A New Federalism for a New Century

Tracy Gordon

At the height of the 1992 presidential campaign, USA Today ran a photograph of Governor Bill Clinton reading Alice Rivlin’s Reviving the American Dream. It is easy to see why the evocative title captured a candidate’s, news editors’, and perhaps the public’s imagination. What casual observers may have missed, however, was Rivlin’s subtitle: The Economy, the States, and the Federal Government. That is where the action really lay.

Rivlin argued that reinvigorating the national economy and restoring trust in government necessitated a new balance of power among federal, state, and local governments. In her vision, states and localities would lead a productivity agenda built on investments in education and infrastructure. The federal government would by and large get out of the way by devolving most education, housing, highways, social services, economic development, and job training responsibilities. However, it would levy a new broadly based energy or consumption tax and disburse the revenues back to states. At the same time, it would take on health care reform, relieving states of one of their largest and fastest-growing financial burdens. It would also balance its books to keep interest rates low and free up investment dollars for businesses and state and local governments.

Bruce Katz argues that the presidential aspirants of 2012 would do well to heed Rivlin’s advice—updated to reflect new fiscal, economic, and political realities. In particular, Katz urges candidates traversing the country to pay closer attention to communities and regions they are visiting. He reminds them that cities and metropolitan areas are “engines of growth” because they are uniquely well positioned to translate local differences into output and productivity gains. It follows that state and local government leaders should have a seat at the table in discussions of national economic revitalization. To this end, Katz prescribes a new task force of federalism and the economy. He would also create a national laboratory on federalism and competitiveness to capture and disseminate the best state and local economic policy ideas.

To fully appreciate why the next administration ought to pay attention to Katz’s argument, it may be helpful to elaborate on agglomeration economies. Going back to Alfred Marshall in 1890 and as elucidated in Edward Glaeser’s recent Triumph of the City, this is the idea that cities and metropolitan areas confer economic benefits on their residents and the nation as a whole by bringing together diverse people and ideas, which grow and multiply so that the whole is greater than the sum of its parts. The success of cities and metro areas is partly a function of scale, or of attracting enough individuals and firms to make investments in large facilities and amenities worthwhile. It also stems from providing shared access to economic inputs, including common suppliers and a skilled workforce. Furthermore, having a large and variegated local economy helps protect against risk, as was clear in the resilience of New York City after 9/11.

Despite the importance of local and regional economies, U.S. federalism or intergovernmental cooperation has a somewhat checkered history. States have clashed with the federal government since the founding of the Republic. The Constitutional Convention of 1787 was one attempt to sort out these differences. However, even the Tenth Amendment to the U.S. Constitution—which explicitly reserves to states any unenumerated federal powers—did little to resolve matters. The nation’s first treasury secretary Alexander Hamilton further muddied the waters by assuming state war debts and paying them off with U.S. bonds, although the federal government declined to come to states’ aid again after the Panic of 1837 and defaults that followed. Of course, disputes about tariffs, trade, and states’ rights also precipitated the nation’s only internal armed conflict, the Civil War.

Fortunately, contemporary disagreements are largely confined to policy issues. The next president will likely continue to spar with governors over K–12 education, environmental regulation, and immigration. Health care reform is also a point of contention, as governors worry about the costs of implementing the Patient Protection and Affordable Care Act (ACA), especially Medicaid expansions scheduled to begin in 2014. In addition, federal fiscal pressures will continue to reverberate to states and localities as discretionary spending cuts take effect in 2013 and Congress and the administration continue to search for reductions to entitlement programs and tax breaks benefiting state and local governments.

The next president may be unable to avoid similar pitfalls. The reason is that American federalism embodies a fundamental tension. The federal government, because of its size and scope, excels at raising revenue, whereas states and localities, because of their proximity to local preferences and conditions, excel at spending it. Unrestricted federal grants are one remedy to this vertical fiscal imbalance, but they tend to be rare and short-lived. Having incurred the political costs of taxation, members of Congress and the administration are generally loath to share the spoils.

To be fair, federal policymakers may be wary of moral hazard, or the possibility that federal bailouts will create incentives for state and local fiscal profligacy. The American Recovery and Reinvestment Act of 2009 (ARRA), although often derided or ignored in the 2012 campaign, may offer a way forward. Early reports suggest that despite initial complaints, it improved coordination not just between federal agencies but also between levels of government. It may have also blunted incentives for gaming through formulas based on explicit criteria (such as local unemployment) and extensive reporting requirements.

The incoming president would do well to study these experiences as well as the gone-but-not-forgotten Advisory Commission on Intergovernmental Relations (ACIR). The ACIR once acted as a clearinghouse for evaluating innovations in federalism, but it was zeroed out in the Republican Revolution led by then Speaker Newt Gingrich. Since the ACIR’s demise, the federal government has continued to grant individual waivers and fund demonstration projects. However, it seems to have lost its appetite for analyzing these experiments, synthesizing results, and drawing lessons across program areas. There is no federal office or agency charged with federalism as federalism, or with optimizing who does what in the nation’s complex government. Whoever becomes president in 2012 would do well to reengage on this essential question.