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A Raw Deal

President Reagan’s call for a “New Federalism” deserves better than automatic praise by Republicans and equally reflexive criticism by Democrats. State-federal relations have been a subject of concern to local officials for years, and a national program to sort out those relationships is overdue. The fact that the administration’s program appears to have serious flaws should not detract from the fact that there is a need for change. It does, however, mean that serious, dispassionate examination should be made of the program.

Any proposal as far-reaching as President Reagan’s obviously starts off with the inertia of the status quo working against it. Its chances for success or failure will depend as much on the timing of the proposal as on its substance. And the timing is very bad indeed. The dismal performance of the economy, together with last year’s tax and budget cuts, has created enormous fiscal pressures on local governments in practically all but the energy-producing regions of the country. The state of Ohio, which recently passed a tax increase of $1.3 billion together with budget cuts in order to close its budget gap, now faces an additional deficit of about $1 billion as a result of the recession.

New York City, with a $250 million surplus in the current fiscal year, is raising taxes and freezing employment to deal with a potential $800 million gap next year. The state of New York is proposing similar actions for the same reason. Whereas four years ago, the Municipal Assistance Corporation was selling long-term bonds to finance New York City’s capital budget at 7.5 percent interest, it is doing so today, with increasing difficulty, at over 14 percent, free of city, state, and federal income taxes. This situation is repeated in city after city, state after state.

This is not happening only in the “Snow Belt,” while the “Sun Belt” flourishes. The state of California now faces a budget deficit estimated at $1 billion. A recent New York Times article noted that many cities in the Sun Belt suffer fully as much from unemployment, poor housing, poverty, and limited economic opportunities as the cities in the Northeast and Midwest. Of nineteen Sun Belt cities, seven had worse hardship ratings than New York. The Sun Belt’s golden glow cannot hide the difficulties faced by New Orleans, Miami, Birmingham, Atlanta, and other cities within its midst. Their problems are national.

Long-term policy changes, such as those currently advocated by the administration, require a stable economic base from which data can be extrapolated in order for rational dialogue on federal-state relations to take place. Until we have a better fix on the recovery of the economy and federal deficits, on inflation and interest rates, it will be utterly impossible for local officials struggling with serious day-to-day fiscal problems to project with any confidence their own set of numbers. Until the economy stabilizes, it will not really be possible to have negotiations of any substance. As Governor James Hunt of North Carolina said, “…we want the nation’s economic problems addressed first.”

What is needed today is a summit meeting, involving the president, the congressional leadership, and the chairman of the Federal Reserve Bank, that will try to resolve the budget impasse and to permit an easing of monetary policy and interest rates. But if such a meeting reached an agreement, it still would not solve our long-term economic dislocations; that is an illusion that should be dispelled. Resolving the problems of the budget and of interest rates is needed to avoid economic disaster. Only then can we take up the issue of federalism along with our many other dilemmas.

How can Midwestern states look at their future unemployment costs without some notion of where the automotive industry’s domestic production will ultimately stabilize? Indeed, how can any state even begin to judge its taxing capacity five to ten years from now, and its ability to take over those programs suggested by the president, without knowing how much of its local taxing power will be required to make up for cuts transferred to local governments currently and to make up for the current recession’s revenue loss?

Until the economy stabilizes, the president has written a symphony for a deaf audience; local officials will hear only the day-to-day problems of their own constituents and argue, with some logic, that in order to solve tomorrow’s problems we have to survive today’s. A more serious timing problem could result if state legislatures, faced with very difficult decisions, find an excuse for inaction by invoking the expectation of the New Federalism. The New York State legislature is about to consider a politically difficult program involving the takeover of the local share of Medicaid, to be financed by various tax increases. Despite a sensible alternative proposal to consider an interim, oneyear takeover program, the legislature may well use the supposed coming of the New Federalism as an excuse to defer any action. That would have disastrous effects in both the cities and counties.

It seems virtually impossible, in view of the upcoming battle in Congress over the budget, which will have great impact on the fiscal capacity of many states, that a national debate on the New Federalism can take place this year. To the question of “If not now, when?” the answer could well be: “Same time, next year.”

Let us now consider Reagan’s federalism proposal itself. It consists of two parts.

First, it proposes a swap of Medicaid costs for state assumption of the costs of welfare and food stamps. The administration estimates that federal payment of all Medicaid costs would save the states $19.1 billion in fiscal 1984, while the assumption of welfare and food stamp programs by the states would cost them $16.5 billion, for a net gain of $2.6 billion.

Second, the president makes a separate proposal to turn back to the states full responsibility for a variety of current federal programs, including transportation, revenue-sharing, education, and community economic development. The administration has not yet published a complete list of the programs it intends to turn back, so it is impossible to estimate the costs of this proposal with certainty. The administration claims that these costs would be offset—at least initially—by savings from the swap and from a temporary federalism trust fund of $28 billion from the windfall profit tax on oil and other excise taxes.

Overall, the administration estimates that the program would be financially harmless to the states, so that no state would suffer an increased burden in the initial stages of the program. This optimistic claim is possible only if one accepts the administration’s proposals for further cuts in Aid for Families with Dependent Children (AFDC) and food stamps—cuts that Congress seems increasingly less willing to make. When the Congressional Budget Office estimated the effect of swapping the costs of Medicaid for the costs of AFDC and food stamps in 1981, it concluded that the states would lose $4.4 billion. If the swap were made in 1984 without changes in the current policy, the Budget Office estimated a shortfall to the states of $1.5 billion (compared to the administration’s estimated gain of $2.6 billion).

For the program as a whole, the Congressional Budget Office has concluded that in 1984 the shortfall to the states for both the swap and turnback/trust-fund program would be $15 billion. The most serious financial problem would come as the trust fund is phased out between 1987 and 1991. At that point, the states would have the choice of either dropping these programs or imposing some equivalent of the wind-fall-profits tax on oil and other federal excise taxes. Obviously, imposing a windfall-profits tax on oil is not feasible for any but the country’s energy-producing states; for the rest, the Reagan plan is merely a formula for assuring the elimination of programs or increases in local taxes. This is bad medicine not only for the states, but for the country.

Any debate on federalism should, I think, be based on two principles. First, government programs should be operated by state and local governments if these have established their own competence to run them—for example, in education and transportation—and if state-by-state differences in programs and program levels are not unfair. We have never believed that all prerogatives are local. Should the poor and the elderly receive different medical care solely because they live in richer or poorer states? Second, no matter who runs programs, they should be paid for fairly. Our personal-income-tax system, for all its shortcomings, is well run and based on the principle of ability to pay. Why should support for education, economic development, or job-training programs be any different?

The inevitable result of the administration’s turnback would be to increase reliance on the most unpopular and unfairly based tax of all: the property tax. A community’s ability to provide services would be the chance result of its local tax base. For some services, such as education, the results of this approach have been found unconstitutional; in other cases, they are merely unfair and unwise.

More than a decade ago, another Republican president recognized this principle and established revenue-sharing of federal tax receipts with the states and cities. Under revenue-sharing, locally run programs were supported by the fairer and more efficient federal tax system. It is unfortunate that the current version of the New Federalism ignores it. This is one of the program’s major deficiencies.

A little-noticed but important result of the current national economic experiment is that it has acted as a powerful force for local tax increases. The federal government, in its pursuit of budget cuts and its inability, so far, to stimulate the economy, has brought an avalanche of deficits down on state and local governments unable to absorb them. The deficits following initiatives such as Proposition 13 have required many states and municipalities to seek tax increases while cutting their own budgets. A survey of cities conducted by the Joint Economic Committee of Congress found that over 40 percent of those who responded (of which half were cities with unemployment over 10 percent) had raised their tax rates. This fiscal pressure creates a further drag on the economy, slows recovery, and reduces federal tax receipts due to the deductibility of local taxes.

Any program of national recovery that reshuffles federal and state responsibilities must create an incentive to reduce local taxes as opposed to increasing them. Such reductions would provide considerable stimulus to the economy, especially in those states hard hit by recession and foreign competition.

From these considerations, we could develop a somewhat different proposal: a New Federalism that would continue to assign to the federal government all income-transfer programs related to poverty and would transfer to the states the remaining programs proposed by the president. Medicaid, food stamps, and welfare would remain federal responsibilities, administered nationally with national standards. The states would be relieved of Medicaid, a program that is estimated to cost $19.1 billion in 1984 and is growing rapidly. The programs to be turned back to the states are estimated to cost $30 to $44 billion by 1984, depending upon whose figures you accept. For this plan to have a neutral fiscal impact, it would be necessary to transfer a stable and permanent revenue source to the states, such as a portion of sharply increased gasoline taxes.

I have advocated for some time an increase of 50 cents per gallon in gasoline taxes both to close our budget gap (and thereby bring down interest rates) as well as to put greater pressure on OPEC prices and reduce our energy consumption still further. There could be no better time for such a tax than when oil prices are going down, as they are now. Of the $50 billion annually raised by such a tax increase, a portion could be transferred to the states to finance these programs. A combination of gasoline taxes and import fees on crude oil would be another possibility. Ultimately, the fairest means of raising revenues would be one suggested recently by Business Week, namely to “dampen down regional and state rivalries by imposing a federal tax on energy resources with the revenues being distributed to all states through a revenue-sharing program.” No such federal severance tax is likely to be enacted soon.

Once the states have assumed responsibility for these programs, we should require that any reductions in them be accompanied by equivalent local tax reductions. Similarly, we should require local tax reductions in every state where the net effect of the national program is to decrease state obligations. If the administration is serious about wanting a smaller federal government, more local responsibility, and fairness in the distribution of burdens and benefits, such an approach would have obvious advantages. Local tax reductions would be a larger political incentive for states to drop useless programs, and the federal government would share in the benefit as a result of the overall economic stimulus such tax cuts might produce.

Such a proposal differs from the administration’s in two ways. First, it would keep poverty programs under federal control. There is no reasonable case for splitting Medicare from Medicaid. Likewise, AFDC and food stamps should remain national responsibilities—everyone eligible for AFDC and many eligible for food stamps also receive Medicaid.

Second, it would support local programs from the national tax base and yet permit local taxes to be reduced. Many critics of the administration believe the federalism proposal is nothing more than a clever attempt to subtract $30 billion in federal programs from the budget by offering a temporary trust fund and the carrot of taking over the state contributions to Medicaid. I hope the administration is sincere, but no program will succeed that offers the states only the painful choice of—and the accompanying blame for—either killing programs or raising taxes.

No discussion of the “New Federalism” can ignore the issues of disparities and major imbalances that are beginning to build serious pressures in this country. Everywhere one turns, disparities are getting greater not smaller.

Consider regional disparities. A recent survey of the National Conference of State Legislatures found that thirty-nine states were facing deficits for the current fiscal year or municipal surpluses below necessary safeguards. The states with the most serious budgetary problems were Washington, Minnesota, Massachusetts, Michigan, Ohio, Oregon, Kentucky, and California. The seven states (apart from Alaska, which is in a class by itself) with the largest surpluses were Oklahoma, Texas, Wyoming, Nevada, New Mexico, Kansas, and North Dakota, all of them energy-producing states.

The same story is also occurring in the cities. The survey of cities by the Joint Economic Committee that I mentioned earlier found widespread plans for service cuts. Fifty-six percent of those who responded admitted to plans for deferring capital spending on water supply and sewers, streets, building maintenance, etc. At the same time, the Northeast and Midwest, with 47 percent of our population, receive 35 percent of defense funds and 20 percent of defense jobs. The South and West, which account for 51 percent of the population, are getting 64 percent of defense funds and 79 percent of defense jobs. It should be easy to see what the dynamics of energy, defense, and sunshine are doing to the distribution of wealth in the United States.

While this is happening, the Reagan administration’s budget and tax policy is increasing the disparity between the well-to-do and the poor. By 1985, the net positive impact of federal budget and tax policy on households having more than $48,000 in annual income will be $140 billion; on households with annual income of $11,500 the net effect will be minus $24 billion. The proposed 1983 budget, for instance, would cut programs for the poor such as child nutrition, Medicaid, and welfare by 10 to 18 percent, while programs of essentially middle-class income support such as Social Security, pensions, and Medicare are cut from 0 to 4 percent. According to the House Budget Committee, 60 percent of the administration’s proposals to reduce the deficit in fiscal 1983 would cut programs to assist the poor and disadvantaged; yet these programs will represent only 6 percent of all federal spending. In the meantime, defense spending will go up by 18 percent. What we are witnessing is not only a high-risk economic program but a radical reordering of our social structures. A functioning democracy must be perceived as attempting to be fair. None of these policies meets the elemental tests of fairness.

Everywhere we look, we find that this process of creating more acute social imbalances is accelerating. Industrial unemployment in the Midwest as a result of Japanese competition and recession; taxpayer migration from the Northeast as a result of the attraction of Sun Belt regions able to lower taxes and increase services. Superimposed on this process is a steep recession brought on by the collision of huge budgetary deficits with restrictive monetary policy, with high interest rates as a result. The currently lower rate of inflation has been achieved by paying the price of high and rising unemployment and dangerously deteriorating financial structures. But behind the dry statistics of the economists, one finds growing misery and despair among millions who cannot find work and untold others who have given up trying. Violence is the companion of despair. It does not take a soothsayer or an alarmist to predict that, if this process continues into the summer, it may be a very hot summer indeed. We have become dangerously complacent about what can happen when over 60 percent of young blacks in Wayne County, Michigan, are unemployed and when a sizable portion of our population believes it has been written off by our government. We may soon have a very rude awakening.

Transferring programs and responsibilities from the federal to local governments, reducing the size of the bureaucracy, reducing federal interference in local affairs—all these are desirable. However, whether we like it or not, any realistic discussion of the New Federalism will have to focus on the increasing disparities and imbalance facing this country. Class disparities and regional disparities carry with them a federal responsibility. No one can seriously doubt today, looking at our older cities, our older industries, our less-educated and poorer population, that a huge shift in national wealth is taking place from one part of the country to another: from cities to suburbs; from poor to rich. These shifts will accelerate if federal initiatives are not taken to reverse them. As now proposed, the New Federalism would aggravate these imbalances rather than attenuate them. How can this be in the national interest, or even in the interest of the regions that are currently more prosperous?

The first debate on federalism took place in Philadelphia more than two hundred years ago. It has continued ever since. Although institutions have changed remarkably, the issues remain fundamentally the same. How can we best maintain the social justice, human dignity, and equality of opportunity that are indistinguishable from the rights to life, liberty, and the pursuit of happiness? The founding fathers, after more than a decade of dissatisfaction with the Articles of Confederation, concluded that these goals could not be achieved without a strong federal government. I believe that is still true today.

The federal government was created to do far more than simply carry mail or make bombs. It was chartered by the Constitution “to promote the general welfare.” For the New Federalism to be meaningful, it must first of all be built on a stable national economic and social base. Most important, it must recognize and enable those under greatest pressure to maintain adequate social services, to protect their tax bases and thereby participate in the future growth and prosperity of the nation. This is not the case today. If the economy can be stabilized, it may be possible next year. However, if the economy is still in deep trouble a year from now we will have many more urgent tasks than the New Federalism.

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