The States Formed the Federal Government, Not the Other Way Around

Fiscal Federalism

The Constitution divided power between two separate but co-equal governing bodies: the states and the national government. This division is called federalism, and it is so important that the sovereignty of We the People cannot be preserved without it. It is the concept that, in most things, the states are not subordinate to the national government but, in fact, are immune to it. Washington, DC, was to handle mostly foreign concerns, and the states were to handle internal concerns. S. 1214, the Federalism Accountability Act of 1999, was a bill to ensure the liberties of the people by promoting federalism, to protect the reserved powers of the States, and to impose accountability for Federal preemption of State and local laws." This bill never became law.

In perhaps the most recent and powerful Tenth Amendment decision in modern history, the U.S. Supreme Court ruled in Mack/Printz v U.S. that "States are not subject to federal direction." But today's federal Tories argue that the "supremacy clause" of the U.S. Constitution says that the federal government is supreme and, thus, trumps the States in all matters... The States (and Counties) are to maintain the balance of power by keeping the feds within their proper sphere. The States are not subject to federal direction... They are sovereign and "the Constitution protects us from our own best intentions." - Sheriff Richard Mack (Ret.), States Can Tell Feds to Shove It, January 25, 2010

By Chris Edwards, Cato Institute
February 2009

Overview

Under the Constitution, the federal government was assigned specific limited powers and most government functions were left to the states. To ensure that people understood the limits on federal power, the Framers added the Constitution's Tenth Amendment:

"The powers not delegated to the United States by the Constitution, nor prohibited by it to the States, are reserved to the States respectively, or to the people."

The Tenth Amendment embodies federalism, the idea that federal and state governments have separate areas of activity and that federal responsibilities were "few and defined," as James Madison noted. Historically, federalism acted as a safeguard of American freedoms. Indeed, President Ronald Reagan noted in a 1987 executive order:

"Federalism is rooted in the knowledge that our political liberties are best assured by limiting the size and scope of the national government."

Unfortunately, policymakers and courts have mainly discarded federalism in recent decades. Congress has undertaken many activities that were traditionally reserved to the states and the private sector. Grants-in-aid are a primary mechanism that the federal government has used to extend its power into state and local affairs. Grants are subsidy programs that are combined with federal regulatory controls to micromanage state and local activities.

The federal government spends about $500 billion annually on aid to the states, making it the third largest item in the budget after Social Security and national defense. The number of different aid programs has soared from 463 in 1990 to 814 by 2006.

With this large and complex array of aid activities, federal and state policymakers are mainly interested in the spending levels of programs and regulatory compliance, not on delivering quality services. And by involving all levels of government in just about every policy activity, the aid system creates a lack of accountability. Congress should reconsider aid programs, and begin terminating activities that could be better performed by the states or the private sector.

The Growth in Federal Aid

Federal granting began during the late 19th century, expanded during the early 20th century, and exploded during the 1960s. Under President Lyndon Johnson, aid programs were added for housing, urban renewal, education, health care, and many other activities. President Johnson called his policies "creative federalism," but his activism dealt a severe blow to the federalism of the nation's Founders.

The unchallenged optimism of the 1960s about the federal government's ability to solve local problems through grants did not last. In the early 1970s, President Richard Nixon argued that federal aid was a "terrible tangle" of overlap and inefficiency. In his 1971 State of the Union address, he lambasted "the idea that a bureaucratic elite in Washington knows best what is best for people everywhere," and said that he wanted to "reverse the flow of power and resources from the states and communities to Washington." For his part, President Jimmy Carter proposed a "concentrated attack on red tape and confusion in the federal grant-in-aid system." Unfortunately, Nixon and Carter made little progress on reforms.

Ronald Reagan had more success at sorting out the "confused mess" of federal grants, as he called it. In a 1981 budget law, dozens of grant programs were eliminated, and many others were consolidated into broader block grants. Reagan's "new federalism" attempted to re-sort federal and state priorities so that each level of government would have responsibility for financing its own programs. However, these efforts to trim the federal aid empire were reversed in subsequent years, although the Republican Congress of the mid-1990s did succeed in turning the federal welfare program into a block grant.

Today, there are more than 800 state and local aid programs, based on my count of programs in the Catalog of Federal Domestic Assistance. They range from the giant $225 billion Medicaid to hundreds of programs that most taxpayers have probably never heard of, such as a $15 million program for "Nursing Workforce Diversity," a $120 million program for "Boating Safety Financial Assistance," and a $150 million program for "Healthy Marriages."

Total federal grant spending in fiscal 2008 was $467 billion. Real, or inflation-adjusted, spending on nonhealth grants rose rapidly during the 1960s and 1970s, fell during the 1980s, and soared in the early 2000s. Real spending on health care grants, mainly Medicaid, has more than quadrupled since 1985.

Seven Reasons to Cut Federal Aid

The theory behind aid to the states is that the federal government can operate programs in the national interest to efficiently solve local problems. The belief is that policymakers can dispassionately allocate large sums of money across hundreds of activities based on a rational plan designed in Washington.

The federal aid system does not work that way in practice. Most federal politicians are not inclined to pursue broad, national goals, but are consumed by the competitive scramble to secure subsidies for their states. At the same time, federal aid stimulates overspending by state governments and creates a web of complex federal regulations that destroys state innovation. At all levels of the aid system, the focus is on regulatory compliance and the amounts spent, not on delivering quality services.

The following are seven reasons why Congress should begin cutting federal grants-in-aid.

1. Grants spur wasteful spending. The basic incentive structure of aid programs encourages overspending by federal, state, and local politicians. The system allows politicians at each level to claim credit for spending on a program, while relying on another level of government to collect part of the tax bill.

Federal politicians design aid regulations that prompt states to increase their own funding of programs. For example, Congress often includes "matching" provisions in programs, which means that the costs of expansion are split between federal and state taxpayers. Under a 50–50 arrangement, for every $2 million a state spends on a program, the federal government chips in $1 million. Matching reduces the "price" to state officials' added spending, thus prompting them to expand programs. Two-thirds of federal aid spending is on grant programs that have matching requirements.

The open-ended federal match under Medicaid, for example, has prompted state governments to continuously expand health benefits and the number of eligible beneficiaries. Indeed, many states have designed complex schemes to artificially raise federal matching payments under Medicaid and to fleece federal taxpayers.

One way to limit the gold rush response of state politicians to matching grants is to convert them to block grants. Block grants provide a fixed sum to states and give them flexibility on program design. For example, the 1996 welfare reform law turned Aid to Families with Dependent Children, an open-ended matching grant, into Temporary Assistance for Needy Families, a lump-sum block grant. Similar block grant reforms should be pursued for Medicaid and other programs. Converting programs to block grants would reduce incentives to overspend and would make it easier for reformers to cut and eliminate programs in the future.

2. Aid allocation is haphazard. The theorists favoring federal grants assume that aid can be rationally distributed to those activities and states with the greatest needs. But in the real world, the aid system has never worked that way. A 1940 article in Congressional Quarterly lamented:

"The grants-in-aid system in the United States has developed in a haphazard fashion. Particular services have been singled out for subsidy at the behest of pressure groups, and little attention has been given to national and state interests as a whole."

A June 1981 report by the Advisory Commission on Intergovernmental Relations concluded,

"Regarding national purpose, the record indicates that federal grant-in-aid programs have never reflected any consistent or coherent interpretation of national needs."

Today, for example, states receive varying amounts of highway funding for each dollar of gasoline taxes sent to Washington. While some congested and fast-growing states that need new highways lose out, some slow-growing states get "highways to nowhere" because they have skilled politicians representing them. A major highway law in 2005 included 6,371 "earmarks" directing spending to particular projects that were chosen by individual politicians, not by transportation experts based on merit.

Even if a program could be operated in a rational way, outside of politics, the states can often nullify the policy choices of federal officials. The Department of Education's $15 billion Title I program, for example, is supposed to target aid to the poorest school districts. But evidence indicates that state and local governments use Title I funds to displace their own funding of poor schools, thus making poor schools no further ahead than without federal aid. In such cases, there is no reason to federalize an activity to begin with, even if one believes in the theory behind federal aid.

3. Grants reduce state policy diversity. Federal grants reduce state innovation because federal money comes with regulations that limit policy flexibility. Grants put the states in a straitjacket of federal rules. The classic one-size-fits-all federal regulation that defied common sense was the 55-mile-per-hour national speed limit. The limit was enforced between 1974 and 1995 by federal threats of withdrawing state highway grant money. It never made sense that the same speed should be imposed in the wide-open western states and the crowded eastern states, and Congress finally listened to motorists and repealed the law.

However, federal regulations tied to grants are increasing in other areas, such as education. Federal education spending has exploded, and so have federal regulatory controls. The No Child Left Behind law of 2002, for example, mandates that all teachers be "highly qualified," that Spanish-language versions of tests be administered, and that certain children be tutored after school. State officials have complained bitterly about these new federal rules, and 30 state legislatures have passed resolutions attacking NCLB for undermining states' rights.

4. Grant regulations breed bureaucracy. Federal aid is not a costless injection of funding to the states. Its direct cost is paid by federal taxpayers who live in the 50 states. In addition, the system generates an enormous amount of bureaucracy at all three levels of government. Each level of government consumes grant program funding with proposal writing, funding allocations, review, reporting, regulatory compliance, litigation, and many other bureaucratic activities.

State and local agencies must comply with long lists of complex federal regulations, which is one reason why the nation employs an army of 16 million state and local government workers. There are three types of federal aid regulations. The first are the specific rules for each program. Each program may come with hundreds or thousands of pages of rules for grantees to follow. The second are "crosscutting requirements," which are general provisions that apply across aid programs, such as labor market rules. The third are "crossover sanctions," which are the various penalties imposed on the states if certain federal regulatory requirements are not met.

What makes matters worse is that the more than 800 federal grants have overlapping mandates, and each program has unique rules. For example, state and local governments deal with 16 different federal programs that fund first responders, such as firefighters. That complicated federal intrusion has led to fragmented disaster response planning and to much first-responder funding going to projects of little value and to regions with little risk of terrorism.

5. Grants cause policymaking overload. A serious problem caused by the huge scope of federal grant activity is that federal politicians spend their time dealing with local issues, such as public schooling, rather than crucial national issues. The huge array of grant programs generates endless opportunities for federal politicians to earmark projects for their home districts, in a chase for funding that consumes much of their time.

Each new aid program has stretched thinner the ability of policymakers to deal with truly national problems because local spending issues divert their attention. Grants have helped create an "overload" on federal decisionmaking capability. It is hard to quantify this problem, but it is clear that most federal policymakers ignore important national problems, such as they did the increasing threat of terrorism before 9/11. Even after 9/11, a number of investigations have revealed that most members of the House and Senate intelligence committees do not bother, or do not have time, to read crucial intelligence reports. President Calvin Coolidge was right in 1925 when he argued that aid to the states should be cut because it was "encumbering the national government beyond its wisdom to comprehend, or its ability to administer" its proper roles.

6. Grants make government responsibilities unclear. The three layers of government in the United States no longer resemble the tidy layer cake that existed in the 19th century. Instead, they are like a jumbled marble cake with responsibilities fragmented across multiple layers. Federal aid has made it difficult for citizens to figure out which level of government is responsible for particular policy outcomes. All three levels of government play big roles in such areas as transportation and education, thus making accountability difficult. Politicians have become skilled at pointing fingers of blame at other levels of government, as was evident in the aftermath of Hurricane Katrina. When every government is responsible for an activity, no government is responsible.

7. Common problems are not always national priorities. Over the decades, policymakers have argued that various state, local, and private activities needed federal intervention because they had become "national priorities." A fact sheet from the secretary of education begins:

"The responsibility for K–12 education rests with the states under the Constitution. There is also a compelling national interest in the quality of the nation's public schools. Therefore, the federal government . . . provides assistance to the states and schools in an effort to supplement, not supplant, state support."

Education is, of course, a priority of many people, but that does not mean that the federal government has to get involved. Indeed, there are few activities that the federal government performs that are not also priorities of individuals, businesses, and state and local governments. The states are certainly free to share their policy experiences in areas such as education, but there is need for top-down control from Washington.

In a 1987 executive order, President Ronald Reagan observed:

It is important to recognize the distinction between problems of national scope (which may justify federal action) and problems that are merely common to the states (which will not justify federal action because individual states, acting individually or together, can effectively deal with them).

The confusion between problems that are national in scope and those that are merely common to the states even extends to areas such as homeland security. Much "homeland security" funding goes toward items that should be funded locally, such as bulletproof vests for police officers and radio systems for first responders. Federalizing such spending only creates bureaucracy and a tug –of war between the states over funding. By contrast, when funding and spending decisions are made together at the state or local levels, policy tradeoffs will better reflect the preferences of citizens within each jurisdiction.

Conclusions

The federal aid system is a roundabout funding system for state and local activities that serves no important economic purpose. During the 1970s and 1980s, government auditors and official commissions pushed for fundamental reforms to the aid system, but those reforms were never made. Ronald Reagan put the system on a diet for a few years, but the core pathologies were not addressed. Since then, hundreds more grant programs have been added, the costs are higher, and the parochial battles over aid are bigger than ever.

The failings of federal aid have long been recognized, but the system has spawned a web of interlocking interests that block reform. Those interests include elected officials in the three levels of government, the hundreds of trade associations representing the recipients of aid, and a large portion of the 16 million state and local workers that depend on federal funding.

The aid system thrives not because it creates good governance, but because it maximizes benefits to politicians. Politicians at each level of government can get involved in spending on a diverse range of programs, while blaming other levels of government for poor service quality and high tax burdens. The federal aid system has been called a "triumph of expenditure without responsibility."

Yet the system desperately needs to be scaled back. With today's large federal budget deficit and the massive cost increases that face entitlement programs, there is little room in the federal budget for state and local activities. Policymakers need to revive federalism and begin to terminate grant programs. If the aid system was shut down, state governments and the private sector would step in and fund those activities that they thought were worthwhile. But by federalizing state and local activities, we are asking Congress to do the impossible — to efficiently plan for the competing needs of a diverse country of more than 300 million people.

Recession Continues to Batter State Budgets; State Responses Could Slow Recovery

PDF of this Report (11pp.)

By Elizabeth McNichol, Phil Olif and Nicholas Johnson, Center on Budget and Policy Priorities
July 15, 2010

The worst recession since the 1930s has caused the steepest decline in state tax receipts on record. As a result, even after making very deep spending cuts over the last two years, states continue to face large budget gaps. At least 46 states struggled to close shortfalls when adopting budgets for the current fiscal year (FY 2011), which began July 1 in most states. These came on top of the large shortfalls that 48 states faced in fiscal years 2009 and 2010. States will continue to struggle to find the revenue needed to support critical public services for a number of years, threatening hundreds of thousands of jobs. States face:

• Budget problems in 2011. Fiscal year 2011 gaps — addressed with spending cuts and revenue increases by most states — totaled $121 billion, or 19 percent of budgets in 46 states. This total is likely to grow over the course of the fiscal year, which started July 1 in most states. It may well exceed $140 billion and would be higher still without federal assistance. The fact that the gaps have been filled and budgets are balanced does not end the story. Families hit hard by the recession will experience the loss of vital services throughout the year, and the negative impact on the economy will continue.


• Uncertainty for the future. States’ fiscal problems will continue in the current fiscal year and likely beyond. Already 39 states have projected gaps that total $102 billion for the following year (fiscal year 2012). Once all states have prepared estimates these are likely to grow to some $120 billion.


• The effects of gaps in 2010 budgets. These new shortfalls are in addition to the gaps states closed in their fiscal year 2010 budgets. Counting both initial and mid-year shortfalls, 48 states addressed such shortfalls in their budgets for fiscal year 2010, totaling $192 billion or 29 percent of state budgets — the largest gaps on record.


• Declining federal assistance. Federal aid to states provided in the American Recovery and Reinvestment Act has lessened state cuts in services and tax increases. But the aid is now mostly gone; only about $40 billion remains to help with 2011 fiscal problems. The federal government could avert deep additional budget cuts that would further harm the economy by extending assistance over the period during which state fiscal distress is expected to continue rather than cutting it off before states have recovered.


• Combined gaps of $260 billion for 2011 and 2012. These numbers suggest that states are dealing with total budget shortfalls of some $260 billion for 2011 and 2012. When all is said and done, states will have closed shortfalls of more than $500 billion since the start of the recession.

State Budget Shortfalls in 2010, 2011, and 2012

States already have faced and addressed extraordinarily large shortfalls as they developed and implemented spending plans for fiscal years 2009, 2010, and 2011 (which have now ended in most states). Shortfalls are the extent to which states’ revenues, hit hard by the recession, fall short of the cost of providing services. Every state save Vermont has some sort of balanced-budget law. So the shortfalls for 2009 and 2010 and most of the shortfalls for 2011 have already been closed through a combination of spending cuts, withdrawals from reserves, revenue increases, and use of federal stimulus dollars.

States’ fiscal conditions remain extremely weak this year – fiscal year 2011 – even as the economy appears to be moving in the direction of recovery. Indeed, historical experience and current economic projections suggest 2011 will be worse than 2010 by the time the year ends due to declining federal assistance. Taking all these factors into account, it is reasonable to expect that for 2011, shortfalls are likely to exceed $140 billion after taking into account approximately $40 billion in federal Recovery Act dollars that are likely to remain available for fiscal year 2011. Once employment is growing again, state budget problems will diminish but it is likely that states will face shortfalls of at least $120 billion in fiscal 2012. This means that states will close shortfalls of some $260 billion for fiscal years 2011 and 2012 combined. Figure 2 shows the budget shortfalls that states faced and will face after taking into account the federal recovery act dollars.

The recession caused a state fiscal crisis of unprecedented severity. Figure 3 compares the size and duration of the shortfalls that occurred in the recession of the first part of this decade to shortfalls reported to date this time. In the early 2000s, as in the early 1990s and early 1980s, state fiscal problems lasted for several years after the recession ended. The same will undoubtedly be the case this time, since the current recession is more severe — deeper and longer — than the last one, and state fiscal problems have proven to be worse and are likely to remain so.

Unemployment, which peaked after the last recession at 6.3 percent, has already hit 10 percent, and many economists expect it to remain at high levels throughout 2010 and beyond. Continued high unemployment will keep state income tax receipts at low levels and increase demand for Medicaid and other essential services that states provide. High unemployment and economic uncertainty, combined with households’ diminished wealth due to fallen property values, will continue to depress consumption, thus sales tax receipts also will remain low. These factors suggest that state budget gaps will continue to be significantly larger than in the last recession, and last longer.

Estimates from the states, although incomplete, are consistent with this outlook. Table 1 lists the shortfalls that states dealt with when adopting budgets for 2011. A total of 46 states addressed shortfalls for fiscal year 2011. This total includes at least 34 of the states that prepare budgets annually and recently addressed deficits for fiscal year 2011. In addition, 11 states that operate on a two-year budget cycle (known as a biennial budget) adopted budgets a year ago that addressed shortfalls for 2011 totaling at least $25 billion. In total, fiscal year 2011 gaps — which have been addressed in most states — total $121 billion or 19 percent of budgets. In addition, at least 39 states have looked ahead to fiscal year 2012 and anticipate shortfalls totaling $102 billion (see table 2.) It is reasonable to expect that it will grow during the course of the fiscal year if revenues again come in under expectations or spending reductions yield less savings than anticipated.

TABLE 1: Gaps States Have Faced in FY2011
	Pre-Budget Adoption Gap in States with Biennial 09-11 Budgets	Pre-Budget Adoption Gap in States With Annual Budgets/New Gap in Biennial States	Total FY11 Shortfall Closed When Budget Adopted*	Total Shortfall as Percent of FY11 Budget
Alabama	0	$586 million	$586 million	8.3%
Arizona	0	$3.1 billion	$3.1 billion	36.6%
California*	0	$17.9 billion	$17.9 billion*	21.6%
Colorado	0	$1.5 billion	$1.5 billion	21.6%
Connecticut	$4.4 billion	$700 million	$5.1 billion	28.9%
Delaware	0	$377 million	$377 million	11.5%
DC	0	$104 million	$104 million	1.7%
Florida	0	$4.7 billion	$4.7 billion	20.2%
Georgia	0	$4.2 billion	$4.2 billion	26.2%
Hawaii	0	$594 million	$594 million	12.0%
Idaho	0	$84 million	$84 million	3.4%
Illinois	0	$13.5 billion	$13.5 billion	41.5%
Indiana	0	$1.3 billion	$1.3 billion	9.4%
Iowa	0	$1.1 billion	$1.1 billion	18.9%
Kansas	0	$510 million	$510 million	8.7%
Kentucky	0	$780 million	$780 million	8.8%
Louisiana	0	$1.0 billion	$1.0 billion	12.5%
Maine	$765 million	$174 million	$940 million	34.7%
Maryland	0	$2.0 billion	$2.0 billion	14.4%
Massachusetts	0	$2.7 billion	$2.7 billion	9.6%
Michigan*	0	$2.0 billion	$2.0 billion*	9.2%
Minnesota	$2.8 billion	$1.2 billion	$4.0 billion	26.0%
Mississippi	0	$716 million	$716 million	16.1%
Missouri	0	$730 million	$730 million	9.4%
Nebraska	$150 million	$179 million	$329 million	9.6%
Nevada	$1.3 billion	$504 million	$1.8 billion	54.0%
N.H.	$250 million	$115 million	$365 million	24.1%
New Jersey	0	$10.7 billion	$10.7 billion	38.3%
New Mexico	0	$333 million	$333 million	6.2%
New York*	0	$8.5 billion	$8.5 billion*	15.9%
North Carolina	$4.4 billion	$1.4 billion	$5.8 billion	30.3%
Ohio	$2.5 billion	$463 million	$3.0 billion	11.3%
Oklahoma	0	$725 million	$725 million	14.8%
Oregon*	Yes	$577 million	See Table 2	See Table 2
Pennsylvania	0	$4.1 billion	$4.1 billion	15.6%
Rhode Island	0	$395 million	$395 million	13.9%
South Carolina	0	$1.3 billion	$1.3 billion	25.6%
South Dakota	0	$102 million	$102 million	8.8%
Tennessee	0	$1.0 billion	$1.0 billion	9.8%
Texas	$3.3 billion	$1.3 billion	$4.6 billion	10.2%
Utah	0	$700 million	$700 million	14.6%
Vermont	0	$338 million	$338 million	30.2%
Virginia	0	$1.3 billion	$1.3 billion	8.8%
Washington*	$2.1 billion	Yes*	$2.1 billion	12.9%
West Virginia	0	$134 million	$134 million	3.6%
Wisconsin	$3.4 billion	0	$3.4 billion	23.9%
Wyoming	0	$147 million	$147 million	10.3%
States Total	$25.3 billion	$95.9 billion	$121.2 billion	18.7%
Note: California, New York, and Michigan have not completed their FY11 budgets so these gaps remain open. California’s shortfall does not include $1.2 billion in proposed reserve replenishment. Oregon and Washington have two-year budgets. See Table 3 for additional gap information

These current year shortfalls are in addition to the gaps states closed when adopting their fiscal year 2010 budgets and the mid-year gaps that developed after these budgets were adopted. Table 3 combines the mid-year gaps with the gaps that were addressed when states wrote their 2010 budgets. In total, 48 states have addressed shortfalls in their budgets for fiscal year 2010, totaling $192 billion or 29 percent of state budgets — the largest gaps on record. (Table 4 of this paper shows the 2009 budget gaps that were addressed.)

TABLE 2: States with Projected FY2012 Gaps>
	FY12 Projected Shortfall		Shortfall as Percent of FY11 Budget
Arizona	$863	million	10.2%
California	$21.3	billion	25.7%
Colorado	$954	million	13.4%
Connecticut	$3.8	billion	21.6%
Florida	$2.3	billion	10.0%
Georgia	$1.7	billion	10.6%
Hawaii	Yes, DK	size	na
Idaho	$182	million	7.4%
Illinois	$17.0	billion	52.3%
Iowa	$800	million	14.1%
Kansas	$217	million	3.7%
Kentucky	$780	million	8.8%
Louisiana	$1.7	billion	21.2%
Maryland	$1.5	billion	11.1%
Massachusetts	$2.0	billion	7.1%
Michigan	$1.4	billion	6.4%
Minnesota	$3.8	billion	25.0%
Mississippi	$1.2	billion	27.6%
Missouri	$982	million	12.6%
Montana	$169	million	9.2%
Nebraska	$147	million	4.3%
Nevada	$1.3	billion	36.7%
New Jersey	Yes, DK	size	na
New Mexico	$236	million	4.4%
New York	$14.6	billion	27.3%
North Carolina	$3.0	billion	15.7%
Ohio	$3.0	billion	11.3%
Oklahoma	Yes, DK	size	na
Oregon	$2.5	billion	17.6%
Pennsylvania	$2.4	billion	9.3%
Rhode Island	$330	million	11.6%
South Carolina	$1.3	billion	26.1%
Tennessee	$374	million	3.7%
Texas	$5.4	billion	12.0%
Vermont	$122	million	10.9%
Virginia	$2.3	billion	15.4%
Washington	$1.2	billion	7.2%
West Virginia	$155	million	4.2%
Wisconsin	$1.2	billion	8.7%
States Total	$102.3	billion	17.7%

Of course, a faster-than-expected recovery could reduce the size of future shortfalls. But several factors could make it particularly difficult for states to recover from the current fiscal situation. Housing markets might be slow to fully recover; their decline already has depressed consumption and sales tax revenue as people refrain from buying furniture, appliances, construction materials, and the like. This also would depress property tax revenues, increasing the likelihood that local governments will look to states to help address the squeeze on local and education budgets. And as the employment situation continues to be weak, income tax revenues will continue to lag and there will be further downward pressure on sales tax revenues as consumers are reluctant or unable to spend.

Some states have not been affected by the economic downturn, but the number is dwindling. Mineral-rich states — such as New Mexico, Alaska, and Montana — saw revenue growth in the beginning of the recession as a result of high oil prices. More recently, however, the decline in oil prices has affected revenues in these states. The economies of a handful of other states have so far been less affected by the national economic problems. Only two states, Montana and North Dakota, have not reported budget shortfalls, but the recession has dampened those states’ surpluses, which were largely mineral-driven as well. Two other states – Alaska and Arkansas – faced shortfalls in fiscal year 2010 but are not now projecting gaps for fiscal year 2011.

The Consequences of Shortfalls

In states facing budget gaps, the consequences are severe in many cases — for residents as well as the economy. To date, budget difficulties have led at least 45 states to reduce services to their residents, including some of their most vulnerable families and individuals. Over 30 states have raised taxes to at least some degree, in some cases quite significantly.

If revenue declines persist as expected in many states, additional spending and service cuts are likely. Budget cuts often are more severe later in a state fiscal crisis, after largely depleted reserves are no longer an option for closing deficits.

Spending cuts are problematic policies during an economic downturn because they reduce overall demand and can make the downturn deeper. When states cut spending, they lay off employees, cancel contracts with vendors, eliminate or lower payments to businesses and nonprofit organizations that provide direct services, and cut benefit payments to individuals. In all of these circumstances, the companies and organizations that would have received government payments have less money to spend on salaries and supplies, and individuals who would have received salaries or benefits have less money for consumption. This directly removes demand from the economy.

Tax increases also remove demand from the economy by reducing the amount of money people have to spend — though to the extent these increases are on upper-income residents, that effect is minimized because much of the money comes from savings and so does not diminish economic activity. At the state level, a balanced approach to closing deficits — raising taxes along with enacting budget cuts — is needed to close state budget gaps in order to maintain important services while minimizing harmful effects on the economy.

The Role of Federal Assistance

Federal assistance is lessening the extent to which states need to take pro-cyclical actions that further harm the economy. The American Recovery and Reinvestment Act enacted in February 2009 includes substantial assistance for states. The amount in ARRA to help states maintain current activities is about $135 billion to $140 billion over a roughly 2 ½-year period — or between 30 percent and 40 percent of projected state shortfalls. Most of this money is in the form of increased Medicaid funding and a “State Fiscal Stabilization Fund.” (There are also other streams of funding in the economic recovery act flowing through states to local governments or individuals, but these will not address state budget shortfalls.) This money has reduced the extent of state spending cuts and state tax and fee increases.

But it now appears likely the federal assistance will end before state budget gaps have abated. The Medicaid funds are scheduled to expire in December 2010, which is just halfway through the 2011 fiscal year in most states. States will have drawn down most of their State Fiscal Stabilization Fund allocations by then as well. So even though the 2011 budget gaps may well be larger than those for 2010, there will be less federal money available to close them. States are likely to respond with spending cuts and tax increases even larger than those that have already been enacted.

Such measures in most states will take effect with the 2011 fiscal year — that is, in July 2010, thereby reducing aggregate demand and weakening the economy at a critical moment in its recovery. If states get no further federal assistance, the steps they will have to take to eliminate deficits will likely take a full percentage point off the Gross Domestic Product. That, in turn, could cost the economy 900,000 jobs next year.

A possibility would be for the federal government to reduce state budget gaps — and hence avert some spending cuts and/or tax increases — by extending the Medicaid funds over the period during which state fiscal conditions are expected to still be problematic, rather than cutting them off in December 2010. The federal government could also provide additional assistance to states for education through the State Fiscal Stabilization Fund. Ideally, such action would occur very soon, so that it can be factored into states’ budget decisions for fiscal year 2011. (Most states are balancing their budgets on the assumption that the Medicaid funding will be extended, but are not assuming additional education funds. If the federal government fails to extend this aid, many states will be forced to reopen their 2011 budgets to make even deeper spending cuts and more tax increases than previously planned.)

TABLE 3: Total FY2010 Budget Gaps
	FY2010 Before Budget Adoption	Additional FY2010 Mid-Year Gap	FY2010 Total	Total Gap as Percent of % of FY2010 General Fund
Alabama	$1.2 billion	$400 million	$1.6 billion	23.7%
Alaska	$1.3 billion	0	$1.3 billion	28.9%
Arizona	$3.2 billion	$1.9 billion	$5.1 billion	65.0%
Arkansas	$146 million	$247 million	$395 m	9.1%
California*	$45.5 billion	Yes*	$45.5 b	52.8%
Colorado	$1.0 billion	$600 million	$1.6 billion	23.8%
Connecticut	$4.2 billion	$513 million	$4.7 billion	27.0%
Delaware	$557 million	0	$557 m	18.2%
DC	$650 million	$167 million	$817 m	13.0%
Florida	$5.9 billion	$147 million	$6.0 billion	28.5%
Georgia	$3.1 billion	$1.4 billion	$4.5 billion	28.8%
Hawaii	$682 million	$533 million	$1.2 billion	25.2%
Idaho	$411 million	$151 million	$562 m	22.4%
Illinois	$9.3 billion	$5.0 billion	$14.3 b	43.7%
Indiana	$1.1 billion	$309 million	$1.4 billion	10.6%
Iowa	$779 million	$533 million	$1.3 billion	22.6%
Kansas	$1.4 billion	$459 million	$1.8 billion	33.9%
Kentucky	0	$1.2 billion	$1.2 billion	14.5%
Louisiana	$1.8 billion	$777 million	$2.5 billion	27.8%
Maine	$640 million	$209 million	$849 m	28.0%
Maryland	$1.9 billion	$936 million	$2.8 billion	20.3%
Massachusetts	$5.0 billion	$600 million	$5.6 billion	20.4%
Michigan	$2.8 billion	$454 million	$3.3 billion	15.8%
Minnesota	$3.2 billion	$209 million	$3.4 billion	22.7%
Mississippi	$480 million	$437 million	$917 m	19.3%
Missouri	$780 million	$931 million	$1.7 billion	22.7%
Nebraska	$150 million	$155 million	$305 m	9.2%
Nevada	$1.2 billion	$384 million	$1.5 billion	46.8%
New Hampshire	$250 million	$180 million	$430 m	28.6%
New Jersey	$8.8 billion	$2.2 billion	$11 b	40.0%
New Mexico	$345 million	$650 million	$995 m	18.2%
New York	$17.9 billion	$3.2 billion	$21.0 b	38.8%
North Carolina	$4.6 billion	$391 million	$5.0 billion	26.2%
Ohio	$3.3 billion	$296 million	$3.6 billion	13.9%
Oklahoma	$777 million	$864 million	$1.6 billion	28.4%
Oregon*	$4.2 billion	0	$4.2 billion	32.4%
Pennsylvania	$4.8 billion	$1.1 billion	$5.9 billion	23.6%
Rhode Island	$590 million	$400 million	$990 m	34.8%
South Carolina	$725 million	$439 million	$1.2 billion	21.5%
South Dakota	$32 million	15.8 million	$48 million	4.3%
Tennessee	$1.0 billion	$170 million	$1.2 billion	12.1%
Texas	$3.5 billion	0	$3.5 billion	10.7%
Utah	$721 million	$279 million	$1.0 billion	22.1%
Vermont	$278 million	$28 million	$306 m	28.3%
Virginia	$1.8 billion	$1.8 billion	$3.6 billion	24.1%
Washington*	$3.4 billion	$2.8 billion	$6.2 billion	27.9%
West Virginia	$184 million	$120 million	$304 m	8.2%
Wisconsin	$3.2 billion	0	$3.2 billion	23.7%
Wyoming	0	$32 million	$32 million	1.8%
Total	$158.5 billion	$33.7 billion	$192.2 b	29.2%
Notes: * California’s mid-year gap is included in the total shown for FY11 in Table 1. Oregon and Washington have two-year budgets. For Oregon, the size of the combined shortfall before budget adoption for FY10 and FY11 is shown here. For Washington, the mid-year gap shown is the projected gap for the two years ending in FY11.

TABLE 4: Total FY2009 Budget Gaps
	Gap Before Budget Was Adopted	Additional Mid-Year Gap	Total	Total Gap as Percent of FY2009 General Fund
Alabama		$1.1 billion	$1.1 billion	12.7%
Alaska		$360 million	$360 m	6.8%
Arizona*	$1.9 billion	$1.8 billion	$3.7 billion	36.8%
Arkansas	$107 million		$107 m	2.4%
California	$22.2 billion	$14.9 billion	$37.1 b	36.7%
Colorado		$1.1 billion	$1.1 billion	14.2%
Connecticut	$150 million	$2.5 billion	$2.7 billion	15.5%
Delaware	$217 million	$226 million	$443 m	12.2%
District of Columbia	$96 million	$583 million	$679 m	10.8%
Florida	$3.4 billion	$2.3 billion	$5.7 billion	22.2%
Georgia*	$245 million	$2.2 billion	$2.4 billion	11.5%
Hawaii		$417 million	$417 m	7.3%
Idaho		$452 million	$452 m	15.3%
Illinois	$1.8 billion	$2.5 billion	$4.3 billion	15.1%
Indiana		$1.2 billion	$1.2 billion	9.1%
Iowa	$350 million	$134 million	$484 m	7.6%
Kansas		$186 million	$186 m	2.9%
Kentucky	$266 million	$456 million	$722 m	7.8%
Louisiana		$341 million	$341 m	3.7%
Maine	$124 million	$140 million	$265 m	8.6%
Maryland	$808 million	$691 million	$1.5 billion	10.0%
Massachusetts	$1.2 billion	$4.0 billion	$5.2 billion	18.5%
Michigan	$472 million	$1.5 billion	$2.0 billion	8.5%
Minnesota	$935 million	$654 million	$ 1.6 billion	9.2%
Mississippi*	$90 million	$363 million	$453 m	8.9%
Missouri		$542 million	$542 m	6.0%
Nevada	$898 million	$561 million	$1.6 billion	19.9%
New Hampshire	$200 million	$50 million	$250 m	8.0%
New Jersey*	$2.5 billion	$3.6 billion	$6.1 billion	18.8%
New Mexico		$454 million	$454 m	7.5%
New York	$4.9 billion	$2.5 billion	$7.4 billion	13.2%
North Carolina		$3.2 billion	$3.2 billion	14.9%
Ohio*	$733 million	$1.9 billion	$2.6 billion	9.4%
Oklahoma	$114 million		$114 m	1.7%
Oregon		$442 million	$442 m	6.6%
Pennsylvania		$3.2 billion	$3.2 billion	11.3%
Rhode Island	$430 million	$442 million	$872 m	26.6%
South Carolina	$250 million	$871 million	$1.1 billion	16.3%
South Dakota		$27 million	$27 million	2.2%
Tennessee*	$468 million	$1.0 billion	$1.5 billion	13.4%
Utah		$620 million	$620 m	10.4%
Vermont	$59 million	$82 million	$141 m	11.6%
Virginia	$1.2 billion	$1.1 billion	$2.3 billion	13.8%
Washington		$1.3 billion	$1.3 billion	8.5%
Wisconsin	$652 million	$1.0 billion	$1.7 billion	11.7%
Wyoming		$119 million	$119 m	6.8%
TOTAL	$46.8 billion	$63.1 billion	$109.9 billion	15.2%
* These states provided a range of estimates for their FY09 gaps; this table shows only the low end of the estimates. For more detail see 29 States Faced Total Budget Shortfall of At Least $48 billion in 2009 available at http://www.cbpp.org/1-15-08sfp.htm. Note: In most cases these shortfalls have already been addressed.

For more detailed information, see “An Update on State Budget Cuts.”

Who's the Boss, the States or the Federal Government?

The Federal Government Exists Because Representatives of the States Created It

By Henry Lamb
March 4, 2010

Is the federal government sovereign, with authority over state governments? Or, are individual state governments sovereign, with authority over the federal government? It's a simple question; it's the answer that's a problem.

The federal government exists because representatives of the states created it. This fact should provide a clue. The federal government was designed by representatives from the states in a document called the Constitution of the United States. The federal government became a reality when the Constitution was ratified by the 9th state, New Hampshire, on June 21, 1788. This infant government, created by the states, began operation March 4, 1789. From that day until this, people have been arguing over whether the federal government or the states possess the supreme authority.

It is quite clear that the people who designed the federal government intended it to be limited in its power. Article 1, Section 8 sets forth 17 enumerated powers of the federal government. The first clause empowers the new government to "lay and collect taxes," to provide for the "defense and general welfare" of the United States. Here's where the argument gets nasty.

One group of people argues that the phrase "general welfare" means whatever Congress wants it to mean with no limitations. Another group of people argues that if this is what the designers intended, why on earth would they have bothered to enumerate the remaining 16 specific powers? It's a reasonable question that the first group prefers to ignore rather than answer.

To be sure that the federal government's authority stayed limited, the primary architect of the Constitution, James Madison, introduced the Bill of Rights in the very first Congress in 1789. These first ten Amendments further clarify the authority and limitations of the federal government. The 10th Amendment in particular, limits the federal government to those powers enumerated in the Constitution and explicitly reserves all other powers to the states and to the people.

Among the powers granted to the federal government is what is known as the "Enclave Clause," which happens to be the 17th enumerated power. This clause provides authority for the federal government to exercise supreme authority over an area "ten miles square" ceded by the states to be the Capitol of the new government, and over any lands purchased from the states with the approval of the state legislature for "…the erection of forts, magazines, arsenals, dock-yards, and other needful buildings."

This is where it really gets sticky. Clearly, the designers intended for the federal government to purchase "with the approval of the legislature" any land to be owned by the federal government within any state. The Constitution empowers the federal government, however, to exercise sovereign authority over its territories, and the authority to add states which are carved out of the territories.

It is reasonable to conclude that when a state is carved out of a territory, it becomes a state subject to the powers and limitations of all the other states within the jurisdiction of the Constitution, and no longer subject to the federal authority suffered by the people when the land area was a territory.

This is pretty much the way it went when Texas was admitted to the Union in 1845. What was called "public land" was shifted to the state of Texas. Today, only 1.9 percent of Texas is owned by the federal government.

In Utah, however, the federal government required, as a condition of statehood, to "disclaim all right to title" of public land, and the feds retained nearly 60 percent of all the land in the state. In Nevada, the feds retained 85 percent of the land.

How can it be legal for the federal government to own land in a state that it did not purchase with the consent of the state legislature? How can it be legal for the federal government to exercise sovereignty over land within a sovereign state? Why were the eleven Western states and Alaska treated differently upon admission to the Union than were the other 26 states that joined the Union – when all states were supposed to be admitted on an "equal footing"?

There is only one logical conclusion: the federal government should not own the land it now claims within any state unless it is purchased with the approval of the state legislature for the purposes set forth in Article 1, Section 8, Clause 17.

There is a growing effort in Western states to force the federal government to honor its Constitutional limitation on land ownership and return to the states that which is rightfully theirs.