New Report Reveals Level of Federal Aid to the States and Importance of Fiscal Federalism

By: William Freeland, Kati Siconolfi, and Steven Johnson

In the face of a stagnating economy and national debt topping $17 trillion, many policymakers in Washington, D.C. are seeking ways to reduce spending. Given that many states increasingly rely on federal spending to craft their state budgets, the necessary federal spending reductions could pose a serious fiscal threat to states that fail to prepare. What’s more, those federal funds come with serious strings attached, which often hamper state autonomy and effectiveness in policymaking. A recent report from State Budget Solutions based on Census data reveals that on the whole, states received 31.6 percent of their total revenue from the federal government in 2012.

The report shows that Mississippi is the most dependent (in percentage terms) on revenue from the federal government, with just over 45 percent of their budget coming from Washington DC. On the other hand, Alaska has the lowest percentage of funds coming from the federal government, at 19.97 percent. State Budget Solutions has a great interactive map seen below,




Despite states receiving an unsustainable amount of funds from Washington, state reliance on federal funds actually fell from 2011 to 2012. The percentage of federal funds in state budgets had been on the increase, largely due to the American Recovery and Reinvestment Act (ARRA, or the “stimulus” bill). A report by the U.S. Census Bureau shows that in 2007, states received more than $407 billion in federal grants. By 2011, that number had risen to over $575 billion. But with the stimulus funds beginning to dry up, federal funding of states dropped to $514.2 billion in 2012. This drop represents the first year-to-year decrease in federal grants to states since 1992.

As the temporary funding from ARRA continues to dissipate, states will have to change the way they spend. Unfortunately, the costly strings attached to the federal funds, like the burdensome “maintenance of effort” requirements, will last far longer than the federal support. As policymakers in Washington D.C. face increasing pressure to reduce spending in order to keep public debt from skyrocketing, federal cutbacks seem inevitable.  Despite this reality, very few states have taken significant action to prepare for the fiscal shortfalls ahead.

To make matters worse, these federal funds hardly ever come with no-strings-attached. Federal money promotes federal interests over state interests and it can be a dangerous temptation for lawmakers to become overly dependent on these funds. A historical example of this is the 55 mph speed limit imposed between 1974 and 1995. States were denied transportation funding unless they complied with this one-size-fits-all policy.

Federal funds going towards public works projects are also subject to Davis-Bacon Act restrictions, which require employees to be paid at the “local prevailing wage”. These prevailing wages unnecessarily drive up costs on projects far above what they would be if the market wage was paid for comparable work. A report from the Cato Institute shows that the costs of projects under the Federal Highway Trust Fund were as much as 38% higher due to these restrictions. One of the beautiful things about our federalist form of government is that states can implement the policies that best meet their particular needs. But for federalism to truly breed competitive governance, legislators need the flexibility to make good decisions, and that means not being tied down by federal restrictions.

The State Budget Solutions report “How States Should Respond to Risk of Reduction of Federal Funds” points to Utah as a state that has led the way in preparing for eventual federal cutbacks. ALEC’s Tax and Fiscal Policy Task Force has developed policy that is modeled after Utah’s financial readiness program. It can be viewed, here and here.

The difficult work of crafting responsible fiscal policy is best done before it is absolutely necessary. Forward-looking legislators can follow Utah’s example and prepare for future federal cuts. Additionally, reducing the amount of federal money used in state budgets can lead to the freedom needed to govern effectively and with great fiscal stability. Fiscal federalism has never been more important for budget stability and promoting state interests.

In Depth: Federalism

Genuine accountability to hardworking taxpayers results when state and local legislators work with members of the community to determine a plan of action that is right for each individual state, city or town. Real solutions to America’s challenges can be found in the states – America’s fifty laboratories of democracy…

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