Expected Federal Budgetary Cost and Its Predictability
The federal government can achieve different degrees of control over the expected cost and predictability of budgetary expenditures for grant programs by making them either mandatory or discretionary programs and, for mandatory programs, by making their funding either open-ended or limited to a specific amount. Specifically, the total budgetary cost of some intergovernmental grants is determined in advance by the legislation that authorizes certain mandatory programs or appropriates funds for discretionary programs. Such grants have limited total resources, whether funded through authorizing legislation or through annual appropriations, and thereby provide greater certainty than do open-ended grants about the effects of a grant program on the federal budget. That certainty about expenditure levels, however, can limit the ability of the federal government to respond quickly to changing needs in times of economic or fiscal difficulty.
Mandatory Programs. Mandatory programs are generally funded outside of the annual appropriation process through authorizing legislation that may be in effect indefinitely or for a designated period. Funding for some programs, such as Medicaid, is provided on an open-ended basis so that when the conditions described in the authorizing legislation are met, more federal funds flow to recipients of state and local grants and the program grows. In addition, Medicaid gives states some control over the way they implement the program. By one estimate, 60 percent of total Medicaid expenditures in 2007 were for individuals and benefits whose coverage was not required by federal law. [See Brigette Courtot, Emily Lawton, and Samantha Artiga, Medicaid Enrollment and Expenditures by Federal Core Requirements and State Options (Kaiser Commission on Medicaid and the Uninsured, January 2012), www.kff.org/medicaid/upload/ 8239.pdf.] Together with open-ended funding, that makes the federal financial commitment dependent on decisions made by state and federal policymakers.
By contrast, some mandatory programs are funded through grants that limit the amount spent by the federal government to a predetermined level. For instance, in determining funding for CHIP, the federal government sets a maximum amount that it will provide to each state. Each state determines the amount that it will spend and receives a grant that matches that amount up to the limit established by the federal government.
TANF is also a mandatory program, but its funding is provided in the form of block grants, which means that funding is constrained by the size of the grants rather than determined by the number of participants or the benefits they receive. When the TANF block grant program was created in 1996 to replace AFDC, its funding level was set to match the amount that had been provided through AFDC and related programs in the previous year. That basic block grant has remained at the same nominal (current-dollar) funding level each year— $16.5 billion—so its real value has declined over time. Some states have also received supplemental grants in certain years and have had access to contingency funds when faced with an economic need.
Highway grants have mandatory budget authority as well (because it is appropriated by the authorizing legislation for surface transportation programs), but annual appropriation acts generally limit how much of those grants the Department of Transportation can obligate each year. For that reason, almost all outlays for those grants are considered to be discretionary spending. [Congressional Budget Office, The Budget and Economic Outlook: Fiscal Years 2012 to 2022 (January 2012), p. 48, www.cbo.gov/ publication/42905. Federal Influence on Spending by State and Local Governments]
Discretionary Programs. Discretionary grant programs are funded through annual appropriation acts, which limit the total amount that the federal government can provide to state and local governments in a fiscal year. Therefore, those funding levels are limited, as specified in law. Most federal intergovernmental grant programs that are not related to health are classified as discretionary. The CDBG program is an example. In 2012, the Congress appropriated $3 billion for CDBG funding, a decrease of more than $300 million from the previous year. CDBG funds go to state and local governments to pay for projects in neighborhoods with concentrations of low- and moderate-income households. The grants support affordable housing and address other community needs. Title I grants for the education of disadvantaged children and many other education grants also are funded through discretionary appropriations.
In most cases, federal grants finance activities that state and local governments also fund out of their own revenues. Federal grants are typically intended to supplement those governments’ efforts rather than supplant them. To that end, many federal grants include matching requirements or MOE provisions that necessitate some financial contribution by the recipient government. Those requirements can take on very different forms because they are tailored to a wide variety of intergovernmental grant programs. Despite the use of matching and MOE requirements, over time, state and local governments may change their spending decisions because of the funds that they receive from the federal government. However, the effect on state and local government spending of federal grants with such conditions has not been clearly established in the current body of economic literature.
States’ contributions are typically financed with revenues generated by collecting fees, tolls, or taxes on sales, income, or property owned in a given jurisdiction or by borrowing funds through bond issues (which would be paid with future fees, tolls, or taxes). The mix of revenue sources that recipient governments draw upon varies, but successful bond issuances are typically intended to finance long-lived infrastructure projects rather than to pay for current consumption of goods and services through income security or other government programs.
Matching Requirements
State and local governments that receive federal grants with matching requirements must contribute a designated share of the cost of a program from their own resources. Those requirements can help ensure that state and local governments participate financially in programs that have local benefits and that the choices they make when administering grant programs align better with federal interests.
For example, many federally funded highway grants require state or local governments to contribute 20 percent of a project’s cost, with the federal government reimbursing the state or local government for the remaining 80 percent. For Medicaid, the largest inter-governmental grant program, the matching rate varies by state. The rate is determined by a formula based on per capita income, which, in 2012, left states responsible for between 26 percent and 50 percent of most Medicaid expenditures; the federal government contributed the rest. In states that choose to expand Medicaid eligibility under the ACA to nonelderly adults with income below 138 percent of the federal poverty level, the federal government will pay all of the costs of covering enrollees who are newly eligible under the program’s expansion from 2014 to 2016. From 2017 to 2020, the federal share of that spending will decrease gradually to 90 percent.
The effect of matching requirements on the incentives facing state and local governments depends on whether a grant program is open-ended or funded in a set amount and on how much a state is spending. With matching, federal grant programs effectively lower the price of a state’s spending on a given program relative to other items in the state’s budget for as long as the federal government continues to spend on the program. For instance, for every dollar that a state government spends on certain types of highway projects, the federal government contributes $4 to the project, so the state gets $5 worth of funding for each dollar it spends—until it reaches the maximum amount the state is slated to receive. However, when states spend more of their own funds than is required to receive the full federal contribution—which occurs in many states—then the lower price that is the result of the matching requirement no longer applies. The matching requirements for CHIP operate similarly to those for highway projects, although the matching rates differ.
In contrast, federal funding for Medicaid is not limited in the same way that highway funding or CHIP funding is; instead, the federal government shares all eligible state expenditures, although its share varies from state to state. Thus, the open-ended nature of Medicaid grants means that the relative price of state spending for Medicaid is always lower than the relative price of state spending on other programs that do not receive federal matching funds. That difference in relative prices tends to spur states to devote more of their budgets to Medicaid expenditures, to spend less than they would have on other benefits or services that do not receive federal matching, and to shift activities that had been funded entirely by the state into Medicaid.
Matching requirements may be seen as a way to ensure that state and local governments pay for the benefits of a program that accrue locally and that the federal government pays for benefits extending beyond the state or locality. However, matching rates are not systematically linked to the share of benefits that remains in the locality. For example, although many federally funded highway grants require states to contribute 20 percent of a project’s cost, with the federal government funding the remaining 80 percent, the benefits of such a project are not likely to be realized in the same proportions.
Maintenance-of-Effort Requirements
MOE requirements are provisions of law that aim to prevent state and local governments from using federal funds to replace funds that states and localities would otherwise have used to pay for that program. MOE requirements take on a number of different forms, depending on the program. For instance, to receive their full allocation of Title I funds for the education of disadvantaged children each year, a local education agency must have spent on primary and secondary education in the preceding year at least 90 percent of what it spent the year before that from nonfederal sources. Although federal highway grants do not typically include MOE requirements, additional highway funding provided in ARRA was accompanied by a requirement that states spend at least what they had planned to before that legislation was enacted. That provision was meant to ensure that the ARRA highway grants provided additional funding rather than simply replace state spending that had already been planned. In the case of Medicaid, the ACA includes an MOE requirement that calls for states to keep their eligibility criteria unchanged for adults participating in Medicaid until 2014 and for children participating in Medicaid and CHIP until 2019. TANF requires that states spend at least 75 percent of what they spent from state funds in 1994 on AFDC and its other predecessor programs.
Those MOE requirements could be viewed as unfair to states that were already spending their own money to meet a goal that the federal government is promoting through the grant program. Such states would have to continue to make a larger financial contribution to satisfy the MOE requirement than other states that had not already been spending their own money to pursue the federal priority. In addition, to the extent that multiple federal intergovernmental grants have stringent MOE requirements, the cumulative effect of those requirements on a state’s budget may be substantial, constraining
the state’s ability to use its funds in a manner that addresses its own current priorities. Alternatively, such requirements may be considered a way to recognize the differences in states’ willingness or ability to pay to reach a federal goal. Federal grant programs may make exceptions to MOE requirements if state or local governments suffer sudden, severe revenue contractions; for instance, both the Title I and Medicaid programs permit states to appeal for some relief from MOE requirements under certain circumstances.