Was the Minneapolis Mess Inevitable?

Is Minneapolis unique? Or do states and localities regularly pay little attention to federal funds?

Senior Fellow, Hoover Institution, Stanford University; Henry Lee Shattuck Professor of Government, Harvard University

“Roughly 400 Medicaid businesses were started in the building behind me over the last several years,” declared Donald Trump’s Medicaid czar, Mehmet Oz, on his visit to an industrial neighborhood in Minneapolis. “They generated about $380 million of billing that you, the taxpayer, were putting up. . . . . Why did no one in the state think this was a concern? . . . I think it’s because they weren’t looking.”

The Federalist angle

Oz’s charges of corruption may just be politics. But whatever courts decide, the fracas provokes larger questions about federalism: Do state and local governments typically spend funds foolishly when they get “free” money from the feds?

For decades, grants from Washington to states and localities have been rising inexorably. As of 2021, the federal share accounted for 27 percent of state and local expenditure, up from 18% in 1993 and massively up from the 3% level existing in 1962. The larger federal role seems destined to continue going forward, as Congress has again agreed to maintain current spending levels.

Local reliance on federal grants is not advised by classic federal theory, which says each governmental tub should rest on its own bottom. Localities should ask their own residents to pay for services rendered, whether they be sanitation services, police and fire protection, or schools. It’s those taxpayers who have a vested interest in how their money is spent, and they can closely observe the outcomes of those expenditures.

The same principle applies if states provide the services, whether they be state highways, state parks, or state colleges and universities. State tax resources—whether they come from state sales taxes, state income taxes, or licensing fees—should be the principal revenue source.

When the federal government foots the bill, state and local officials may see the money as borderline costless, because the people of any one state contribute only a small amount to the total amount in federal. The federal tax revenue generated by Minnesota is 2.4% of the total federal tax collected from all states by the IRS in 2024. This means that only 2.4% of projects paid entirely by the federal government are directly paid with funds from the residents of Minnesota in 2025. In other words, if waste and abuse in a federal program in Minnesota amounts to $400 million dollars, the price tag born by Minnesotans would be just $9.6 million, not nothing—but nowhere close to the cost had the undertaking been funded by the state. Price tags vary depending on the size and wealth of a state. For Californians, a $400 billion price tag would translate into $63.2 million; for Vermonters, just $480,000.

To find out whether localities slack off when money arrives from higher tiers of government, a colleague and I examined the connection between the share of total cost paid from local tax funds and student achievement levels in a school district. We looked at patterns nationwide, and then, to get causal estimates, we zeroed in on districts that suddenly received large amounts of new money from the state. Both methods showed students learning substantially more when districts paid a higher share of educational costs.

Still, inequities can be severe when localities are asked to cover the cost of all their services. Some cities—Greenwich, Connecticut; Los Altos California; Evanston, Illinois; for example—have ample resources to pay for schools, parks, health, and welfare programs; others are less favored, burdened by low property values and dense populations of poor citizens. To avoid gross inequalities, federal and state funds are essential. In our study, we found that the more the schools relied on federal and state grants the less wide the achievement gap between rich and poor students. In other words, there is a trade-off between efficiency and equity.

The practical solution to the trade-off dilemma is to ask the federal government to concentrate its fiscal efforts on relatively simple programs that direct cash to those in need. Social security, supplemental social service, and easily cashed food stamps work well, because the administration structure for these programs is simple. More complicated programs are best left to the lower tiers of government. Ordinarily, the feds should not finance services that require large-scale co-ordination among hundreds and thousands of employees. Police, fire, schools, sanitation services and the like should be mainly financed by local dollars. To play the role of watchdog, local governments need skin in the game.

It’s not an accident that the poster child of abuse and waste in Minnesota involved a complicated pre-school program. Congress would have been better advised to have helped poor people with their childcare by giving monies directly to parents. If a complex professionally operated program is to work well, it needs to be designed and paid for locally.

__________________________________________________________________

Paul E. Peterson is a senior fellow at the Hoover Institution, Stanford University and a professor of government at Harvard University.

­­