Read an Excerpt
American Domestic Priorities
An Economic Appraisal
University of California Press
Copyright © 1985 John M. Quigley and Daniel L. Rubinfeld
All right reserved. ISBN: 0-520-05522-5
Chapter One
Fiscal Allocations in a Federalist Economy: Understanding the "New" Federalism Robert P. Inman
From its constitutional beginnings to today, the United States public economy has been committed to the concept of federalism in the provision of public services. The use of multiple layers of government, with each higher level possessing rights of control over a lower level, is a founding principle of our fiscal structure. But while the constitutional commitment to a federalist system is clear, the precise structure and performance of that system are not.
Significant changes have taken place in our federalist fiscal system, both historically and in recent years. Scheiber (1966) has identified four stages of historical development of United States federalism: first, a period of "dualism" (1790-1860) in which states and the federal sector coexisted with essentially equivalent responsibility and powers; second, a time of "centralizing federalism" (1860-1933) as power began to gravitate to the federal level; third, a period of "cooperative federalism" growing out of the social programs to deal with the national crisis of the Great Depression (1933-1964); and finally, the recent period of "creative federalism" in which the federal government has taken an active policy interest in the specific problems of state and local governments. The first three periods can be characterized as times when the states (and their localities) made fiscal policy largely independently of direct federal interventions, while the recent period of creative federalism has involved the federal government directly in state and local fiscal affairs. Federal grants-in-aid and all their spending requirements, as well as the many new federal regulations of state-local governments, have deeply affected the budgetary choices of the state-local sector.
In January 1982, President Reagan proposed a significant break with this trend toward federalization of our public economy. As originally presented in his budget message of that year, President Reagan's "new" federalism proposed: (1) that Medicaid become a fully federal program (which the administration hoped to curtail as part of its health-care-reform efforts); (2) that the states and localities assume responsibility for food stamp programs and Aid to Families with Dependent Children (AFDC); and (3) that more than sixty federal programs in education, community development, transportation, and social services be returned to the states, with the states receiving $28 billion a year from a federal trust fund to help pay for their new responsibilities. The trust fund was to be supported by federal excise taxes. Dollars paid from the trust fund would not be restricted to expenditures on the reassigned programs, however. The funds could, if a state so decided, be allocated to other state programs or to state tax relief. The intention of the president's new federalism was clear: to reduce federal influence on state-local fiscal choice.
What is less clear is how state and local governments will react to this restructuring of our current federalist fiscal system, and whether the present federal government will relinquish control and embrace the new federalism. Yet from the perspective of fiscal policy these are the central issues. Changes in federal grants and federal regulations will assuredly affect state and local governments' budgetary decisions. The relative economic and political attractiveness of the new federalism and of the creative federalism it seeks to replace ultimately rests on the actual allocations of resources. This paper offers some first (but considered) guesses as to what might happen under, and to, Reagan's reforms, and concludes that President Reagan and his supporters are not likely to be disappointed in the economic consequences of the new federalism, though they will be unhappy with its political prospects.
Our Current Federalist Fiscal Structure
In order to predict the future under President Reagan's new federalism, it is important to understand our present federalist fiscal structure and how it evolved. The Reagan proposals are a significant challenge to the historical trend toward federalization of United States fiscal policy. Table 1.1 summarizes the federal and state/local government spending patterns over the past eighty years. As columns 1-3 show, the federal government share has grown steadily; today each sector is responsible for about half of all domestic public spending. The major source of the growing federal share was expansion of social insurance programs-"transfers to persons"-from the mid 1930s to 1950 and again from 1960 to 1980 (Table 1.1, columns 7-9). While the federal government's responsibility for transfers was growing, its responsibility for direct provision of nondefense public goods and services was declining (Table 1.1, columns 4-6); the state-local sector is the primary producer of domestic public services. Overall, the major source of the historical growth in total government activity has been transfer programs, however, and these programs are the financial responsibility of the federal government.
A similar move toward the federal level is observed in the historical trends of government receipts measured as taxes plus contributions to social insurance (see Table 1.2). In 1929, all government receipts were $430.80 per capita (in 1972 dollars), of which 33 percent was raised by the federal government. By 1950 the federal share was 74 percent of all receipts. The federal share has declined slightly in recent years, but a comparison of the 1929 and 1983 divisions of the revenue-raising function shows essentially a reversal of roles between the federal and state-local sectors. In 1929, state-local governments were the main source of public dollars; now the federal government has assumed that role.
The federalization of our fiscal structure has manifested itself in other ways as well. The federal government now actively participates in state and local budgetary choices. It does so in two ways: through a carrot called grants-in-aid, and through a stick called regulation. Table 1.3 details the recent growth of federal aid to state and local governments. From a position of very modest absolute and relative importance in 1940, federal aid had grown by 1980 to a sizable real-dollar transfer-a total of $192/capita-and to over 25 percent of state and almost 14 percent of local non-debt revenues. Growth has been particularly dramatic over the last two decades, most noticeably in direct federal-to-local aid. Table 1.4 illustrates the other important features of the aid explosion. The growth has occurred in categorical formula grants and categorical projects grants rather than in block grants. Block grants are federal dollars targeted for broad programmatic missions-e.g., education, employment, community development. Categorical aid is directed at narrow program categories-e.g., school lunches, sewer construction, low-income transfers to fatherless families. Categorical aid can be given to states or localities according to a well-specified formula (formula grant), or states and localities may submit a specific project proposal for federal funding (project grant). Categorical aid often requires the state or local government to match the federal funds with state or local revenues. Block grants generally do not require such a match; instead, they serve as "free" money to the state-local sector.
Does such aid influence state-local fiscal allocations? The econometric evidence from over twenty years of research is quite unequivocal on the point: it does indeed (see the surveys in Gramlich 1969 and Inman 1979). Federal aid increases state and local spending on the targeted activities, and often on non-targeted activities as well. Categorical matching aid is the greatest stimulus to state-local spending. Block grants and the totally unconstrained, general-revenue-sharing aid induce the least increase in public spending. In the next section I review three recent studies which show that the impact of federal categorical and categorical matching grants on state and local budgets has been sizable. While there has been much political debate about whether these federal aid programs are good or bad for the state-local sector, no one has denied that these programs have been an important influence on state-local budgetary choices.
The federal government also regulates many activities of the state-local sector, now more than ever. Figure 1.1 summarizes the growth of federal regulatory programs. Four types of regulation have been identified: direct orders, which must be obeyed to avoid civil or criminal penalties (e.g., the Equal Employment Opportunity Act of 1972, which bars job discrimination on the basis of race, color, religion, sex, or national origin); crosscutting regulations, broad federal mandates that apply to all forms of federal assistance (e.g., the Civil Rights Act of 1964); crossover regulations, which require performance on one policy dimension under penalty of loss of federal assistance from another, well-specified program (e.g., the 55mph speed limit required under threat of loss of federal highway assistance); and, finally, partial pre-emptions, in which federal law establishes a policy goal which, if not met by the state-local sector, will allow direct federal provision or enforcement (e.g., the Clean Air Act Amendments of 1970). The 1970s saw by far the greatest growth in federal regulation of the state-local sector. The results have been mixed. The Civil Rights Act is an example of significant accomplishment, but most environmental regulations have produced only modest gains in air, water, and land-use quality, yet have imposed large costs on state and local governments (Advisory Commission on Intergovernment Relations n.d., p. 22). Again, while the relative benefits and costs of federal regulation of the state-local sector can be debated, there can be little doubt that these regulations have significantly influenced the policies and budgets of state and local governments.
We are now a federalized, federalist system. President Reagan's "new federalism" reforms strike at the heart of this centralization process. First, the two major income-maintenance programs now at the federal level-food stamps and AFDC-are to be returned to the state and local sectors. In 1983, these programs were estimated to cost the federal government $16.4 billion. A dollar shift of this magnitude will reduce the federal share of transfer to persons from 87.2 percent in 1983 (Table 1.1, column 8) to 83 percent.
Second, the Medicaid program is to become fully a federal responsibility. On the surface, this adjustment appears to run counter to the defederalization intentions of the Reagan policy. The new federal Medicaid outlays, approximately $19 billion, will increase the federal share in transfers to persons, from 83 percent following the decentralization of welfare, back to 87 percent. Despite this upward adjustment in federal spending, it can be argued that the offer to take on the state's share of Medicaid is a necessary component of the new federalism package. The states and their congressional representatives will not accept the income-maintenance programs without some form of budget relief to compensate for the additional expense of these programs. Direct grant relief might be more of the same-federally funded aid for federally mandated programs. Relief could, however, be offered in the form of a federal takeover of a state responsibility. But which state responsibility? The state share of the Medicaid program is an excellent choice for three reasons: (1) the state Medicaid outlay is large and growing and a bit more than the federal dollars now spent on food stamps and AFDC, i.e., it is a "fair" trade; (2) the states have been doing a very poor job of controlling Medicaid outlays; and (3) there is a growing desire at the federal level to control federal health care costs, and Medicaid, if federalized, can more easily be included within any new federal regulations. The states do not want the responsibility of Medicaid, and for reasons not entirely related to federalism, the Reagan administration is willing to take it on. From the point of view of the new federalism, the swap of the state share of Medicaid for income-maintenance programs seems the best available trade.
Third and finally, Reagan's new federalism proposes to return to the state-local sector sixty-one existing federal-education, social-service, transportation, and community-development categorical aid programs for state administration and funding. To ease the estimated $30.2 billion financial burden imposed by these new programs, the federal government would make available to the states $27.6 billion from a federal trust fund supported by federal excise taxes. (The states' shortfall between program costs and trust fund transfers equals the states' gain from the welfare/Medicaid swap.) The intention of this exchange is to reduce federal control over state and local spending; categorical aid and its particular expenditure restrictions are dropped and replaced with unconstrained federal assistance. This federal-trust-fund aid is to be phased out, however, over four years beginning in 1988. Thus, the third component of the new federalism is intended first to reduce federal aid restrictions and then, beginning in 1988, gradually to reduce federal government spending and taxes. Overall, the new federalism is: (1) to leave the federal share of transfer outlays largely unaffected but to move to the federal level those redistribution expenditures (Medicaid) that the states have found the most difficult to control; (2) to replace federal categorical aid with lump-sum aid, thereby reducing federal control over state-local spending; and finally, (3) to reduce federal spending and taxes by gradually phasing out the trust fund and its associated taxes. Or so the proponents of the new federalism hope. Whether the new federalism will in fact have these defederalizing effects is an open question.
Will the "New" Federalism Work?
While the calculations above concerning effects of President Reagan's new federalism on our fiscal system are reasonable first guesses, they are really only that-first guesses. Budget aggregates were simply moved from the federal to the state-local column and back again. Missing from such calculations is any sense that there are governments, and voters, who determine what those budget aggregates will be. Yet an analysis of such a fundamental realignment of fiscal responsibilities as the new federalism proposes must recognize that the state-local sector will react to the reforms. To predict the consequences of new federalism we must first understand the budgetary process of state and local governments.
Continues...
Excerpted from American Domestic Priorities Copyright © 1985 by John M. Quigley and Daniel L. Rubinfeld. Excerpted by permission.
All rights reserved. No part of this excerpt may be reproduced or reprinted without permission in writing from the publisher.
Excerpts are provided by Dial-A-Book Inc. solely for the personal use of visitors to this web site.
