The State of Fiscal Aid
The President's FY2011 budget includes $25.5 billion to continue increased federal Medicaid payments to states first included in the American Recovery and Reinvestment Act. The original funds, which will total $87 billion, along with the $54 billion State Fiscal Stabilization Fund were designed to offset deep cuts to state and local government services as revenues plummeted and demand for services skyrocketed.
By all accounts, the money has served its purpose, helping prevent layoffs for hundreds of thousands of teachers and, anecdotally at least, plugging gaps that otherwise would have been eliminated with measures that would have exacerbated pain during a time when the federal government is trying to alleviate it.
The funds were not, however, large enough to deal with state budget deficits. And the new funds, in fact, are a drop in the bucket compared to gaps in state budgets that may reach $180 billion in 2011 plus shortfalls in city budgets of at least $50 billion between now and 2012.
Like the fiscal stabilization funds included in the stimulus package, the new money will likely be funneled directly to states (there are some exceptions, like that of New York where counties help pay the costs of Medicaid). In general, observers suggest that this is just as good for local governments as it is for state governments: budgets are fungible, so a $100 million payment to a state government for Medicaid can generally prevent $100 million of cuts to local school districts or $100 million of cuts in state aid to cities. The stimulus package curbed this fungibility slightly by including maintenance of effort requirements- for example, that states could not make eligibility requirements for Medicaid stricter than they were prior to a specified date, thus preventing a state from receiving a federal reward for cutting services.
Though funneling fiscal stabilization funds through state governments does generally benefit local governments, such assistance is a blunt tool. Certainly, it is easier and probably faster for the federal government to send (and then to track) money to 50 state governments rather than to the 80,000 or so localities in the United States. Plus, increased funding for Medicaid like that in the stimulus package is pretty good at targeting the states in the worst fiscal shape.
But funneling money only through state governments creates a political problem for localities, especially larger cities that rely on state governments for significant aid. Such aid permits state governments to hold city governments hostage, essentially requiring them to formulate budget requests that emphasize the worst cuts they could possibly make - firings of teachers, police, and firefighters - in order to demonstrate to state governments how much they need state assistance. Realistic budgeting this is not. Direct federal assistance would free cities and localities to use, as the popular saying now goes, a scalpel rather than a hatchet.
More significantly, states do not always pass federal assistance on equitably or efficiently or, sometimes, at all. State priorities, far from the federal government's goal of economic stabilization, lie in simply balancing the budget. State legislatures might do so in any number of ways that disadvantages cities, perhaps using savings from the federal government's Medicaid allocation to save jobs at the state level while cutting aid to cities and localities. This "pass-the-buck" phenomenon means that cities - as the lowest rung on the governance ladder - might end up lagging behind states and even the national economy with budget deficits lingering as property values and, in consequence, property tax revenues remain depressed.
Funds for state and local fiscal stabilization do not quite constitute government investment, though they might prevent cuts to investment, such as spending on infrastructure. However, targeting funds strategically to both states and cities could alleviate the budget pressures that both are now experiencing while preventing either from dragging down a recovery.