Study: Turns Out Federal Money Isn't Free Money For North Dakota

The North Dakota Policy Council, in partnership with Columbia Economics, has released a study about the impact of federal grants on state spending. Not surprisingly, it turns out that federal money isn’t free money. Not only does it cost us all as federal tax payers, but by accepting the money the state ends up inflating state-level spending and taxes.

From the summary of the study:

Based on a standard econometric model and a 30-year panel data set of federal grants and state taxes, a study finds strong evidence that federal grants-in-aid result in significant upward “ratcheting” of state taxes over time.

The study found that each dollar of federal aid leads states to boost spending by about 45 cents in that year, 61 percent of which results in permanent state budget obligations that must be financed by higher state-local taxes.

In addition to the hidden budgetary costs of federal grants-in-aid, accompanying grant rules and regulations can have a significant effect on the ability of states to maintain local political control over key areas of state and local policy. …

The study predicts that each $1 of federal grants increases state taxes between $0.221 and $0.274 in the long run, primarily state personal and corporate income taxes and general sales taxes.

In North Dakota, federal grants amounted to $2.17 billion in 2010, more than one-third of total state and local expenditures. At over $3,200 in federal aid per resident.

Today, North Dakota ranks as the 6th highest recipient of federal grants in the nation.

The traditional view among state lawmakers is that federal grants represent a “free lunch” from Washington. Federal aid allows states to expand popular government programs without relying on local tax revenue—an institutional arrangement that yields benefits both to state residents and local lawmakers. However, a growing number of economists have begun questioning the conventional view that federal aid represent a simple transfer of resources from Washington.

Specifically, accepting federal funds have put a lot of upward pressure on state taxes:

We find federal aid to North Dakota led to indirect state tax increases of between $128 and $1,181 per capita per year between 1995 and 2010, with an average annual tax increase of between $375 and $711 per person per year. Over the 16-year period, this amounts to an effective state tax increase of between 6.5 percent and 31.8 percent compared to a baseline of no federal grants, with a mean tax increase of 19.2 percent. Similarly, we find federal aid increased North Dakota’s own-source revenue by between 6.5 percent and 24.8 percent, with a mean upward “ratcheting” of 15.6 percent.

There’s no such thing as a free lunch.

Recently, in defending his decision to slip the Obamacare expansion of the state Medicaid program into his executive budget, Governor Jack Dalrymple described the funds come “at no cost to us.” But clearly there is a cost to us, both in terms of federal taxes and state taxes.

This is an important fact to note as the state Senate considers this week voting to approve the expansion of Medicaid. It’s a 45% expansion of the existing program, adding tens of thousands of new participants, and the House’s justification for passing the expansion was that they attached a sunset clause to it so that if the feds pull their funding the law would go away.

But let’s not kid ourselves. The legislature isn’t going to end the expansion, kicking tens of thousands of people off the program, if the feds pull the funding. Which is something House Majority Leader Al Carlson admitted on the floor of the House at the end of the debate over the expansion: