Thank you for having me here today to talk about the importance of the federal budget to state and local governments. The views I am going to express today are my own and should not be attributed to the Tax Policy Center, the
In this short testimony, I'd like to make three main points:
1. States and localities are key economic players and service providers.
2. Both these roles are severely tested in recessions and other economic shocks.
3. The federal government often steps in to help states and localities, but it could do more.
States and Localities Power Much of the American Economy and Public Sector
The nation's 50 states and more than 90,000 local governments (counties, cities, towns, school districts and special-purpose districts such as water or transit authorities) spend nearly
Together with the federal government, states and localities provide subsidized health insurance to lowincome individuals and families and cover about half of all long-term care expenses through the joint federal-state Medicaid program.7 They administer critical parts of the social safety net including unemployment insurance, Temporary Assistance to Needy Families (TANF), the
States and Local Governments Are Often Hard Hit in Recessions
States and localities get roughly half their combined general revenue from taxes, another quarter from federal grants (mostly Medicaid), and the remainder from charges (including public college and university tuition, parking meter fees, public hospital payments, and highway tolls) and other sources.8 Sales taxes, including business gross receipts taxes and separate taxes on motor fuel, cigarettes, and alcohol, are the single largest source of state and local tax revenue (18 percent of general revenue), followed by property taxes (17 percent) and individual income taxes (12 percent).
State and local governments spend roughly two-thirds of their budgets on programs in education, health, and public welfare (a broad functional category defined by the
States in particular tend to rely on procyclical revenues--ones that rise and fall with the economy.
However, their spending is countercyclical, meaning that it generally rises in a downturn because of greater demands for public programs, especially those targeted to people who are low income or unemployed.9
This potential mismatch between revenues and spending in their responsiveness to the business cycle creates problems for state and local elected officials, who must generally balance their budgets each year.10 It also poses problems for the larger economy because tax increases and spending cuts undertaken to close projected budget deficits can undermine a national economic recovery.
Economists have long noted the potential for such "fiscal perversity" at the state and local level, blaming it for prolonging the Great Depression and
In the 1970s federal policymakers experimented with various forms of countercyclical state and local fiscal assistance starting with the Local
Countercyclical fiscal assistance then fell out of favor until the early 2000s, when the Jobs and Growth Tax Relief Reconciliation Act of 2003 (JGTRRA) appropriated
The American Recovery and Reinvestment Act (ARRA) of 2009 was the next major experiment with countercyclical fiscal assistance, directing nearly
ARRA worked faster than JGTRRA and many would argue it was more effective. Aid started to flow in the first quarter of 2009, retroactive to six months earlier. With JGTRRA, aid did not start until after the recession was already over--because of delays enacting the legislation, but also because the 2001 recession was relatively brief. In addition, ARRA was better targeted to places affected in the downturn.16 The Federal Government Should Do More to Prepare for State and Regional Economic Shocks and Help Places Left Behind in the Current Recovery
The federal government allocates roughly
Federal money isn't a bailout; it's a quid pro quo. The federal government recognizes that state and local governments have certain advantages when it comes to tailoring programs to their populations, geographies, and costs. It wants to encourage them to spend more on valued goods and services whose benefits may extend across jurisdictional lines. Examples include roads, bridges, and investments in human capital or help for struggling families.
Another consideration is equity or fairness. Some states and localities may start out with less income, wealth, and other resources to tax. Alternatively, they may have populations that are older, sicker, geographically dispersed, or otherwise more expensive to serve at a given level of quality.18 Americans who care about providing struggling families with a basic level of assistance might be willing to subsidize these states and localities to do more.
The federal government has long distributed grants and had state and local governments provide goods and services using these funds, almost always with strings attached. However, the US intergovernmental grant system falls short in both static and dynamic terms. In the static sense, federal grants do a poor job responding to divergent regional economic and fiscal fortunes and in equalizing differences in fiscal and economic capacity. In a dynamic sense, federal grants typically are not as responsive as they could be to the regional effects of economic shocks or recessions.
To make grants better economic equalizers, federal policymakers should reexamine funding formulas that may be out of step with current economic and social conditions. Federal highway grants should be based on need and performance rather than only highway lane miles, vehicle miles traveled, population, and tax payments to the federal
At a minimum, the federal government could help states and localities by reducing uncertainty associated with late federal appropriations, short continuing resolutions, and threatened shutdowns.24 It could also minimize the use of expiring tax provisions that complicate efforts at federal income tax conformity and that provide less effective incentives for desired behaviors than permanent policy.25 In summary, the US federal-state-local partnership did not come easily. It evolved over 200 years that included defaults, bailouts, a civil war, the introduction of new revenue sources and social insurance programs, and lots of trial and error. It is an enduring and robust partnership, but it is a work in progress.
There are several ways in which the US federalist system can be made stronger, especially in an economic crisis. Thank you for the opportunity to share these three points with you. I welcome the opportunity to take questions and to continue to work with you in the future.
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1 "Table 3.3, State and Local Government Current Receipts and Expenditures," National Income and Product Accounts (NIPA),
2 "Table B-1a. Employees on Nonfarm Payrolls by Industry Sector and Selected Industry Detail, Seasonally Adjusted," Current Employment Statistics-CES (National),
3 "Table 1.1.2, Contributions to Percent Change in Real Gross Domestic Product," NIPA, BEA, last updated
5 "Table 303.10. Total Fall Enrollment in Degree-Granting Postsecondary Institutions, by Attendance Status, Sex of Student, and Control of Institution: Selected Years, 1947 through 2028," Digest of Education Statistics,
8 Federal grants are a higher share of state (33 percent) than local general revenue (4 percent), although local governments receive a substantial share (36 percent) of funds from states that pass through federal grants. See
14 GAO, "Federal Assistance: Temporary State Fiscal Relief" (
15 ARRA created individual income tax credits, expanded business tax incentives, and launched federal initiatives in high speed rail, health information technology, and an energy "smart grid." At its peak (2009-12), it provided a fiscal impulse of about
16 However, unemployment was a better indicator of Medicaid enrollment pressures than the across-the-board FMAP increase or hold-harmless provision. See
17 "What Types of Federal Grants Are Made to State and Local Governments, and How Do They Work?" Tax Policy Center Briefing Book, Urban-Brookings Tax Policy Center, accessed
21 GAO, "Formula Grants: Funding for the Largest Federal Assistance Programs Is Based on Census-Related Data and Other Factors" (
22 See, for example,
25 See, for example,