Federal Aid To States

A down economy always catalyzes calls for increased government spending on all manner of “relief” programs. It has long been a mystery to me where people get the idea that money spent by government appears magically from the wellspring of good intentions — that resources used by government are not extracted from use elsewhere but are “free” and, therefore, painless. I suppose it comes from the fantasy that it is always possible to arrange for “someone else” to pay for those resources — that “I” (and everyone else) can assign the pain to “you” and take the benefit for myself. How to make that selfish arrangement seems to be a primary topic of debate in modern political discourse.

One peculiar form of that fantasy is the perpetual call for the federal government to “assist” the states in whatever projects — or messes — they have undertaken. The federal government distributes money to individual states for transportation, for health care, for welfare, for law enforcement, for education, and for a host of other things. And with every economic downturn, as government budgets go into crisis when tax revenues fall, calls for increases in federal aid to make up shortfalls in state government budgets are added to the general cacophony of demands for more government spending overall.

The most recent economic downturn was no exception. But this time the calls for federal assistance to the states were made more exasperating by the fact that much of the crisis was the result of irrational long-term spending decisions that had been locked into place during the economic boom which preceded it, when state government officials acted as if the extraordinary revenues generated by the boom would continue forever.

This piece was submitted to the San Jose Mercury News but not published.

15 January 2003

With the announcement of the latest economic package in Washington, and with state budgeting processes starting across the country, there has been a great deal of discussion recently of the need for the federal government to come to the rescue of states suffering the ill effects of a bad economy. This week Governor Davis insisted that the national treasury offset California’s expenditures for security and immigration (among others), and similar pleas have been heard from many state and local leaders and from congressional democrats criticizing President Bush’s spending priorities. The current economic woes have wrought havoc across the country — I know of no states which are not facing budget shortfalls — and help from Washington would certainly seem to be one way to blunt the effects. But that is a mirage.

The idea of federal assistance for the states makes a kind of sense if it is viewed as a form of insurance, a mutual-aid pact administered by the federal government to spread the risk of short-term local problems. If today California is down and New York is up, so money flows from east to west, tomorrow it may be the other way around; in the end it roughly balances out and, even if the balance is not perfect, the resulting risk reduction and stability increase is worth the overhead cost. Even if, in fact, the roles never reverse — if West Virginia is always a recipient rather than a donor — that is a matter of circumstance not structure, no different than auto or home insurance in which some high-risk people collect often and most never need to.

However, demanding additional federal assistance to offset misfortune that is national in scope makes no sense at all. If all states need assistance at once, there is no possibility of mutual aid: the federal government cannot reallocate money among the states; it must manufacture it, either by cutting expenditures on its own responsibilities, extracting more money from the citizens, or borrowing against future earnings.

But of course those are precisely the options available to the individual states. Demanding federal assistance to make up state budget shortfalls nationwide is purely an exercise in passing the buck: ask the President and the Congress to make difficult and unpopular choices so the Governors and Legislatures won’t need to. If the solution is program cuts, they are likely to be as painful — and as controversial and difficult to implement — at the federal level as at the state level. If it is borrowing, the federal and state governments are pulling from the same capital pool and making the same long-term commitments. If it is tax and fee increases, they are collecting from the same citizens and corporations. And, in all those cases, a federal program of assistance forces a single menu of tradeoffs that everyone must live with rather than individualized tradeoffs that can vary between states depending on local circumstances and needs.

In fact, from a revenue standpoint, an economic downturn is likely to be less painful for the states than for the federal government because federal revenues are tied almost entirely to economic activity (sales and income taxes), whereas most states and municipalities collect some taxes on assessments of fixed capital assets (property taxes) and on user fees (automobile registrations and the like) which are less volatile during short-term economic swings.

It is true that state governments across the nation are in short-term financial trouble. The solution, however, is not passing the buck to the federal government. The solution is to develop, at the state level, individual long-term plans for fiscal stability that account both for each state’s unique needs and resources and for the cyclical nature of revenues.

In the short term, that will require some combination of spending cuts, tax and fee increases, and borrowing — a combination that should and will be different from state to state — to get through the immediate crisis. In the long term, it requires state and local governments (and the federal government as well) to manage revenues and expenses in a more rational manner than they have in the past, basing persistent spending commitments and tax rates on long-term average revenue prospects rather than on short-term peak projections, borrowing to fill short-term budget gaps during bust times, paying down debt (and building reserves) during boom times, and using revenue windfalls in good years to fund one-time capital or project expenditures rather than as a down payment on permanent spending commitments.

© Copyright 2003, 2005, Augustus P. Lowell

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