FEDERAL GRANTS AND THE DECLINE OF THE

FEDERAL SYSTEM*

BY ROGER A. FREEMAN **

The growth rate of Federal aid to State and local governments is virtually unparalleled in our fiscal history. From $7 million at the turn of the century it soared to about $1 billion in the midthirties to midforties, and to nearly $14 billion in the current year. On the average the amount tripled every 10 years and almost quadrupled in the past 10. Even more startling is the multiplication of program which now cover most major domestic public services, with the few remaining gaps being rapidly filled. Continued expansion was foreshadowed at the first session of the 89th Congress which wound up its work 2 weeks ago. For once, academic advice, presidential recommendations, and congressional action appear to be in harmony and point in the same direction. When the Joint Economic Committee earlier this year gathered the views of 48 economists on "Fiscal Policy Issues of the Coming Decade" most of those who referred to Federal-State relations suggested an expansion of Federal grants in some form or other. None disagreed. The last time I heard a plea for greater financial self-reliance by local governments was in 1964 during a study trip through the Soviet Union when I read an article by two Russian ecoonmists who, writing in an economic journal, suggested that local units ought to try to depend less on support from the budgets of higher governments.

It is remarkable that the U.S. Government was able to multiply its grants and other domestic activities-without significantly changing the ratio between total Federal spending and the gross national product over the 14 years, as President Johnson pointed out some time ago. It did so by a sharp relative cutback in defense outlays which meanwhile dropped from 66 percent of total Federal spending to 42 percent. That retrenchment in national security provided the leeway for a dramatic expansion of civilian public services which seems to have far from runs its course.

The steadily swelling flow of Federal funds into local channels has enjoyed wide popularity but, as any rapid growth, has also caused some dislocations, friction, administrative or political problems, or even unhappiness among less favored groups. General opposition focused particularly on the charge that the spectacular expansion of Federal grants to State and local units is leading to a centralization of governmental power at the expense of home rule, local autonomy, and individual freedom.

*Speech delivered at the 58th Annual Conference on Taxation, National Taxation Association, New Orleans, La., Nov. 9, 1965.

**Senior staff member, the Hoover Installation on War, Revolution, and Peace, Stanford University.

But Federal grants thrive on opposition. A joint conference of representatives of Congress and the Governors' Conference in August 1948, concerned over the postwar growth of Federal grants to over $1 billion, recommended that amounts for fiscal 1950 be cut by no less than 20 percent. As it turned out, grants in 1950 were not 20 percent smaller but 34 percent larger and kept on climbing. Two years later a new administration assumed office which was troubled by thhe apparent trend toward a power monopoly at the national level and set about to reverse it. Following suggestions by Senator Robert A. Taft, it prevailed on Congress to form a study commission "because the activity of the Federal Government has been extended into many fields which, under our constitutional system, may be the primary interest and obligation of the several States. . ." In his 1954 budget message the President said: "This budget marks the beginning of a movement to shift to State and local governments and to private enterprise Federal activities which can be more appropriately and more efficiently carried on in that way."

The creation of the Commission on Intergovernmental Relations was heralded by some of its friends as the Second Coming of the Constitutional Convention and expected to help stem the tide of Federal power or according to others try to turn back the clock of history. but when the Commission rendered its report 2 years later it was obvious to friend and foe that the world would little note nor long remember what was said here. The New Yorker would have placed the "on one hand... but on the other hand. . ." report in its department of anticlimax if it had mentioned it at all, which like other media, it did not. As it was, the Commission succeeded during its short life and in the thereafter in attaining a degree of anonymity which the Central Intelligence Agency envied and has ever since been trying to emulate.

Federal grants meanwhile soared to $7 billion in 1960 and totaled almost $14 million in the President's recommendations of January 1965. Back in 1960 I discussed in my book "Taxes for the Schools,' the remarkable fact that Federal grants tripled during the life of an administration which was committeed to cutting them and wondered aloud "how fast Federal aid and Federal activities in general will expand in the future if an administration comes to power that favors them." The record of the past 5 years has answered my question.

THE FISCAL MISMATCH AND THE NEED FOR FEDERAL AID

The classic and most frequently advanced justification for Federal grants and for far larger grants-is inadequate fiscal capacity of State and local governments or what Walter Heller recently called the "fiscal mismatch": State and local governments are responsible for most domestic public services whose needs are exploding while the National Government has preempted the most lucrative revenue sources. U.S. Treasury tax receipts, the story goes, expand with the economy and at a faster rate while State and local revenues are sluggish and grow only slowly. The record proves this to be true during every shooting war, from 1916 to 1920, from 1941 to 1945. But during peace peri

ods, before and after every war, the opposite has been true. In the past 20 years GNP grew 203 percent, Federal revenues 135 percent, State and local revenues (from their own sources) 434 percent. This was of course due to the fact that Federal tax rates were cut (ever so slightly) while State and local tax rates were raised. So, now the case for more Federal aid has to be slightly modified: State and local governments, by quintupling their tax receipts have overexerted their fiscal powers and exhausted their capacity. This gives us two compelling reasons to prove the need for a sharp expansion of Federal grants: State and local tax revenues rise (a) too slowly, (b) too fast. Some observers feel that this is a "heads I win, tails you lose" proposition.

Federal financial assistance is also needed, we are told, because State and local governments are hamstrung by obsolete constitutional limitations which prevent them from exercising adequate taxing and borrowing powers. Those tight and unreasonable restrictions do not seem to have stopped State and local governments from boosting receipts (from their own sources) from $13 to $71 billion in the past 20 years or from pushing their outstanding debt from $17 to $92 billion. So, again, the case for Federal grants had to be slightly modified: State and local debt grew 428 percent in the past 20 years, Federal debt only 16 percent, which apparently proves that State and local governments are dangerously overexpanded while the Federal debt has shrunk in relative terms and Federal borrowing capacity is underused.

Strangely enough it is never mentioned in that connection that Federal debt soared 1,283 percent in the preceding dozen years while Statelocal debt declined 9 percent or that Federal and State-local debt were of approximately equal size three decades ago while today Federal debt is three times larger than State-local.

Now I am not quoting those figures in an attempt to prove that more Federal aid is needed or that it is not needed. That may depend on other considerations. I only want to throw light on the statistical acrobatics which are being widely used to present a one-sided and distorted picture of the record of Federal and State-local finance. Even the originators of new grant-in-aid programs do not seem to believe that State and local governments are at the end of their financial ropes: they almost always include matching formulas which call for sizable State and local contributions and often provide incentives for boosts in the spending of local funds. Such stimulants would serve no purpose if State-local governments had no remaining fiscal capacity. Several students of the subject such as Dick Netzer and Arthur Smithies have indeed concluded in recent reports that State-local governments are far from having exhausted their fiscal potential.

The 1950's and first half of the 1960's were characterized by continuous rounds of tax boosts at State and local levels which, to the taxpayers' chagrin, refute the snide remark of the American Assembly in October 1955: "Zeal for new tax levies is not characteristic of State legislatures." More than half the States enacted substantial tax boosts in 1963 and about two-thirds did in 1965.

But to boost taxes is a political hazard for the Governor, mavor, legislator, or local functionary who must run for elective office while a new Federal grant program only bestows credit and earns gratitude for the public officials, Federal, State, or local, who enact the program

or distribute its benefits. In the common folklore Federal money comes "for free," a very comforting thought which parallels the reasoning of the patient who told his psychiatrist that he was making long-distance calls to himself. "Isn't that expensive?" inquired the doctor. "No, it doesn't cost a cent," said the patient, "I am reversing the charges."

There is eternal glory (and political profit) in being the author of something akin to the Morrill Act, Hill-Burton Act or GeorgeBarden Act which initiated major Federal grant programs. But whoever heard of a tax bill named after those or any other legislators at any level of government? Small wonder that elective officials increasingly find Federal aid more conducive to political longevity and thus more attractive than boosting a local tax. Charles Conlon remarked at the 1952 Tax Conference in Toronto that "The taxes which somebody else levies and you spend are of course the most desirable kind."

But there is something more to the distinction between "desirable" and "undesirable" taxes. A major share of federal revenues comes from the progressive personal income tax while the bulk of State and local funds is derived from taxes which are either proportional or even regressive. To be sure, if we allocate all taxes and all public expenditures by income brackets and relate the two-a study which unfortunately has not been undertaken for several years we may be driven to the conclusion that government is primarily a huge machine for the redistribution of income. But, maybe, it is not doing enough of it.

Though the difference in incidence of Federal and State-local taxes may not be as great as is often imagined or asserted, there undoubtedly is a different impact upon various economic groups. Consequently those who feel that redistribution of income-from those who earn it to those who yearn it-is a major purpose and virtue of a tax system, or of government as such, favor financing through the National Government and abhor the growth of State and local taxation. Moreover they are steadily at work-and were successful in the Revenue. Acts of 1964 and 1965-in making the Federal tax system more progressive. They are presently hard at work in preparing further revisions of the same type. Obviously, it is far easier to engender enthusiasm for a new program if the potential beneficiaries can be told (or at least made to believe) that somebody else will foot the bill. Small wonder then that Federal grants possess a political charm for officeholders and officeseekers, for prospective recipients and for many local taxpayers which is overwhelming and decisive-as their spectacular record proves.

ALTERNATIVES TO PROGRAMMATIC GRANTS

The National Government could, of course, financially aid State and local governments by means other than programmatic grants. Some of those devices have been drawing attention in recent years. One plan which according to recent newspaper stories is now under active considerations in the Treasury Department would grant credit on the Federal income tax for a percentage of State personal income

taxes. This would soon force the 14 States which levy no such tax to impose it and cause others to boost their rates. That may well be the plan's real aim.

Credits on the Federal income tax could provide broader and more effective aid to State and local governments if they extended to all taxes rather than single out the State income tax. Or, the credit device could be tailored to favor priority programs such as education. At hearings of the Senate and House committees studying means of aiding the schools-and, according to announcements giving relief to the property taxpayer-earlier this year I suggested to grant an income tax credit for school property taxes. Another way of helping particularly higher education would be the granting of income tax credits for tuition, charges, and gifts which I recommended to several congressional committees in 1963.

Other plans would allocate a small share of certain federally collected taxes to States. The House of Representatives in fact twice passed such programs but rescinded them soon after. Redistribution. of Federal taxes to States (or also to local governments) would make funds available for the financing of public services at local discretion. Such plans of general subvention or tax sharing are widely used to distribute State-collected taxes to local governments, and also in several countries of the British Commonwealth. The United Kingdom adopted a system of general grants to local authorities in 1958. The U.S. Government however has so far extended its "cooperative federalism" only to spending programs and not to taxes.

General Federal grants to the States attracted little attention in the United States until Walter Heller, while still Chairman of the Council of Economic Advisers in the summer of 1964, advanced an idea which has since become known as the "Heller plan." A Presidential task force was summoned which endorsed the proposal in a report which was never made public but whose essential features can be gathered from several speeches by the task force chairman, Joseph Pechman, in 1965.

Senators Jacob Javits and Vance Hartke introduced a bill (S. 2619) to implement the Heller plan on October 11, 1965. It would distribute 1 percent of the personal income tax base, or about $2.5 billion a year, among the States, 80 percent in proportion to population and the remaining 20 percent to the 12 or 15 States with the lowest per capita income. Companion bills are pending in the House.

The "Heller plan" found a friendly reception among State Governors. Management and labor as represented by the NAM and the AFL-CIO agree on the Heller plan (and those groups are not very often on the same side of major policy proposals); they both are against it. The NAM believes that the pleasure of spending public money should be tied to the pain of raising it (as the State Governors once expressed it) and that in any case priority should go to cutting taxes and restraining public spending. The AFL-CIO feels that it wields more power in Washington than in some of the State capitols and that it can advance its goals better by a centralization of program decisions.

The Federal departments administering major Federal grantsHEW, Labor, Commerce-and the Treasury Department also voiced