The Price of Federalism

1. Federalism's Enduring Tension: From Dual Sovereignty to Modern Complexity

The power surrendered by the people is first divided between two distinct governments, and then the portion allotted to each subdivided among distinct and separate departments.

Historical evolution. American federalism began with the principle of dual sovereignty, where national and state governments controlled separate spheres, as articulated by James Madison. This division was initially seen as a safeguard for liberty, preventing the concentration of power and the tyranny of a single majority. Early federalism, however, came at a terrible price, culminating in the Civil War, which ultimately ended the doctrine of state nullification and secession.

Modern transformation. Post-Civil War, federalism evolved from dual sovereignty to a system where the national government held ultimate authority, but state and local governments retained independent elected leaders and taxing powers. This modern federalism, often described as "marble-cake" federalism, became more complex, involving cities, counties, and special districts, each with its own responsibilities. The Supreme Court's interpretations of the Commerce and Spending Clauses significantly expanded federal power, allowing the national government to influence state and local affairs through grants and regulations.

The "price" question. This evolution raised new questions about the "price" of federalism: whether the national government was shirking responsibilities, imposing unfunded mandates, or if state and local governments were assuming duties they couldn't afford. The 1991 California fiscal crisis, mirroring earlier issues in New York City, highlighted these concerns, prompting a re-evaluation of the system's efficiency and equity.

2. Functional Theory: National for Redistribution, Local for Development

For federal governments to function effectively, the division of responsibilities among levels of government must respect the comparative advantage of each level of government.

Comparative advantage. Functional theory posits an optimistic view of federalism, suggesting that each level of government is best suited for specific tasks.

• Local/State Governments: Best for developmental programs (physical and social infrastructure like roads, schools, public safety) because they are disciplined by market forces. Residents and businesses can "vote with their feet," pressuring local officials for efficient, responsive services that enhance property values and economic growth.
• National Government: Best for redistributive programs (transferring resources to the needy, elderly, disabled) because it can prevent out-migration of wealth and in-migration of the poor, which would bankrupt lower-level governments.

Market discipline. Local governments, unlike the national government, operate under significant market constraints. Inefficient policies or excessive taxes can lead to residents and businesses relocating, impacting property values and revenue. This competition fosters efficiency and innovation, turning local communities into "laboratories" for public service delivery.

• Local governments rely heavily on property taxes and user fees, which are less progressive and less likely to drive away mobile capital and labor.
• They avoid progressive income taxes, which would incentivize wealthier residents to leave.

Grants and spillovers. While local governments excel at development, functional theory acknowledges fiscal disparities and spillover benefits (e.g., well-educated students benefiting other regions). National or state block grants can address these, but must be carefully balanced to avoid undermining local efficiency or imposing excessive regulations. The national government's role in development should be limited to broad national standards (e.g., interstate highways, food safety) where uniformity outweighs local responsiveness.

3. Legislative Theory: Self-Interest Drives Inefficiency and Fiscal Strain

Legislators at all levels of government will seek to distribute governmental benefits for which they can claim credit and, if at all possible, will shift governmental burdens to other levels of the federal system.

Reelection imperative. Legislative theory offers a more pessimistic outlook, arguing that policymakers' primary goal is reelection. This drives them to secure visible benefits ("pork barrel" projects) for their constituents while shifting costs and blame to other levels of government or diffuse taxpayers. This behavior leads to inefficient resource allocation and fiscal imbalances within the federal system.

Pork barrel politics. Legislators favor developmental projects with geographically concentrated benefits (e.g., dams, courthouses, research centers) that they can claim credit for, even if the overall national cost outweighs the benefits. This tendency is particularly strong in the House of Representatives, where members are more directly tied to specific districts.

• Examples: Federal funding for local performing arts centers, obscure research institutes, or turning a minor author's home into a national monument.
• This pursuit of "pork" contributes to rising government expenditure and deficits, as the political benefits of spending outweigh the diffuse costs to taxpayers.

Blame avoidance and unfunded mandates. To avoid blame for tax increases or unpopular policies, legislators shift redistributive responsibilities to state and local governments through unfunded mandates. They get credit for addressing social problems (e.g., disability access, welfare reform) while lower tiers bear the financial burden.

• Examples: Americans with Disabilities Act (ADA), Clean Air Act Amendments, welfare reform requiring states to garnish wages.
• The 1995 Unfunded Mandates Reform Act aimed to curb this, but its prospective nature and easy override mechanisms suggest the issue will persist as long as political incentives remain.

4. American Federalism's Functional Evolution: A Shift Towards Competence

Despite the fact that each party is only half right in its understanding of the nature of the federal system, the overall direction of public policy has been moving in a quite sensible direction.

Post-war growth and complexity. Modern federalism, born during the New Deal, experienced a significant growth spurt during the Great Society era (1960s-1970s). National domestic expenditures surged from 9% to 15.5% of GNP between 1962 and 1990, with state and local spending also increasing. This period saw the rise of "marble-cake" federalism, with extensive intergovernmental programs and regulations.

National focus on redistribution. Empirical data reveals a clear trend consistent with functional theory: the national government's spending increasingly concentrated on redistribution.

• Redistributive spending: More than doubled from 4.8% to 10.3% of GNP (1962-1990).
  • Social Security and Medicare: Increased from $73 billion to $398 billion.
  • Welfare and poverty programs: Grew from $30 billion to $108 billion.
• Developmental spending: Increased modestly from 4.2% to 5.2% of GNP, with transportation actually declining as a percentage of GNP.
• Even during the "Reagan retrenchment," redistributive spending continued to grow in real terms, demonstrating its entrenched political support.

State and local focus on development. Conversely, state and local governments maintained their primary focus on developmental activities.

• Developmental spending: Remained dominant, with states pouring money into education ($41 billion to $167 billion) and safety services ($15 billion to $55 billion).
• Redistributive spending: Increased only slightly from 2.2% to 3.5% of GNP, despite the civil rights movement and Great Society initiatives.
• This divergence suggests a functional specialization, with the national government handling broad social safety nets and lower tiers managing local infrastructure and services.

5. State Policy Variation: Wealth, Politics, and Demographics Shape Spending

The amount that states spent for which they were reimbursed by federal grants-in-aid was excluded from the calculation.

Persistent disparities. Despite increasing national economic integration, significant variations in state and local government expenditures persist, showing little sign of diminishing over the past three decades. These differences are influenced by a complex interplay of economic, demographic, and political factors, rather than converging towards uniformity.

Determinants of developmental spending:

• Taxable Resources: Wealthier states spend significantly more on developmental programs, reflecting higher demand for public services.
• Central City Population: States with a higher percentage of residents in central cities spend more on development, likely due to higher service costs, monopoly effects, and diseconomies of scale.
• Professional Legislatures: States with more professionalized legislatures (higher salaries, more staff) tend to spend more on development, as career politicians seek to expand government services to claim credit.
• Partisanship: States with more Republican legislators tend to spend more on development, aligning with the party's focus on economic growth strategies.

Determinants of redistributive spending:

• Taxable Resources: Wealthier states also spend more on redistribution, though less responsively than for development, suggesting that charity is less income-elastic than demand for public services.
• Population Density: Densely populated states spend more on redistribution, as greater social interdependency creates more demand for social services.
• Central City Population: Similar to development, a higher percentage of central city residents correlates with increased redistributive spending.
• Professional Legislatures: Professionalized legislatures also lead to higher redistributive spending, as politicians expand services.
• Partisanship: States with more Democratic legislators spend more on redistribution, reflecting the party's ties to lower-income groups.
• Minority Population: States with a larger minority population spend less on redistributive services, suggesting a "perverse effect" possibly linked to perceptions of "undeserving" poor and underrepresentation of minority interests in state legislatures.

6. The Welfare Magnet: A Race to the Bottom in State Assistance

The lower the benefit, the more repellent the state is to poor people—both by encouraging poor residents to leave and by deterring other poor people from moving to the state.

Declining state welfare benefits. After steadily increasing for over three decades, the real value of state-funded Aid to Families with Dependent Children (AFDC) benefits began a consistent decline after 1970, falling by 42% by 1993. This conservative drift in state welfare policy is a stark contrast to earlier trends and is driven by several factors.

Causes of decline:

• Slow Economic Growth: While overall family income grew, hourly wages for average workers declined, creating a tighter budget for middle-income families who fund welfare. However, this only partially explains the drastic cuts.
• Changing Perceptions of the Poor: AFDC became increasingly associated with "undeserving" poor (unmarried mothers, long-term dependents), despite actual welfare statistics showing stable racial composition and declining long-term dependency. This perception, possibly fueled by racial prejudices, influenced public support.
• Federal Offsetting Increases: Crucially, federal welfare benefits (Food Stamps, Medicaid, Earned Income Tax Credit, SSI, housing assistance) expanded significantly (70% increase in real terms for families with children between 1975-1990). States, seeing the federal government assume greater responsibility, reduced their own contributions, knowing federal programs would partially compensate recipients.
• The Welfare Magnet Effect: States actively cut benefits to avoid becoming "welfare magnets," attracting poor people from other states. Empirical evidence confirms that higher state benefits correlate with faster increases in poverty rates, and states respond by cutting benefits.

Intensifying race to the bottom. The proposed elimination of AFDC entitlements and replacement with fixed federal block grants (as seen in 1995 proposals) is predicted to intensify this "race to the bottom." States will face increased pressure to cut benefits further to avoid bearing the full cost of any increase in welfare recipients, potentially leading to severe adverse effects on the most vulnerable populations.

7. Federal Grants: A Blend of Equity Goals and Political Self-Interest

The allocation of federal aid among the states seems to be influenced by factors identified by both functional and legislative theory.

Conflicting expectations. Functional theory expects federal grants to equalize state fiscal capacities and address needs like poverty. Legislative theory, however, predicts that grants will be shaped by congressional self-interest, favoring constituents and avoiding redistribution from wealthier to poorer states. The reality is a complex mix of both.

Distribution of developmental aid:

• Wealthier states benefit: States with higher taxable resources receive significantly more developmental aid, contradicting the equity goal of functional theory. This reflects legislative theory's prediction that representatives from wealthier states ensure their constituents receive a proportionate return on their federal taxes.
• Small and rural states benefit: States with smaller populations and higher rural percentages receive more developmental aid per capita, demonstrating the overrepresentation of these interests in the Senate.
• House Public Works Committee influence: Membership on this committee correlates with increased developmental aid for a state, suggesting some "pork barrel" influence.

Distribution of redistributive aid:

• Poverty-responsive: States with higher poverty rates receive more redistributive aid, aligning with functional theory's expectation that the national government addresses social needs.
• Tax effort rewarded: States with higher tax effort (indicating greater local demand for public services) receive more redistributive aid, suggesting that federal funds supplement existing state commitments.
• Densely populated states benefit: Denser states receive more redistributive aid, likely due to greater social interdependency and associated problems.
• House Ways and Means/Education and Labor Committee influence: Membership on these committees correlates with increased redistributive aid, indicating that these powerful committees can direct funds to their members' states, even for formula-driven programs.

Presidential vs. Congressional influence. While presidents can dramatically impact the overall level of federal aid, they have less effect on the allocation of aid among states. The distribution pattern remains remarkably stable over time, driven by long-term power relationships and the need for broad legislative coalitions.

8. Big Cities' Fiscal Predicament: A Tale of Two Belts

Big cities are often thought to be the Achilles' heel of the federal system.

Divergent urban trajectories. Big cities face significant financial challenges, but these differ markedly between the older "Rust Belt" cities (Northeast, Midwest) and the newer "Sun Belt" cities (South, West). This divergence stems from historical economic advantages, political traditions, and demographic shifts.

Rust Belt cities' challenges:

• Eroding monopoly: Historically enjoyed monopolistic control over valuable land at transportation hubs, leading to less market discipline.
• High costs: Developed large, often inefficient bureaucracies with strong public-sector unions, leading to higher wages and work-rule concessions.
• Demographic decline: Experienced significant population loss (from 14.5% to 8.0% of U.S. population, 1957-1990) and increasing concentrations of low-income minorities.
• Higher spending: Spend 28% more per person than the average local government, with per-pupil education expenditures consistently higher than the national average, yet often yielding poorer educational outcomes for minorities.

Sun Belt cities' characteristics:

• Competitive environment: Grew as highway cities, facing more competition and adopting more efficient, business-oriented governance models.
• Lower spending: Generally spend less per person than the average local government, and their per-pupil education costs are now below the national average.
• Population growth: Experienced substantial population growth, often through annexation, increasing their share of the U.S. population.

Aid distribution. Both Rust Belt and Sun Belt cities received increased national aid during the cooperative federalism era, but this aid was cut back after 1977. Despite these cuts, big cities still receive about 50% more federal aid per capita than other local governments. Rust Belt cities historically received more state aid and have maintained a higher level of state support compared to Sun Belt cities, which receive significantly less state aid. This suggests that Rust Belt cities' fiscal problems are more rooted in their internal cost structures and legacy of inefficiency rather than a lack of external support.

9. The Inevitable Price of Federalism: Persistent Fiscal Disparities

The federal system is going to suffer from fiscal disparities for decades to come.

Unavoidable inequalities. Even with optimal functional alignment, federalism inherently carries a price, most notably in persistent fiscal inequalities among states and localities. People tend to segregate by income, leading to significant differences in taxable resources, tax effort, and public service spending across jurisdictions. This stratification, while less extreme than racial segregation, remains substantial and has not diminished over time.

Legislative constraints. The political realities of a federal system make it difficult to rectify these disparities through legislative action.

• Electoral incentives: Legislators are elected to represent their constituents' interests, making them reluctant to vote for policies that tax their wealthier constituents to benefit poorer areas.
• "Fair share" mentality: Constituents expect their representatives to bring home a "fair share" of federal resources, often proportionate to their tax contributions, rather than supporting broad redistribution.
• Court limitations: While state courts have sometimes mandated equalization of per-pupil education spending, implementation by state legislatures often faces strong resistance from wealthier communities.

Efficiency vs. Equity. The trade-off between efficiency and equity is a core challenge. While local autonomy fosters efficiency and responsiveness to local needs, it also allows for significant disparities in public services. A society must decide the acceptable level of inequality in public services, especially when it accepts considerable inequality in the private sector. The argument for public-sector equality is strongest for education, where equal opportunity is a foundational principle.

10. Policy Imperatives: Reinforce Functional Roles and Address Urban Challenges

The path the federal system is taking is basically sound. It is not a matter of overhauling or reversing the fundamental direction in which the system is moving.

Strengthening national redistribution. The national government should continue to expand its role in financing and setting standards for redistributive policies. This includes:

• National health policy: Designing a national health policy that limits state discretion to ensure essentially equivalent programs nationwide, preventing states from shifting health costs.
• Welfare reform: Implementing national welfare programs like substantial child allowances and expanded earned income tax credits (EITC) to replace AFDC, ensuring a safety net that doesn't force states into a "race to the bottom." The 1993 EITC expansion and Clinton's 1995 child tax credit proposal are steps in this direction.

Limiting developmental pork. The national government should continue to reduce its involvement in developmental projects. While some national coordination (e.g., scientific research, integrated transportation systems) is necessary, most developmental activities are best handled at state and local levels due to market discipline and local responsiveness. The decline of "pork barrel" spending, driven by fiscal deficits and tax indexation, is a positive trend that should be sustained.

• Unfunded mandates: While the 1995 ban on new unfunded mandates is politically popular, a strict interpretation could hinder necessary national coordination for issues like environmental protection or transportation. Mandates should be funded when they serve broader national objectives.

11. The Enduring Challenge of Urban Decline: A Haunting Tale

It is the lives of the minority poor isolated in our central cities that haunt the ending of this otherwise happy tale.

Rust Belt cities' unique struggle. The most significant unresolved challenge in American federalism is the social, economic, and political decline of older central cities in the Rust Belt. This decline is a complex issue, partly an unavoidable consequence of technological innovation eroding their historical monopolies and partly due to internal inefficiencies.

Factors contributing to urban decline:

• Technological shifts: Advances in transportation and communication continue to decentralize economic activity, drawing businesses and residents away from congested, older urban cores to suburbs and newer regions.
• Concentration of poverty: Aging housing stock in central cities attracts lower-income residents, exacerbated by suburban land-use restrictions that limit affordable housing options elsewhere. This leads to a disproportionate concentration of poor minorities.
• Legacy of inefficiency: Historically, Rust Belt cities developed large, often inefficient public-sector bureaucracies with strong union influence, leading to higher service costs that are difficult to retract, further hindering their competitiveness.

Limited external solutions. Neither state nor national governments are likely to assume the full fiscal burden of these cities. While federal and state aid exists, it's insufficient to offset deep-seated structural problems. Big cities must find internal solutions.

• Private sector delivery: Cities need to explore private-sector delivery of publicly financed services to improve efficiency and reduce the burden of organized labor and cumbersome bureaucracies.
• Education reform: Education, often a third of municipal budgets, is a prime area for reform. Despite rising per-pupil spending, central-city schools often show poor outcomes for minority students. Tuition vouchers, though controversial, could offer a path to greater efficiency and choice, potentially breaking the cycle of decline.