What Might Cuts in Federal Government Spending Mean for the Fifth District?

In a previous post, we examined the concentration of the federal government workforce in the Fifth Federal Reserve District — a region that includes the government-concentrated District of Columbia and surrounding areas in Maryland, Virginia, and West Virginia. However, workforce concentration is just one aspect of federal government spending in our district. Virginia and Maryland, for example, have consistently been among the top recipients of federal contract dollars. To understand the extent to which the Fifth District relies on the federal government requires examining not only the federal workforce, but also the scope of federal spending in the region. Even though we cannot fully gauge the impact of potential spending cuts until we know which programs and agencies will be affected, we can assess where federal spending occurs in the district and which areas might be more impacted by a decline.

The Picture of Federal Spending

The U.S. federal budget consists of three main spending categories: mandatory spending (spending required by law and including programs like Social Security and Medicare), discretionary spending (spending that Congress can adjust annually during the appropriations process and including areas like border security, education, and transportation), and net interest on the federal debt.

In fiscal year 2023, the federal government spent $6.1 trillion, which accounted for about 24 percent of the U.S. GDP. More than 60 percent of the budget was mandatory spending, and another 11 percent was net interest payments. Of the $1.7 trillion of discretionary spending, a little less than half was spent on national defense and the other half was non-defense. As we articulated in the article on the federal government workforce in the district, civilian employment related to the Department of Defense, Department of the Navy, and Department of the Army is particularly large in some parts of the Fifth District, most notably in Virginia.

Even separate from direct payroll, changes to discretionary spending have the potential to affect different parts of the nation differently. Some of the spending flows to nonprofit organizations, private companies, and state and local governments that provide services to or on behalf of the federal government. The rest of this article will examine discretionary spending in the Fifth District by looking at federal awards and transfers to state and local governments.

Federal Awards in the Fifth District: Government Contracting and Grants

Federal award spending refers to specific transactions and obligations in which the federal government allocates funding to recipients through contracts, grants, loans, or other forms of financial assistance. This includes funds for private companies, state and local governments, universities, nonprofits, and individuals.

Total federal award spending in 2023 was approximately $4.8 trillion. To contextualize the spending, we focus on federal award spending as a percentage of state personal income (the income that individuals receive from wages and salaries, Social Security and other benefits, dividends and interest, business ownership, etc.). In the Fifth District, the share is highest in D.C., followed by South Carolina. Between 2008 and 2023, this spending averaged 65 percent of personal income in D.C. and 38 percent in South Carolina, both significantly above the U.S. average of 19 percent. Virginia (25 percent), West Virginia (23 percent), and Maryland (20 percent) also exceeded the national average, while North Carolina was slightly below at 16 percent.

Among all types of federal government award spending, contracts are the component predominantly awarded to the private sector. For example, the government could award a contract to a defense contractor for building military equipment or to a technology provider to supply computer services for government agencies. In 2023, the federal government obligated approximately $705 billion through contracts.

For many years, a large share of contracts have been awarded to organizations operating in Virginia, Maryland, California, and Texas. However, because California and Texas are larger economies, these funds make up a smaller share of economic activity in those states. In fiscal year 2023, Virginia ranked first, Maryland fourth, and D.C. ranked fifth in terms of federal contract awards (in fact, the D.C. metro area accounted for about 24 percent of total federal contract spending in that year).

Government grants are another channel for federal discretionary spending. Although Virginia is the top state recipient of contract dollars, South Carolina had a higher share of federal grants as a share of state personal income on average in the last 15 years, which ranks it high when it comes to all federal obligations as a proportion of state personal income.

Another Channel: Transfers to State and Local Governments

Another channel through which federal discretionary dollars flow to communities is transfers to state and local governments. These transfers are known as federal intergovernmental grants.

Federal support varies significantly across state and local governments. In order to remove the effects of pandemic-era funding shocks, we use data through 2019. For the average U.S. state, federal funds as a share of state and local government general revenue declined until the late 1980s but later increased and stabilized at around 22 percent.

D.C. remains dependent on federal funding, but it has become less dependent over time. In 1976, federal funds accounted for nearly 60 percent of D.C.'s revenues, but this share fell to 27 percent by 2019 — only slightly above the U.S. state average. In contrast, federal transfers are now about 31 percent of West Virginia state and local general revenue, up from 20 percent in 1989. In fact, by 2019, West Virginia ranked among the top six states in terms of federal government transfers as a percentage of total revenue.

Although it is useful to understand total federal funding allocated to state and local government within a state, the trends are different.

There has been a moderate long-term increase in the share of state revenue coming from federal sources, rising from 27 percent in 1977 to 31 percent in 2019 (despite a pronounced decline during the 1980s). D.C. remains unique in its dual role as both a state and local government and, as noted earlier, its overall financial independence from federal transfers has grown over time. On the other hand, West Virginia, South Carolina, and North Carolina remained among the most dependent states in the Fifth District, consistently receiving a higher-than-average share of federal funding via intergovernmental transfers relative to their general revenue. In contrast, Maryland and Virginia had lower-than-average reliance on federal transfers. Despite hosting many federal agencies and military installations, their state budgets are less reliant on direct intergovernmental transfers.

While a portion of the federal transfers to states shown in the figure above may ultimately reach local governments through "pass-through" grants, other federal transfers are awarded directly. Federal transfers allocated directly to local governments are relatively modest; the federal share of local government revenue remains consistently low -- averaging around 4 to 6 percent across all district states and for the typical local government in the U.S.

Like transfers to state governments, direct federal transfers to local governments have undergone significant changes over time. From 1977 to the early 2000s, there was a long-term decline in federal government transfers as a percentage of local general revenue, dropping from 9.25 percent in 1977 to around 3.5 percent in the early 2000s. This decline reflects fiscal decentralization efforts and policy shifts that placed greater financial responsibility on state and local governments. However, from the early 2000s to 2019, this trend stabilized and even showed a slight increase. After reaching a low of 3.5 percent, the share of federal transfers increased modestly to about 4.9 percent in the mid-2010s before stabilizing at 3.9 percent by 2019. This modest increase may be partially attributed to federal responses to economic downturns, but it also suggests a shift in how federal support for local governments evolved in the face of changing fiscal policies.

Conclusion

The Fifth Federal Reserve District has a disproportionate share of the government workforce and government contracts. However, district states look a lot more like the rest of the country when it comes to the role that federal transfers play in state and local government revenues. Over time, the role of federal transfers in state and local government finances has evolved. Looking ahead, changes in federal spending policies, including potential shifts in discretionary allocations or entitlement funding, will affect how states and local governments in the Fifth District manage their budgets. In this evolving landscape, understanding the distribution and impact of the federal government's presence remains crucial for assessing the region's economic resilience and long-term fiscal sustainability.

Views expressed are those of the author(s) and do not necessarily reflect those of the Federal Reserve Bank of Richmond or the Federal Reserve System.