These levels of government are facing fiscal pressures from similar sources as the federal government -- rising health-care costs, free falling revenues, an aging workforce and pension obligations. One could argue indeed that state and local governments are the proverbial canary in the coal mine, the first to deal with a flood of fiscal sacrifices that will eventually wash across the beltway. And their fiscal actions now constitute a significant drag on the recovery, with more dire prospects ahead as federal stimulus funds expire.
But we could say the same for many key sectors of the private economy -- energy and communications are but a few of the giants that could be at the table as well. So, why do state and local governments merit a unique place at the table of federal budget deliberations?
In a federal system, federal, state and local governments all depend on a fiscal commons -- the share of economic resources that we collectively decide to devote to government.
In recent decades, the spending and revenues of different levels of government have become increasingly intertwined. State and local governments have become more dependent on federal aid to fund key services. In an historic first, federal government assistance to states and local governments has supplanted sales, property and income taxes as the biggest source of revenue for state and local governments. It appears that, with the stimulus, federal assistance will account for 41 percent of all state revenues through 2010.
While not as widely known, the federal government increasingly depends on state and local governments to implement nearly every major domestic policy initiative taken at the national level since the New Deal. Employing nine times as many employees as the national government, state and local governments have become the real governmental workhorses, responsible for the stewardship of a daunting range of national responsibilities. As Ray Scheppach of the National Governors Association reminds us, the state and local sector will be responsible for the health care of more Americans than Medicare thanks to the expansions of Medicaid and the new health insurance exchanges ushered in by health reform.
Health reform is only the latest in a growing number of federal programs where an expanding federal role has been enabled by the allure of relying on the fiscal resources, legal authority and public legitimacy of state and local governments. An ever growing list of federal mandates and preemptions have become a fiscal yoke crowding out other priorities within tightly constrained state and local budgets. Federal grants have become the Trojan horse, containing a daunting variety of conditions and mandates of their own. Concurrently, federal preemptions of state tax policy, such as the prohibition preventing state sales taxes for goods sold over the internet, exacerbate the dilemmas faced by states in financing their expanded national responsibilities.
As the president's deficit reduction commission considers spending cuts and tax increases, it may well be tempted to adopt strategies further pushing costs down to other levels of government. Some of these actions may be warranted -- the federal financial role for such areas as highways or education may very well need to be reexamined.
However, the commission should be mindful that unilateral federal fiscal actions, while politically tempting, will exact a steep price for our system of shared governance. Go-it-alone fiscal actions risk overgrazing the fiscal commons shared with state and local partners and continuing the erosion of state and local fiscal capacity and adaptability that is the hallmark of a healthy federal system. Imbalances can also result when governments separately impose tax burdens on the private economy without carefully considering their aggregate impact on economic efficiency and equity.
Ultimately, such actions threaten to confuse the public, making it difficult to apportion blame and accountability for the results of fiscal sacrifice, both good and bad. Paradoxically, as federal fiscal limits have prompted greater reliance on states for national programs, the federal government itself has a rooting interest in sustaining strong state and local governments, whether it knows it or not.
By contrast, concerted and coordinated action across the levels of government in our federal system provides the best prospects for resolving the fiscal challenges in the most expeditious and effective manner. Since most public problems spill over the boundaries in our system, collaboration across governments offers the most effective way to address shared problems through shared governance and financing.
One example of how such a process of fiscal collaboration might produce win-win outcomes involves the consideration of a consumption tax, or a value-added tax. The United States is the only major advanced nation without a national consumption tax, and a VAT could help address the growing federal fiscal obligations of an aging society. A VAT has advantages for states and local governments as well, since it would reach the growing service economy that retail sales taxes do not.
Absent an intergovernmental partnership, the danger to the states from a national consumption tax is very real. A federal government desperate to solve its own billowing deficits could enact a consumption tax unilaterally that would threaten to undermine state sales taxes. However, as Australia has shown, a national government can adopt such a tax with state and local governments sharing in the gains. States can piggyback on the expansive national consumption tax base, replacing their own declining sales taxes with a far more productive tax. An intergovernmental dialogue and a real policy-making partnership could lead to adoption of a consumption tax in this country that satisfies the fiscal interests of the entire public sector.
