The Role of Federal Funds in State Spending

Over the years—most often during periods of federal budget retrenchment—analysts have considered whether the federal government and states should “swap” responsibilities. That is, whether the federal government should reduce or eliminate its grants in one program area, and redirect those resources into another. Such sorting out holds the promise of allowing the entity with full funding responsibility over an area to improve its efficiency and effectiveness. For states, it could provide flexibility that federal oversight typically precludes, and reduce or eliminate costly and often-burdensome requirements that accompany most federal assistance.

During the Reagan administration, it was suggested that states assume full funding responsibility for the major welfare program (Aid to Families with Dependent Children) while the federal government would take full responsibility for Medicaid. In retrospect, this would have been an excellent deal for states, but it never gained traction.

We are now in another period of federal budget retrenchment. Due to efforts to reduce the federal budget deficit, most federal grant programs outside those designated as “mandatory” have seen level funding at best, and sometimes significant reductions, especially in inflation-adjusted terms. The prospect of swapping greater federal responsibility in one program area for greater state responsibility in another is gaining renewed interest.  

To understand the potential impact of federal-state responsibility swaps, it is necessary to consider the importance of federal funding in each of the major categories of public spending. This Special Analysis examines the major areas of state-federal fiscal relations, and provides background information on states’ reliance on federal funds in a host of program areas.