Too small to fail: The role of Medicaid in mitigating pandemic‐related fiscal strain on local governments

Abstract Local governments across the United States have had a prominent role in financing the pandemic response during the ongoing COVID‐19 outbreak and economic recession. Yet, such governments are increasingly facing budgetary strain as sources of tax revenue evaporate. If the financial burden on such governments can be eased, they may better address those aspects of pandemic response to which they are uniquely suited, such as coordinating resources and re‐allocating space within their communities. This paper investigates the role of Medicaid, traditionally the default insurer of the unemployed, as a stabilizing force on local government budgets. Using panel data from county governments during the Great Recession (2006–2012), we estimate the effect of state Medicaid generosity on public finances. We find that Medicaid mitigates the effect of unemployment shocks on county government expenditures, specifically safety‐net programs and debt. We apply these point estimates to extrapolate predictions based on contemporary state Medicaid generosity and local unemployment rates. In this way, we show that Medicaid continues to mitigate the financial strain on local government during the COVID‐19 pandemic. Applications For Practice • Local governments contribute heavily to hospital, health, and welfare services in the United States, and are an important implementor of pandemic policies.• As the pandemic spreads, local governments incur additional expenditures in a time of depressed revenue.• Often, the debate around Medicaid financing is framed around federal and state government budgets. However, local governments support the safety‐net for indigent residents by assuming a substantial role in the finance and delivery of health care and will likely benefit from this relief.• Our findings indicate higher Medicaid generosity reduces the downstream economic strain on local governments emanating from labor market shocks.• State and federal policy may establish grants to aid local governments during the pandemic, such as in the CARES Act of 2020. However, we establish that the Medicaid program is itself a channel by which state and federal governments can support local governments.