As with most policy initiatives, deficit reduction started first in state and local governments. Thanks to its unique role in the economy, the federal government was insulated from making hard choices. In fact, federal deficits increased partly due to federal efforts to bail out the rest of the economy, including states and localities.
The day of reckoning is fast approaching in Washington, however. With deficits exceeding peacetime highs of 10 percent of GDP and debt forecast to approach 100 percent of the economy by the end of this decade, it is simply a matter of time before the federal budget will have to undergo major surgery on both the spending and the revenue sides. Already, three commissions have weighed in with recommendations for over $4 trillion in deficit reduction over 10 years, and Vice President Biden has followed through with Republicans with over $2 trillion in spending cuts on the table.
There is strong evidence that state and local governments will be the primary victims of these federal fiscal actions. Since domestic discretionary spending will be capped and cut under nearly all proposals, cuts in federal grants are clearly in the offing. The president's fiscal-year 2012 budget included cuts of nearly $50 billion in grants funded from discretionary appropriations, reflecting both the expiration of Recovery Act funding and new cuts to programs such as Community Development Block Grants. Mandatory entitlements are on the block as well, with cuts in Medicaid matching reportedly being proposed by the administration in the Biden budget negotiations. More fundamental cuts are in store in the two major tax expenditures affecting state and local governments--deductibility of state and local taxes and tax-exempt bonds.
What should state and local governments do about this? I would argue that reflexive lobbying to retain everything might be self-defeating. In trying to protect everything, state and local lobbyists might paradoxically lose the most. They would lose credibility if they are perceived as being in denial on the central policy challenge facing the federal system.
Rather than being served up for dinner, it would be far better if state and local leaders were in the kitchen helping federal officials prepare the meal. This means being prepared to come to the federal table with a thoughtful proposal that triages state and local claims. I would hope that state and local organizations would use performance criteria to prioritize their claims. Only those programs with the highest potential bang for the buck and relevance should survive. States and localities can follow the advice of one former federal budget director who said that cuts should be concentrated on weak claims, not weak claimants.
What might such a proposal look like? Here is my take on what states and locals should propose:
Grant consolidation: The Government Accountability Office's report identifying widespread overlap and duplication in federal programs includes many grants. States and localities should develop consolidation proposals merging such fragmented grant programs as job training, transportation and emergency management. Given the greater potential efficiencies that may be realized, this process will reveal where cuts in federal funding can be proposed.
Grant targeting: Many grant programs are allocated to all states or eligible localities regardless of relative need or fiscal capacity by recipient jurisdictions. Thus, for instance, the Community Development Block Grant provides more funding per person in poverty for Greenwich, Conn.--one of the wealthiest towns in the nation--than Bridgeport, Conn.--a poor city perennially on the verge of bankruptcy. Targeting provides an excellent opportunity to propose reduced federal funding by allocating cuts disproportionately to those states and localities that can best afford to provide services from their own resources.
Tax deductibility: This is one of the weakest state and local claims on the federal budget. While state and local governments gain indirectly by lowering the price faced by their residents from state and local taxes, one study found that state and local governments gain only about 7 percent of the lost federal revenue from this deduction that costs $48 billion this fiscal year. Moreover, since the benefits accrue only to the minority of taxpayers who itemize their deductions, wealthier communities with the lowest relative need for additional taxes gain the most.
Consumption taxation: One of the federal commissions, the Domenici-Rivlin task force, proposed a national consumption tax of 6 percent. State and local governments have reflexively opposed this as an incursion on their sales tax. Rather than oppose, state and local governments should be at the forefront of endorsing this proposal, as long as it contains appropriate safeguards. If states were given the opportunity to piggyback on the federal tax, they could broaden the base of their increasingly limited retail sales tax to realize significant revenue gains with lower rates.
There are no guarantees that volunteering for fiscal sacrifice will earn state and locals a place at the table. In fact, it might invite federal officials to accept these proposals and assume that there is more where they came from. However, what makes these proposals compelling is that they would jettison programs and claims that are simply not justified in any era.
Fragmented, poorly targeted grants have always constituted weak claims that have needlessly expanded the cost of government at all levels. Tax deductibility comes with a high federal cost and little impact for the communities that need it most. And state and local sales taxes are losing their revenue yield thanks to the growth of the Internet economy and service sectors that escape their reach.
