The Local Fiscal Multiplier of Intergovernmental Grants: Evidence from Federal Medicaid Assistance to States

Abstract

Advocates of Medicaid expansion argue that federal Medicaid assistance to states fosters economic activity, generating positive local multiplier effects. Furthermore, during economic downturns, Congress regularly tweaks federal match rates for state Medicaid spending – including during the COVID-19 public health emergency – in order to assist states. Despite heavy reliance on Medicaid funding formulas, identifying the economic effect of these federal transfers has proved challenging. This is because federal Medicaid assistance (to states) is endogenous, since funding levels are correlated with unobserved factors driving state economic activity. To address this concern, we construct an instrument based on a slope discontinuity in the federal matching rate for state Medicaid spending. Using state-level panel data from 1990 to 2013, we find that federal Medicaid assistance does stimulate economic activity, but the implied cost per job created is quite high and the multiplier is well below 1. Despite modest economic effects over the entire sample period, we find that federal Medicaid assistance provided powerful fiscal stimulus to states after the Great Recession when the implied multiplier shot up to 1.5.