the relationship between employment changes and state fiscal relief and suggest that government-related employment and spending may explain part of this relationship.

1. See U.S. Recovery Accountability and Transparency Board (2009).
2. See National Governors Association and National Association of State Budget Officers (2008) for a discussion of the exact balanced budget requirements.
3. See National Conference of State Legislatures (2009a).
4. A possible effect operating in the opposite direction is that states with larger economic declines could decrease Medicaid generosity to balance their budgets. To ensure that this did not occur, the ARRA specifically mandated that eligibility standards not be tightened, so distressed states could not alter their eligibility rules and still receive ARRA funding.

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