There’s no such thing as a “free” lunch. Similarly, funds from the Federal government are not “free” either. Strings attached such as matching requirements and maintenance of effort mandates impose steep additional costs on states accepting federal dollars.
These are the key findings of a new academic study authored by Dr. Eric Fruits of Economics International Corp. and published by the Civitas Institute.
The study finds that each dollar of additional federal grants to states is associated with a total increase of 54–86 cents in new state and local taxes. Across states as a group, each dollar of additional federal grants to states is associated with a total increase of 82 cents in new state and local taxes.
In North Carolina, the research shows that each additional dollar of federal intergovernmental transfers to the Tar Heel State is associated with 81 cents in additional state and local taxes and fees.
In short, as North Carolina accepts more federal funds, your state and local taxes rise.
Importantly, these results suggest that the increases in federal grants to state and local governments associated with the ACA’s Medicaid expansion will have significant future tax implications at the state and local level as these governments raise revenue to continue, expand, and promote these newly funded programs into the future and as federal support tapers off once the expansion is in place.
A vast literature has examined the impact of federal grants on state and local spending. Recent academic peer-reviewed research finds a “ratchet” effect in which federal transfers to the states are associated with increased state and local taxes and charges. Research points to several reasons why additional federal funding would lead to greater state and local own-source spending:
- A “flypaper” effect, in which federal funds are accepted as a supplement to, rather than a substitute for state and local taxes and charges.
- A “stimulus” effect in which matching fund and maintenance of effort requirements tied to federal funds require increased spending from state and/or local funds. In addition, matching requirements may stimulate state and local spending by encouraging projects that would not have been undertaken without the matching funds.
The research presented in this report supports these recent published findings. This statistical study is the most comprehensive analysis to date, using information from U.S. states spanning the period from 1972 to 2012, and controlling for state-by-state differences in economic and demographic factors.
The results clearly demonstrate that federal transfers to state and local governments result in higher state and local taxes and fees.
As mentioned above, North Carolina has a ratchet effect similar to states as a group. Statistical analysis controlling for the economic and demographic factors that vary across states and over time indicates that—holding other variables constant— for every additional dollar in federal funds North Carolina receives, state and local taxes and fees increase by 81 cents.
As it turns out, accepting “free” federal money is rather expensive.
In 2012, North Carolina state and local governments received $18.2 billion in federal intergovernmental transfers and spent $57.2 billion raised from state and local sources.
- A hypothetical 10 percent increase in federal transfers to North Carolina would amount to about $1.8 billion more federal money to the state.
- However, the statistical analysis in this study indicates that this would be associated with approximately $1.5 billion more in spending from state and local own sources, or an additional $150 per person in taxes and charges.
Over the last few decades, North Carolina – like most states – has seen its reliance on federal funds increase. For instance, the FY 2015-16 budget estimates roughly $16.2 billion in federal funds, which is nearly three and a half times the $4.7 billion in federal dollars the state received 20 years ago.
As a result, this coming year federal funds will account for 32 percent of the total state budget, up from 26 percent in 1995-96.