How ‘free’ federal money costs North Carolina

With the 2016 election right around the corner, the candidates are searching for wedge issues to appeal to large swaths of the electorate. Medicaid expansion, particularly in North Carolina and other states that have opted against expanding the federal health insurance program, is shaping up to be one of those talking points.

The Affordable Care Act contains a provision that expands Medicaid coverage to almost all individuals with incomes below 138 percent of the poverty line. But in its 2012 decision to uphold the ACA’s constitutionality, the Supreme Court ruled that the federal government could not compel states to expand their Medicaid programs. At this point, 19 have sided with North Carolina and chosen not to.

The arguments over whether to expand Medicaid vary state by state, but proponents often point to the federal government’s offer to foot almost the entire bill. For example, Ohio Gov. John Kasich supported Medicaid expansion as a way “to bring Ohio money back home – that is, avoid bearing any of the cost.”

But a new study released by the Civitas Institute suggests that this argument may be lacking, since it doesn’t account for associated increases in state and local spending.

Analyzing all federal funding to state and local governments finds that each additional dollar of federal money sent to the states is associated with an average increase of 82 cents in new state and local taxes. Across all states, a hypothetical 10 percent increase in federal grants to state and local governments would be associated with approximately $50 billion in additional increased state and local taxes, charges or other revenue sources. In real terms, this translates to an additional government burden of $158 per person. This is in line with existing peer-reviewed research that concludes that each dollar of additional federal grants is associated with 54 to 86 cents in new state and local taxes.

Implementing the ACA’s Medicaid expansion in the remaining 20 states, which would cost the federal government an estimated $469.2 billion over the next decade, would therefore cost state and local governments an additional $318.4 billion.

The fact that these 20 states have not expanded the program reflects a realization that “free” federal money can be very expensive after all.

Two reasons why

But why does federal government spending, which should theoretically crowd out state spending and taxes, in reality increase spending and associated taxes? The U.S. Government Accountability Office suggests two reasons. First, federal grants usually require matching state spending, which is often paid for by increased taxes or fees. Many necessitate a dollar-for-dollar match in spending. Second, federal grants often have a maintenance of effort condition requiring states to prolong the funding after a certain timeframe. In this way, the federal government guarantees that its money adds to state spending rather than takes its place.

In North Carolina, for instance, the research shows that each additional dollar of federal spending – Medicaid included – is correlated with 81 cents in additional state and local taxes and fees. This is called a “ratchet” effect, in which federal transfers to states like North Carolina lead to an increased demand for the revenue that pays for it.

Yet even though the federal government promises to cover near 100 percent of the cost, like it has done with Medicaid through 2016, state taxes will still have to cover an increasing state share in future years as the federal support subsides. Meanwhile, maintenance of effort requirements restrict potential Medicaid reforms that could save millions, forcing North Carolina taxpayers to foot a higher Medicaid bill.

Our most recent research sheds new light on the potential consequences of accepting federal money. While Medicaid expansion might make sense as a wedge political issue, North Carolinians should be wary of “free” federal money. It could cost them billions of dollars.

Eric Fruits, Ph.D., is president of Economics International Corp. Brian Balfour is policy director for the Civitas Institute in Raleigh.