Increasing Federal Medicaid Assistance Provides Effective Economic Stimulus

Increasing the federal share of Medicaid costs (the federal medical assistance percentage, or FMAP) would not only protect health coverage during the pandemic and recession, but also increase employment and economic output by providing relief to hard-pressed state budgets, research on the 2009 Recovery Act shows.

The Families First Act took an important first step, raising the FMAP by 6.2 percentage points during the public health emergency. But that increase, together with other flexible fiscal relief that subsequent legislation provided, will fill only a small portion of projected state budget shortfalls. The National Governors Association and over 100 other organizations recently called on Congress to provide additional, larger FMAP increases for as long as the economic downturn lasts.

The Recovery Act significantly increased state FMAPs during the Great Recession. This assistance was highly effective in strengthening state labor markets and economies, according to a study by economist Gabriel Chodorow-Reich, now at Harvard, and colleagues.

Each additional $100,000 of state fiscal relief from increasing the FMAP boosts employment by 3.8 job-years, the study’s authors estimate. That’s equivalent to an output “multiplier” per dollar of spending of about 2. That is, a dollar spent on increasing FMAP adds about two dollars to gross domestic product, making it highly efficient economic stimulus.

An FMAP increase provides particularly effective economic stimulus for at least two reasons. First, additional federal funds go to states almost immediately upon enactment. Second, states can spend the money quickly. The additional federal funds free up funds that states would otherwise spend on Medicaid. Since those freed-up funds are not restricted to a particular use, states can direct them to where the need is greatest.

As Chodorow-Reich and colleagues confirmed, states spent the Recovery Act’s FMAP increases to avoid budget cuts or tax increases, rather than using them to add to cash balances or rainy day funds. Buttressing this conclusion, they find evidence of reduced layoffs in government-financed sectors of the economy, including health and education, as well as induced employment gains in other sectors.

The authors derived their estimates by comparing labor market outcomes across states that received different Medicaid funding increases due to differences in their Medicaid programs. This approach provides particularly strong evidence on the effect of FMAP increases on the economy. It’s also broadly consistent with other studies examining the impact of Recovery Act spending or other federal assistance to states or localities.

Unlike the federal government, states must balance their operating budgets every year. When tax revenues fall in a recession, they can respond in three ways: cut spending, raise tax rates, or draw down rainy day funds and other cash balances. Federal fiscal relief strengthens the economy by reducing the need for states to cut their budgets.

Therefore, as the President and Congress consider the next legislation to combat COVID-19, alleviate hardship, and spur the economy, one of the most effective steps would be to provide robust fiscal relief to states and localities — in part by increasing the federal share of Medicaid costs. That assistance would help these governments avoid cuts in services and investments that would worsen racial inequities. It would also help them avoid laying off workers and imposing other budget cuts that would make the recession deeper and longer.