State governments face large declines in tax revenues and increased demand for state programs during and after recessions. Because states generally must balance their budgets annually, this fiscal pressure forces states to cut programs, raise taxes, or both. These fiscal changes deprive states’ residents of valuable public services and substantially reduce overall economic activity, thereby worsening economic downturns.
To prevent this outcome, Matthew Fiedler, Jason Furman, and Wilson Powell III propose to transfer federal funds to state governments during periods of economic weakness by automatically increasing the federal share of expenditures under Medicaid and the Children’s Health Insurance Program when a state’s unemployment rate exceeds a threshold level. The increase in a state’s matching rate would be proportional to the amount by which the state’s unemployment rate exceeds the threshold and would phase down automatically as the state’s economy recovers. The authors calibrate their proposal to offset around two-thirds of the budget shortfalls that emerge in economic downturns.