The Changing Face of Fiscal Federalism

Thomas R. Swartz, John E. Peck

• Publisher: Routledge
• Year: 2020
• ISBN:
  9781315289113
• Edition: 1
• Topic: Teologia e religione
• Subtopic: Studi biblici

A remarkable change has occurred in how we finance the public enterprise, yet this change has gone largely unnoticed by the general public. Policy makers in the federal, state and local levels of government have had to respond to this change. The causes of the change, future policy directions, and the eventual impact on society of this change is the subject of this book. Six of the nation's most influential economists, political scientists and sociologists have been asked to comment and their views can be found here.

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Six Profiles of the Changing Face of Fiscal Federalism: An Overview

THOMAS R. SWARTZ AND JOHN E. PECK

Overview

A truly remarkable sea change has occurred in how we finance the public enterprise, yet this change has gone largely unnoticed by the general public. Policy makers at the federal, state, and local levels of government have had to respond to this change. Individuals who have suffered its consequences have had to adjust to a new economic environment. It is only now, however, that experts in the field of government finance have begun to chart its future course. The causes of the change, future policy directions, and the eventual impact on society of this change is the subject of this book. Six of the nation's most influential economists, political scientists, and sociologists have been asked to comment on this change. Their views are found on the pages that follow.

What is this change that is of such concern to these experts? In simple terms, it is the reshaping of the system of providing basic government services, and who will pay the bill. In the past ten years, we have reversed policies that were established by federal lawmakers over the previous thirty years. What had been a clear and forthright policy to reduce vertical and horizontal fiscal imbalances among federal, state, and local governments has given way to the establishment of a new "competitive federalism" where governments are expected to finance their own activities. That is, our old system which was characterized by the federal government taking active steps to level up those governments that did not have the wherewithal to provide basic government services has been replaced by what John Shannon calls "fend for yourself federalism"—if a service cannot be paid for at the level where provided, then do without it.

The implications of operating in a competitive environment are, of course, the same for governments as they are for individual business firms. Revenues are revenues, whether raised through taxes or raised through the sale of products. In order to maximize its share of the pie, each governmental unit is required to measure its competition and to implement strategies that lead to survival and, hopefully, to establishing a cushion for future growth. The competitive upside of this policy is a public sector equivalent of Joseph Schumpeter's concept of "creative destruction"—the threat of bankruptcy will force a business enterprise (government) to operate efficiently. They will provide only those goods and services that their constituencies demand and they will provide these goods and services in the most cost-effective manner. Cities, towns, and even states that cannot compete, are simply left behind. Thus the structure of the public sector, like its private sector counterparts, will continually evolve. Those communities that are successful will not only attract new residents and businesses; they will attract imitators who will try to replicate their success. Those that fail will lose population and their economic base. Over time, these communities will simply disappear or learn the harsh lessons of the market and adapt.

The competitive downside is equally clear. When a city, town, or state fails, its elected officials and public workers face the prospect of unemployment, and those residents who are unable to flee must ultimately pay the price for this lack of market efficiency. Government services must be reduced. Taxes must be raised. And the community must brace for its eventual demise, since there is little chance for success under these circumstances. Reduced service levels coupled with higher taxes are certainly not conducive to attracting newcomers or retaining the existing population—particularly if the services that are cut and the taxes that are raised are those affecting the relatively affluent. The question then becomes: who can move and who is forced to stay behind in this competitive environment? Can the less affluent move to the flourishing communities? Can the mom and pop grocery stores leave their neighborhoods? Can the aged be uprooted and moved to new cities and towns? Probably not, since the poor do not have the financial resources to move, the small business units are often dependent upon a local market, and the aged are reluctant to start again in a new and strange place. Thus, when a city, town, or state dies, it traps within it those who cannot move. It traps those who are least able to compete. It traps the poor. It traps the small inefficient firms. It traps the aged.

In these circumstances, it can be argued that the true losers are the citizens who by historic accident happen to reside in less successful jurisdictions. These citizens must now weigh the net benefits of hanging on or of moving on to greener pastures. Critics question whether such a process when applied to the governmental sector is creative destruction or merely destruction. If it is the latter, it runs counter to the classical notion of public service.

This issue above all others is central to The Changing Face of Fiscal Federalism. The contributors to this volume are noted authorities on American fiscal federalism. They outline the historic and philosophical foundations of our system of intergovernmental finances. They discuss how responsibilities of the various levels of government are now being sorted out. They consider what new commitments and related costs must be shouldered at each level of government, and they consider how we are likely to pay for the new set of obligations.

Leveling the Playing Field

In 1966, Walter Heller, the principal architect of the fundamental changes in the nation's economic policy under President John F. Kennedy, wrote: "Federal-state-local fiscal relations are at last on the threshold of a promised land created by vigorous economic growth and balanced political reapportionment [emphasis added]."¹ With respect to the fiscal implications, Heller referred to his concept of intergovernmental fiscal relations, a system of federal revenue sharing that was both pragmatic and generous. The ideology underlying Heller's optimism—later to be supported by Presidents Johnson and Nixon and finally implemented by Nixon in his policy of "New Federalism"—is best described as a ' 'leveling of the fiscal playing field" for all governmental entities. While virtually every form of grant-in-aid contains an element of generosity on the part of the granting government, some came to view this particular form of sharing as the most generous ever conceived by the federal government, since it avoided the narrowly defined and closely regulated aspects of "categorical" programs. In practice, general revenue sharing, which was put in place in 1972 and finally lifted in 1986, had virtually no strings attached. That is, these federal grants could be used by state and local governments for nearly any purpose they chose.

The revenue sharing idea was first suggested by Henry Clay in the 1820s. It was a part of his "American System"—the basis for the domestic side of the Whig party's program. The first modern bill was introduced by Melvin Laird in the Eisenhower years, but Heller and Joseph Pechman, on the scene during the Kennedy and Johnson years, were the persons that must be given credit for giving real form to the notion that was finally implemented in 1972.² By then, the Advisory Commission on Intergovernmental Relations (ACIR) had dubbed the concept as "an idea whose time has come."³ The need for leveling up was based on the conviction that in terms of both efficiency and fairness, fiscal federalism should be reshaped to "relieve immediate pressures on state-local treasuries, improve the distribution of federal-state-local fiscal burdens, reduce economic inequalities and fiscal disparities, stimulate state and local tax efforts, and build up the vitality, efficiency, and fiscal independence of state and local governments."⁴

In 1960, before Kennedy's New Frontier, Johnson's Great Society, and Nixon's New Federalism and, therefore, before the notion of leveling up had gained widespread support, there were some one hundred thirty separate categorical aid programs which almost exclusively benefited state rather than local governments. These categorical grants were narrowly drawn. The money received could only be spent on the activity that was clearly and concisely specified by the grantor government. Four of the most important categorical grant programs were those that provided employment security, aid to families with dependent children, highway support, and aid to the aged. These four programs alone accounted for 75 percent of total federal grant outlays.

Over the next eighteen years, Congress and the administrations of four presidents had little difficulty adding a number of grant-in-aid programs which by 1978 made up what we know as our system of fiscal federalism. It was the era of new programs: The Economic Opportunity Act, Medicaid, Title I and H of the Elementary and Secondary Education Act, Manpower Training and Development Act, Comprehensive Employment and Training Act, Community Development Block grants, Law Enforcement Assistance Act, and the Economic Development Administration.

President Richard Nixon wrote in his memoirs that the Kennedy and Johnson administrations had erroneously emphasized a centralizing approach to correcting social problems that confront modern industrial countries. He maintained that this "undermined fundamental relationships within our federal system, created confusion about our national values, and corroded American belief in ourselves as a people and as a nation."⁵ Nixon's concept of a "New Federalism" was intended to right these wrongs and to reverse the flow of power from the federal government to the states and localities. "The 'New Federalism': revenue sharing, government reorganization, and welfare reform were all directed toward satisfying the national conscience while returning control to the states and localities through a selective decentralization."⁶ With the passage of the State and Local Federal Assistance Act of 1972, general revenue sharing became the cornerstone of Nixon's "New Federalism." As with virtually all of the Nixon second term initiatives, the protracted fight for his administration's survival and the eventual fall of his presidency diminished the efficacy of the "New Federalism." Nixon's Special Assistant and an important contributor to the new federalism policy, William Safire, reported of the despair expressed by his administration colleague, George Shultz, for what might have been: "What a waste. In the first term we discovered where the levers were, how to actually change the direction of power away from Washington Here was a new term, a real mandate, a chance to put some good ideas into action. Now it's all gone up in smoke. We had it in our hands to do such great, sound things, in the way that was right for the country. We had it right in our hands."⁷ In dealing with issues of fiscal federalism, President Gerald Ford moved to regain the initiative that the Nixon administration had lost. This new short-lived administration consolidated categorical grant programs into broad block grants. This effort, which allowed state and local governments to spend federal grant monies on a broad array of related programs, represented mid-ground between the unconditional general revenue sharing grants and the narrowly drawn categorical grants. Thus, the Ford effort continued the process of decentralization that was achieved by the general revenue sharing program of 1972, the manpower revenue sharing program of 1973, and the community development block grant program of 1974. The 1976 renewal of general revenue sharing that passed through Congress with Ford's endorsement marked the last fiscal federalism initiative that was introduced during the Ford years.

By the late 1970s, the 130 categorical aid programs of 1960 had given way to more than 500 assistance programs. This financial aid was distributed directly to more than 80 percent of the nation's local govern-ments.⁸ Thus, in 1978 the federal government was a major actor in the affairs of state and local governments. Indeed, in 1978, federal aid as a percent of state and local outlays reached its zenith. In that year, more than 25 cents of every dollar spent by lower levels of government was provided by the federal government. This invasion of the federal government into the affairs of state and local governments began to cause widespread concern. Which "piper called the tune"—the federal government that supplied the tax dollars or the state and local governments that spent them? Others worried about the loss of economic efficiency in the system. Would state and local governments be fiscally responsible if they did not generate the tax dollars they spent? Still others were concerned that there were no disincentives for state and local governments to initiate new spending programs. It could be argued, in fact, that the presence of categorical grants would actually encourage these governmental units to adopt new programs, whether they needed them or not. What state or local government could pass up an opportunity to offer its constituency the benefits of a new program if someone else was going to pay the bill?

Competitive Federalism

In retrospect, it is clear that the years from 1960 to 1978 were the "golden years" of fiscal federalism for state and local governments. Many of these governments began the period with severe fiscal stress: there was rural poverty in Appalachia, the urban poverty particularly in the older cities of the Northeast and Great Lakes states, and lagging economies found in the " old South," Nearly all of these regions and cities emerged at the end of the "golden years" well on the way to financial health. Budget surpluses were commonplace. The impact of the Kennedy/Johnson Appalachian Programs was realized at the same time as energy prices rose in the face of OPEC's efforts to squeeze oil supplies. This coincidence of events caused the once idle coal region to find a new life. The worst of the urban blight disappeared and some of the most distressed cities began to experience a renaissance. Lastly, the South began to stir. President Johnson moved the space industry southward, and soon other industries followed suit as they left the snowbelt in search of the now air-conditioned South and Southwest.

America seemed to have turned a corner. The need to level the playing field was less obvious. Perhaps we thought that the problems of the poor were solved when we no longer saw the rawest, meanest side of poverty, and the physical decay of our cities was largely eliminated. Or, we believed that the devastating consequences of racism were behind us when steps were finally taken to integrate the public schools. Or, we trusted that all cities were financially secure once the near financial collapse of some major urban places such as New York, Cleveland, and Newark was averted. Whatever the cause, we began to act as if our cities, towns, and states could go it alone and pay their own way.

Our national mood suddenly changed in the late 1970s. To be more precise about this, our national mood began to change on the morning of June 7,1978. That was the morning when Californians went to the polls and passed Proposition 13 (the Jarvis-Gunn Amendment). This 389-word amendment to the California State Constitution set in motion a radical shift in our system of fiscal federalism. In one bold stroke, it reduced the most important source of local government tax revenues, the property tax, by 57 percent and saved local California taxpayers nearly seven billion dollars per year. It established a property tax rate limit of 1 percent for all real property—that is, the nominal property tax rate applied to all homes, farms, factories, businesses, and vacant lots. It rolled the 1978 assessment levels back to amounts that existed in 1975-76⁹ and froze them at that level until the property was sold or improved. It limited future yearly increases in individual property tax bills to a maximum of 2 percent per year, and mandated that the state legislature obtain a two-thirds majority of both houses if it were to increase any other tax in California.

Within months of the passage of Proposition 13, numerous states followed the California lead by placing tax/expenditure control referenda before their voters. The airwaves and the print media were filled with news of Michigan's Headlee Amendment, Massachusetts' Proposition 21/2, Florida's Proposition ...

Table of contents

• Cover
• Title Page
• Copyright Page
• Dedication Page
• Contents
• Illustrations
• Preface
• 1 Six Profiles of the Changing Face of Fiscal Federalism: An Overview
• 2 The Deregulation of the American Federal System: 1789–1989
• 3 Federalism and Urban Policy: The Intergovernmental Dialectic
• 4 Changing Federalism: Trends and Interstate Variations
• 5 State Finances in the New Era of Fiscal Federalism
• 6 Big City Finances in the New Era of Fiscal Federalism
• 7 The Economics of Fiscal Federalism and Its Reform
• Index
• About the Contributors