How Does Federal Fiscal Policy Impact South Dakota’s Budget?
It had to end at some point.
More than six years after the COVID-19 pandemic hit the world stage, federal American Rescue Plan Act (ARPA) aid is finally coming to an end. As South Dakota returns to its normal federal funding posture post-ARPA, ‘normal’ still means federal dollars finance roughly two-fifths of the total state budget. The fiscal question facing state policymakers is not whether federal funds disappear, but how exposed South Dakota is to federal policy shifts in Medicaid, transportation, education, and other key areas.
In fiscal year 2026, approximately $1.5 billion (or 61%) of the state’s receipts are projected by the Bureau of Finance and Management to be provided by sales and use tax. A mix of other income sources (state lottery, contractor’s excise tax, insurance company tax, unclaimed property receipts, tobacco taxes and a bank franchise tax) round out the state’s income balance. During this year’s legislative session, state revenues forced lawmakers to make difficult choices, especially on the “big three” priorities of Medicaid health care providers, education, and state employees. Enhanced revenue projections delivered during the session made the choices slightly easier and enabled a 1.4% boost for those categories.
A changing revenue picture
Substantial changes to both sales and property tax design are on the horizon with the passage of Senate bills 96 and 245. Senate bill 96 authorizes counties to adopt an optional 0.5% sales tax to reduce property taxes on owner-occupied homes. Senate bill 245 creates a state-backed property tax reduction fund for homeowner relief, utilizing revenue from a 0.3% increase in state sales tax.
As lawmakers grapple with the future of sales tax receipts under this new design, it’s worth taking a closer look at a historically large (and essential) part of South Dakota’s budget and government service delivery: the federal contribution.
In FY 2023, South Dakota ranked 16th highest in the nation for its proportion of federal funds that make up the state budget. The recently enacted HB 1326 establishing the fiscal year 2027 budget totals nearly $7.5 billion, and $3.1 billion of that, or 41.5%, is projected to come from the federal government. Ten years ago, federal funds accounted for 36.4% of the state budget. While it’s true that federal stimulus in response to the COVID-19 pandemic significantly increased aid to states, this year’s proportion of federal funds isn’t necessarily unusual. 20 years ago, toward the end of the Mike Rounds administration, 41.6% of the fiscal year 2007 budget came from the federal government. In a 2002 report to Governor Janklow, the Auditor General celebrated “the sound financial condition of South Dakota” after closing the books on a fiscal year in which 36.8% of the budget came from federal funds.
While it cannot claim the largest proportion of federal funding in state history, the 2027 budget does mark another year in a series of sustained fiscal infusions from the federal government that peaked in 2021. According to a review of state documents by South Dakota News Watch in 2023, the state received a total of $13.84 billion in federal COVID-19 relief funding, $4.2 billion of which was received by the state government.
As detailed by a report to the Joint Committee on Appropriations on January 14, the final funds delivered to the state by the American Rescue Plan Act (ARPA) are due to be spent by the end of 2026 under federal deadlines. That $106 million is dedicated to a wide range of recipients, including environmental projects, broadband expansion, workforce housing, tourism marketing, health care revenue replacement, behavioral health, a Department of Health cardiac monitors/defibrillator initiative, reemployment assistance, telemedicine, Capitol Lake improvements, a public health laboratory build and remodel, and regental campus build remodels.
For six years, state policymakers have lived in an unusual fiscal environment, adjusting their budgets for a temporary post-COVID revenue reality. That the Covid relief era is finally over is made clear in this year’s budget adjustments:
- Tourism: -$8,750,000 federal authority for completion of ARPA marketing projects
- Health (Family & Community Health): -$8,000,000 federal stimulus grants
- Health (Laboratory Services): -$2,000,000 federal stimulus grants
- Education (General Administration): -$2,607,000 federal stimulus grants
These adjustments are key to the state’s offramp from one-time funding, since any costs covered by ARPA need to be replaced by general funds, some other funding source, or sunset altogether. But even with the end of ARPA funding, and consistent with recent budgets, federal funds will continue to play an essential role in the fiscal health of South Dakota. The design of federal programs explains why.
Why does South Dakota receive so much federal funding?
Evaluating why South Dakota is toward the top of the list of states with a high proportion of federal budget funds requires distinguishing between one-time dollars like ARPA and structural federal expenditures.
Medicaid is the largest driver of federal funds to the state, which is true of most states. According to Pew, in fiscal year 2024, the program accounted for 68.8% of total federal grants to states and was the largest source of federal funding in all but one state.
Governed by a formula known as the Federal Medical Assistance Percentage (FMAP), a slight majority of South Dakota Medicaid expenses are paid for by the federal government. The Department of Social Services estimates that even a one percentage point shift in the FMAP can reduce or increase South Dakota’s funding responsibility by $13 million, making the state’s budget highly sensitive to the formula. South Dakota’s share of annual Medicaid expenses has risen from approximately 36% in 2021 to 48% in 2026.
In fiscal year 2025, 16% of South Dakotans were enrolled in some form of Medicaid services. A 2025 DSS report notes, “40% of South Dakota’s children will rely on Medicaid or Children’s Health Insurance Program (CHIP) during the first year of life” and 54% of nursing home residents are dependent upon Medicaid to pay for their care. The portion of the state budget dedicated to Medicaid is therefore a direct reflection of FMAP and the medical and financial health of the state’s citizens.
The second-largest recipient of federal funds in the state is the Department of Transportation. Federal transportation funds are primarily distributed to states through grants using formulas determined by Congress. Metrics like population, lane miles, vehicle miles traveled, and tax contributions play a factor in the funding. These funds, largely from the Highway Trust Fund, are managed by State Departments of Transportation and often require state matching funds, with money reimbursed to states after project approval. The Tax Foundation found in a study published March 30, 2026 that only two states, Maryland and New Jersey, raise enough revenue to fully cover their highway spending. The analysis found that South Dakota covers 37% of its own highway spending, making the federal government an indispensable part of the state’s transportation budget.
The third-largest block of federal funding in the state is allocated to the Department of Human Services (DHS), also highly impacted by Medicaid spending and FMAP. Funding for developmental disabilities services ($167M), the South Dakota Developmental Center in Redfield ($13M), long term services and supports ($204M), rehabilitation services ($23M), and services to the blind and visually impaired ($3M) make up the 2027 DHS budget.
Taken together, the Department of Social Services, the Department of Transportation, and the Department of Human Services account for nearly 80% of South Dakota’s federal funding.
Where does federal money go in South Dakota?
Fiscal stability risks and watchpoints
The end of ARPA has shifted the focus on these one-time funds from budgeting and allocation to project implementation and compliance to maximize the impact of federal assistance. As federal funding support for states reverts to structural norms, state lawmakers could have fewer opportunities to fuel the state’s economy with one-time federal funding.
The future of federal fiscal policy looms large for South Dakota. Federal funding formulas, match rates, and grants have long been core to South Dakota’s balanced budget. Beyond sales tax receipts, one of the greatest risks to South Dakota’s budgets remains federal attitudes toward health care spending. State policymakers will likely closely monitor proposed changes to federal Medicaid, transportation aid and formula grants. What should they watch in particular? FMAP changes, Medicaid eligibility and utilization, and federal appropriations volatility. Considering the largest recipients of federal funds in South Dakota, changes to federal Medicaid, transportation, or education policy remain significant risks to the state’s general fund and overall fiscal health.
