On January 15, I testified before the House Budget Committee on how to strengthen the federal-state-local government partnership. I urged Congress to revise funding formulas to better respond to regional differences and economic shocks and to adopt a more predictable federal budget process. I made four main points:
1. States and localities are key economic players and service providers.
The nation’s 50 states and more than 90,000 local entities spend nearly $3 trillion a year on goods and services, including public schools, colleges and universities, roads, bridges, and other infrastructure. Together with the federal government, they administer the social safety net, including Medicaid, Unemployment Insurance, and Temporary Assistance to Needy Families (TANF).
2. State and local governments are severely tested in recessions and other economic shocks.
States in particular tend to rely on procyclical revenues that rise and fall with the economy. But state spending is countercyclical. That means it generally rises in a downturn because of greater demand for public programs, especially those targeted to people who are low-income or unemployed.
This potential mismatch creates problems for state and local elected officials, who generally must balance their budgets each year. It also poses problems for the larger economy, because tax increases and spending cuts needed to close projected state and local budget gaps can undermine a national economic recovery.
3. The federal government does a lot to help states and localities.
The federal government allocates roughly $700 billion a year in grants to state and local governments. It also helps them through the tax code: for example, individual taxpayers can deduct state and local taxes (up to a $10,000 cap after the 2017 Tax Cuts and Jobs Act) and exclude municipal bond interest from taxable income.
Federal funding is an acknowledgment that states and localities can do a better job than the federal government customizing programs to their own populations, geographies, and costs. Thus, Congress has long encouraged cities, counties, and states to spend more on goods and services whose benefits may cross jurisdictional lines, such as roads and bridges, or are important to all Americans, such as education and help for struggling families.
4. But the federal government could do more by redesigning its grant formulas.
The US intergovernmental grant system falls short in two ways. First, federal grants don’t respond well to differences in regional economic fortunes or fiscal capacity. Federal policymakers should reexamine funding formulas that may be out of step with current economic and social conditions. Examples include Medicaid, Title I education, highway grants, and Community Development Block Grants.
Second, federal grants could be more responsive to economic shocks or recessions. To address this problem, policymakers ought to consider making permanent and automatic a feature of the 2009 American Recovery and Reinvestment Act that allocated more money to places experiencing large drops in employment. Congress could also restructure federal highway grants to address regional economic declines.
Aside from restructuring programs, the federal government could help states and localities by reducing uncertainty associated with late appropriations, short-term continuing resolutions, and threatened agency shutdowns. It also could minimize the use of temporary tax provisions that make it harder for states to conform to federal income tax law and provide less effective incentives for the behavior they are intended to change.
The federal, state, and local partnership is critical to running effective government. And with a few modest changes, it could be even better.
