State Budgets in the Shadow of Federal Uncertainty

We all know that a key distinction between Congress and the states is that the states are required to balance their budget each year. But about a third of the average state budget actually derives, not from state revenues, but from federal loans and grants.

One-Third of State Spending Comes from Federal Transfers

On average, 34% of state spending came from the federal government in FY 2024. So out of just over $3 trillion spent by the states, a little over $1 trillion came from the federal government. This is down a bit from recent years because the federal government injected extra cash into the states during the COVID-19 pandemic, ticking the federal funds percentage rate of state budgets up to a record high of 36% in FY 2021. Subsequent federal laws under the Biden Administration, including the Infrastructure Investment and Jobs Act (IIJA) and the Inflation Reduction Act (IRA) are still actively sending extra funds to the states to implement the law’s provisions. 

The Trump Administration's Halt to Grants and Loans to States

Enter the second Trump Administration. Shortly after taking office, the Administration’s Office of Management and Budget published a memo to halt all grant and loan payments to states while the agency reviewed each payment for compliance with the flurry of executive orders the President had just signed. States immediately complained that they could not access needed funds and 22 state attorneys general sued and received an injunction to free up the funds. However, the Administration has been reluctant to proceed and also delayed payments owed to the states under the IIJA and IRA, which are federal laws enacted by Congress.

It’s unclear which expected funds the states will receive going forward, which the administration will attempt to hold back, and whether Congress will act to slash the funding already approved for states. But regardless of the details, these are funds that make up a significant portion of state budgets, so even a minor disruption could sow chaos in the state budgeting process. Each federal dollar cut will need to be made up with new state revenues or corresponding cuts in state spending. 

What Does Federal Funding to States Pay For?

These graphs and data are pulled from the indispensable State Expenditure Report from NASBO. The report also breaks down where those federal funds are going. And a majority of those funds are heading to one program in particular: Medicaid. The joint state-federal health care program for low-income Americans is managed by the states but primarily funded from federal dollars. The federal government provides 69% ($606 billion) of the $880 billion costs of the Medicaid program. Congressional Republicans are debating significant cuts to Medicaid funding in order to pay for expiring tax cuts. 

Additional big ticket items from federal funding to the states is K-12 education, which makes up about 10% of the federal funds sent to states, and primarily supplements special education services and high-poverty school districts. On average, federal funds make up 18% of K-12 spending in the states. Federal funds account for 37-43% of total K-12 spending in a trio of neighboring southern states — Louisiana, Mississippi, and Alabama. The final big piece of federal funds to states is building transportation and infrastructure, a sector that’s been on the rise thanks to recent federal laws like the bi-partisan infrastructure act. Federal funds made up about a quarter of state spending on transportation last year. 

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This article appeared in our Morning MultiState newsletter on February 25, 2025. For more timely insights like this, be sure to sign up for our Morning MultiState weekly morning tipsheet. We created Morning MultiState with state government affairs professionals in mind — sign up to receive the latest from our experts in your inbox every Tuesday morning. Click here to sign up.