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Commentary By Chris Pope

Degenerate Federalism

In practice, federalism has become largely a way of bilking U.S. taxpayers

Over the past few months, states and cities have been competing for the privilege of hosting Amazon’s second headquarters. To this end, Maryland has pledged a “blank check” in transportation spending tailored to the company’s needs, New Jersey has enacted bipartisan legislation to provide Amazon $7 billion in tax credits, and Chicago is proposing to give the company $1.32 billion in personal income taxes paid by its workers. But residents of those localities concerned about a “winner’s curse” shouldn’t worry — taxing and spending by state governments is now heavily subsidized by federal taxpayers.

This practice of cost shifting has produced a dynamic characteristic of modern American federalism: an intensifying competition between states to shift costs to federal taxpayers. The major responsibilities of state governments (education, Medicaid, transportation, social services) involve opportunities to claim federal funds, and so the art of state government has largely become an effort to find increasingly creative ways of expanding expenditures by making such claims.

In theory, federalism is a pillar of conservatism, but in practice, conservatives find themselves increasingly preoccupied by the need to reform a system of state–federal relations that has become structured to eliminate fiscal responsibility. The capping of the State and Local Tax (SALT) deduction was one of the most controversial elements of the tax-reform legislation passed at the end of last year, and the inability to reform Medicaid’s open-ended system of matching funds doomed the attempt to repeal and replace the Affordable Care Act. This year, immigration enforcement has been stymied by “sanctuary cities,” while the Environmental Protection Agency has found its efforts constantly undermined by the State of California.

In The Wealth of Nations, Adam Smith observed that prosperity depended on the division of labor, which could be achieved in proportion to the size of the market. Trade would best flourish when least impeded by parochial regulations. To achieve this end, Article I of the U.S. Constitution gave Congress the power to regulate commerce and restricted the right of states to impair it.

In a 1982 article, “The Two Faces of Federalism,” future Supreme Court justice Antonin Scalia suggested that the main reason conservatives so frequently defended the authority of states was that they had “simply been out-gunned at the federal level for half a century.” Yet he warned that “a tactic employed for half a century tends to develop into a philosophy.” Instead, Scalia suggested, conservatives should pursue a concerted agenda of federal legislation to protect markets from taxation and regulation by states.

Many conservatives believe that federalism offers the prospect of government regulated by market forces, constraining costly, oppressive, and corrupt policies — and thereby absolving activists of the hard work of winning elections and addressing the messy trade-offs inherent in enacting reforms. They draw on the theory of the late economist Charles Tiebout, who suggested that decentralizing the provision of public services offers individuals a chance to “vote with their feet” by moving to jurisdictions whose services offer them the best value for their money.

But Tiebout’s model is deeply flawed. Firstly, it assumes that people can easily move to cheaper states rather than being bound to their locations by employment, family ties, homeownership, or other personal attachments to places. Secondly, it assumes that politicians seek to maximize the size of their resident population rather than gain a plurality of votes. (As Andrei Schleifer and Ed Glaeser of Harvard University have detailed, Boston mayor James Michael Curley was happy that his policies caused WASP constituents to leave the city, since they tended to vote for his opponents.) Thirdly, taxation, spending, and regulation at the state level can only add to and layer upon the big government that already exists at the federal level.

It would be a stretch to claim that states’ rights were designed to safeguard free markets and individual liberty. While James Madison sought a federal veto on state laws (and others advocated the outright abolition of states) at the Philadelphia Convention of 1787, such proposals were understood to be incompatible with the need for the Constitution to be ratified by slave states. Even after slavery’s abolition, states’ rights owed much to the exigencies of Jim Crow, whose defenders were often happy to support expansions of federal programs so long as they didn’t threaten segregation but who occasionally insisted on delegation of management to states as the price of support. The state role in distributing federal welfare funds, for instance, is an artifact of concerns held by segregationist elements of FDR’s New Deal coalition.

To say that slavery and racial oppression would have been prevented by a stronger right of citizens to move is to imagine the national government’s restricting the rights of states. In Federalist No. 10, James Madison offered the core of his defense of the U.S. Constitution, arguing that smaller political communities would be more easily dominated by factional passions and interests able to “concert and execute their plans of oppression.” To alleviate this tendency, Madison recommended: “Extend the sphere, and you take in a greater variety of parties and interests; you make it less probable that a majority of the whole will have a common motive to invade the rights of other citizens.”

The power of states is often justified under the pretext that state governments are “closer to the people,” but the opposite is true. Americans know far less about state than federal politics, and turnout for state elections is much lower. Whereas federal policymaking is subject to constant scrutiny from thousands of publications and draws on research by a vast array of specialized think tanks and scholars, state policymaking is to a large extent an under-resourced, amateur enterprise, easily dominated by lobbyists whose self-interested claims are often the only source of relevant information.

Progressive Supreme Court justice Louis Brandeis sought to justify the power of states by calling them “laboratories of democracy” able to “try novel social and economic experiments without risk to the rest of the country.” Yet the number of people employed by state and local governments (7.6 million) dwarfs that of federal employees (2 million), meaning that lower levels of government are often dominated by public-sector unions. As a result, states are preoccupied with rising labor costs, and their policy innovation consists to a large extent of attempts to devise creative new ways of shifting those costs to the federal government.

Having been exempted from federal regulations designed to ensure adequate funding of employee pensions, for example, states now face multi-trillion-dollar shortfalls. The only realistic alternative to rapid, tighter federal regulation of state-employee pensions in the near term is likely to be federal bailouts down the road.

Most major items in state budgets are subject to a similar dynamic — and, in some of the largest programs, cost-shifting has become a cornerstone of the law. This is most clearly the case with Medicaid, which funds health care for low-income Americans. The federal government gives states one to three dollars for each dollar they spend delivering Medicaid services to eligible beneficiaries (and nine dollars for every dollar they spend on beneficiaries made eligible by the Affordable Care Act). This rewards states for inflating the cost of the program. In fact, 49 states tax hospitals for the sole purpose of padding Medicaid costs, for which they can claim federal reimbursement — revenue they then share with health-care providers to compensate them for participating in the scam.

Medicaid was originally intended to assist the poorest states, which have the slimmest tax bases and the greatest unmet medical needs. This is why some states receive just one federal dollar for each of their own that they spend, while others receive about $3. But this system nonetheless distributes federal funds according to how much states spend of their own money, and as a result the wealthy states that need the least help receive the most: Connecticut, for example, receives three times more funding per low-income resident than Alabama, despite Connecticut’s receiving just one federal dollar for each dollar of its own, compared with $2.50 for Alabama.

Rather than targeting funds to fill gaps in access to essential medical services for the poor, this arrangement has allowed wealthier states to expand entitlements to long-term care for the middle class. That people so frequently retire across state lines makes this a particularly silly way to distribute federal assistance for long-term care: In 2016, Florida received $629 per resident for Medicaid, compared with a national average of $1,035.

Because states can claim an average of two dollars from the federal government for every dollar they spend on Medicaid, they divert funds into Medicaid from other spending priorities. This generates political pressure for Congress to extend additional assistance to states, so that basic transportation and education responsibilities are not neglected. When states can pressure the federal government into picking up most of the cost of infrastructure projects, there should be little surprise that states propose “bridges to nowhere.”

Under unitary government, taxation is somewhat constrained by the Laffer-curve effect, whereby increasing taxes above a certain point reduces aggregate revenues. But when multiple layers of government have the right to tax, the total tax burden exceeds the amount that each level would independently deem optimal, as each layer of government seeks to claim resources at the expense of the others. Studying this phenomenon, known as “overfishing,” Christopher Berry of the University of Chicago has found that the aggregate rate of taxation tends to increase with the number of layers of government in a geographic area. The ability to deduct state and local taxes from federal tax obligations further exacerbates the problem, by essentially subsidizing high-tax jurisdictions.

The ease with which federalism can be used to expand the size of government has not gone unappreciated by sophisticated liberal strategists. Over the past four decades, Congress has done little to expand eligibility for the fully federal Medicare program, yet legislation to expand Medicaid was enacted in 1982, 1984, 1985, 1986, 1987, 1988, 1989, 1990, 1996, 1997, 1999, 2000, 2009, and 2010. As a result, the program’s enrollment soared from 20 million in 1985 to 70 million in 2015.

Federalism gives the Left two chances to make individuals dependent on government: once locally and once nationally. If state programs run out of money, Congress is often pressured into providing funds to avoid a catastrophe. This was why so many residents of blue states thought Obamacare necessary: State regulations imposing inflated premiums, provider networks, and benefits had broken private insurance markets, causing individuals to be unable to purchase affordable insurance from the individual market. It is no coincidence that the best-functioning part of the American health-care system is employer-sponsored insurance, which is specifically exempt from state regulation.

In a 1961 essay, “The Practice and Theory of Federalism,” the Canadian academic and future prime minister Pierre Trudeau argued that “socialists must consider federalism as a positive asset, rather than as an inevitable handicap.” Citing the “superb strategist” Mao Zedong, Trudeau went on to suggest that “the drive towards power must begin with the establishment of bridgeheads,” with federalism “allowing dynamic parties to plant socialist governments in certain provinces, from which the seed of radicalism can slowly spread.”

States’ rights have since given the Left an essential foothold from which to advance once-outlandish policies on abortion, drugs, marriage, and immigration. The notion that competition binds states to good sense and conservatism is naïve wishful thinking. Conservatives like to imagine that federalism offers an incremental way of slowing the speed of social change, but in reality, it tends to be a form of buck-passing, which serves as a substitute to crafting a sustainable solution at the national level.

Why has federalism tended to shift policy to the left? Antonin Scalia suggested that it was because the conventional conservative attitude to federalism amounted to a form of unilateral disarmament: “When liberals are in power they do not shrink from using the federal structure for what they consider to be sound governmental goals. But when conservatives take charge, the most they hope to do is to keep anything from happening.” While a Republican Congress is generally happy to enact legislation that leaves states the freedom to shift policy further to the left, Democratic Congresses are never so careless as to allow states to cancel out their efforts by shifting it back to the right.

What can be done about this state of affairs? In short, states need to be kept on a tight leash.  

Firstly, conservatives should stop imagining that state governments are necessarily champions of free markets. Even under the best of circumstances, they will always consist of politicians with their own purposes — including politicians in Albany and Sacramento who are seeking opportunities to shift the country leftward and fleece federal taxpayers.

Secondly, Congress needs to eliminate any incentive that its programs may establish for states to inflate their expenditures — which means turning matching funds into block grants, so that fiscal rights wouldn’t come without responsibilities.

Thirdly, Republicans should realize that handing out cash and passing the buck to states tends to leave difficult problems and trade-offs unresolved. It is easiest to address social problems in a targeted and efficient way if you do so directly.

We ought not to have an overly romantic view of federalism at odds with that of the architects of the Constitution. It is of the states, after all, that John Marshall was speaking when he warned: “The power to tax is the power to destroy.”

This piece originially appeared at National Review


Chris Pope is a senior fellow at the Manhattan Institute. Follow him on Twitter here.

This piece originally appeared in National Review