Coming to Grips with Fiscal Realities

Financial pressures demand transformation but transformative government demands broad authority -- something federal policies make difficult.
by | August 15, 2007
 

In the 1980s, Australia faced economically ruinous budget deficits exceeding 4 percent of its economy. Facing a collapse of confidence from international credit markets, the nation's leadership set about to right the fiscal imbalance, pulling the nation out of the teeth of fiscal ruin and ultimately into surplus for many years since.

While Australia's record of fiscal responsibility is envious, one of the strategies it used was not as admirable: to shift costs to its states. Fiscal leaders made significant cuts to grants to the states, viewing states as "hollow logs" that had the capacity to absorb these cuts with offsetting actions of their own.

The shifting of fiscal imbalances is a tempting strategy for hard-pressed leaders at all levels of government in a federal system. As long-term models prepared by the GAO and CBO show, the modest federal budget deficits of today will explode in as little as 10 years, reflecting the costs of baby-boom retirement and rising health care costs. However, a recent GAO study shows that state and local governments cannot serve as "hollow logs" to accommodate federal budgetary reductions. Assuming no change in spending or tax policy at the state and local level, GAO simulations show that, over the next 40 years, state and local governments' fiscal outlook will deteriorate, both for the general fund balance (darker line) and for total unified expenditures and revenues. The primary driver is the same factor that is bedeviling federal finances: the exponential growth of health care costs reflected in higher state spending for both Medicaid and state-employee health insurance.

The implications of the gloomy fiscal outlook for both sectors suggests that a resolution should be achieved through a collaborative process. Such a process might engage actors from all levels of government to rethink the roles of each level of government in common areas, reflecting the increased interdependence of responsibilities across our intergovernmental system for education, transportation, and health care.

However, the prospects for such joint policymaking are not bright. A new issue of Publius: the Journal of Federalism contains a retrospective of how federalism has fared in the Bush era. 1 Despite an administration and Congress that were among the most conservative in the postwar era, it is notable that federal officials took actions to centralize power and impose additional costs on state and local sectors that were the equal of any era in our postwar period. Unlike many other Administrations, moreover, there was no concerted federalism initiative to turn back or devolve power to the states or localities.

The recent history of federal mandates and preemptions illustrates the problems and dilemmas. The administration and a Republican Congress defined themselves by major new domestic policy initiatives that constituted major policy departures and federal role expansions involving centralization of areas traditionally controlled by states and localities, in many cases with bipartisan support:

o Education. The passage of No Child Left Behind--a signature domestic priority of the administration--marked the most significant centralization of education policy at least since the Great Society.

o Welfare. The 2006 amendments to TANF significantly recentralized a program that was considered a triumphant example of devolution to the states, with new work requirements and restrictions on flexibility that enabled states to shield hardest-to-serve clients from federal work requirements.

o Homeland security. The administration and Congress adopted grants and mandates that, together, served to centralize emergency preparedness, infrastructure and other state and local services. The passage of the Real ID Act is illustrative: States have been saddled with federal standards for driver's licenses estimated to cost over $11 billion. Election administration. The Florida election crisis in 2000 prompted passage of the 2002 Help America Vote Act instituting sweeping new federal standards requiring new voting systems, provisional ballots, statewide voter data bases and standards, and access to polling places for disabled persons.

o Taxation. The major changes in depreciation, dividends, and estate taxes ushered in with the tax cuts of 2001 and 2003--central to the Bush economic agenda--presented states with a significant erosion of their income tax bases, forcing states to acquiesce and accept their consequences or decouple from the federal tax base. The phase-out of the shared federal-state estate tax regime through 2010 is estimated to cost states that don't decouple from federal tax bases as much as $9 billion annually. The state sales tax regimes continue to be threatened with federal preemption, as Congress extended the preemption of state authority to tax Internet access in 2004.

The presence of the congressional point of order on unfunded mandates enacted in 1995 was not able to stem this centralizing tide--many of these mandates were enacted as conditions of aid or tax policy, which are excluded from the mandate reform's purview.

The roots of federal mandates and preemptions run deep through the modern political system. Changes in our party system have converted national elected officials from being ambassadors of state and local party leaders to independent political entrepreneurs anxious to establish their own visible policy profiles to appeal to a diverse coalition of interest groups, media and an increasingly independent base of voters. These trends toward congressional and presidential policy activism span partisan boundaries, obscuring differences on federal role questions that used to define our party system. The relatively recent shift of business groups from allies of the states to advocates of national regulation further underscored the nationalization of the policy agenda in the American system, reflecting the policy implications of a more globalized economy. In truth, many of these mandates had broad support not only from both parties, but from many state and local officials themselves, as they often nationalized and even provided additional funding for policy innovations initiated by state and local governments.

Does the centralization of policymaking in our system preclude a collaborative approach to our long-term fiscal challenges? Will the needs and concerns of the intergovernmental system be adequately considered when the time comes to consider such issues as tax policy, health care, pension reform, infrastructure finance, and other key problems that will have to be addressed sooner or later by policymakers? These are questions that I will address in my next column.

Tim Conlan and John Dinan, "U.S. Federalism and the Bush Administration." Publius: The Journal of Federalism, 37:3 (Summer, 2007).

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