Issue #15, Winter 2010

Federalism and Its Discontents

The states are drowning. The best life-preserver that Washington can throw at them is to take over Medicaid.

Awash in red ink thanks to the worst economic crisis since the Great Depression, state officials chaotically scrambled over the last year to keep their laboratories of democracy from exploding. With state tax revenues plummeting at the steepest rate on record, and with all except Vermont legally bound by balanced budget constraints, most governors and state legislatures were forced to dampen their local economies further by cutting services and raising taxes. The stock market collapse depleted already underfunded state pensions. Federal stimulus relief slightly dulled the pain, which nonetheless remained severe in most populous states. A majority of states cut funding for public health programs for poor, elderly, and disabled residents; reduced aid to K-12 schools and early childhood education; and slashed support for public colleges and universities.

All but a handful of governors in populous states saw their approval ratings sink well below 50 percent no matter how they responded to the crisis. In states like Texas, Florida, Missouri, Louisiana, South Carolina, Alabama, and Mississippi, rigid ideological opposition to time-tested responses like increased federal unemployment insurance defied logic and compassion. Thirty-one states raised their taxes, mostly by soaking the poor and working class through higher sales and sin taxes, although eight of those states also increased tax rates on upper-income residents. Gubernatorial scandals and statehouse clownishness further led citizens across the country to equate their state capitals with the word “dysfunctional.”

But while unusually severe this year, fiscal crises in states are neither new nor fleeting. The federal Government Accountability Office (GAO) projected even before the recession that “state and local governments will face an increasing gap between receipts and expenditures in coming years,” primarily because of rapidly rising health care costs that will escalate their Medicaid and state employee medical insurance obligations. Those financial pressures, in conjunction with balanced budget strictures, threaten to keep states in a permanent austerity mode. Scott Pattison, executive director of the National Association of State Budget Officers, told The Wall Street Journal, “There are so many issues that go way beyond the current downturn. This is an awful time for states fiscally, but they’re even more worried about 2011, 2012, 2013, 2014.” Don’t even ask about the state budgetary outlook for 2025 or, worse yet, 2035. The consequences for vital public sector services in the United States are profound: Education, law enforcement, social services, mass transit, and other basic connections between average citizens and their government will be continually squeezed, dragging down the nation’s potential for more broadly shared economic prosperity.

Although America’s system of federalism has always been much more decentralized than other democracies’, it has been pushed to the breaking point through a confluence of political forces that date back to the Johnson Administration. One is the conservative movement’s highly effective “devolution” campaign, consistent with long-standing Republican support for “state’s rights,” which advocates shifting responsibilities from the federal government to the states. Another is the state-level tax revolt launched in 1978 with the passage of Proposition 13 in California, a policy earthquake that prompted similar tremors throughout the country and subsequently kept state officials wary of raising taxes, even when obviously necessary. A third factor was the increasing enthusiasm among “Third Way” Democrats, particularly in the 1990s, for “reinventing government,” in part by relying more on state and local governments to innovate because they are closest to their “customers”–which only added to the burden load. Fourth, the conservative mindset that dominated Washington from 1980 until the 2008 elections virtually precluded domestic reforms that would entail higher levels of federal spending, with a few notable exceptions like the Medicare drug benefit. Fifth, few voters pay much attention to their state governments, which tend to receive only limited media coverage, perpetuating an opaque environment in which scandals brew, inertia prevails, and tough choices get deferred.

And finally, but perhaps most importantly, the nation’s inability, until this year, to radically restructure its medical insurance system has left states–along with the federal government, employers, and families–groaning under the weight of soaring health care costs. Even still, the health care proposals now under consideration in Congress seem unlikely to ease those pressures on state governments significantly and might end up adding to their Medicaid obligations.

Right-wing activist Grover Norquist may have failed in his notorious quest to shrink government “down to the size where we can drown it in the bathtub” through relentless tax cuts, but serially hacking it into 50 pieces has done much to weaken the country’s ability to govern itself. The result is a vicious cycle: The prevailing perception that the public sector is incompetent will continue, preventing governments from getting the resources necessary to do their jobs. Progressive ambitions for improving economic security and opportunity for all Americans will thus remain elusive.

The solution is to rebalance the federal-state division of labor, with each level concentrating on the responsibilities it has traditionally managed most effectively. By far the most important step would be to federalize parts of Medicaid, the massive health insurance program for the poor, the disabled, and nursing home residents that is jointly financed by the national government and the states. Ideally, federalization would, over time, help integrate Medicaid into a universal, national health insurance system. As Social Security and Medicare demonstrate, federal social insurance enjoys great economies of scale, management efficiencies, and broad popularity while avoiding the unjust state-to-state disparities in coverage and shoddy implementation that have long plagued joint federal-state programs. At the same time, reducing and eventually eliminating the growing share of state budgets devoted to Medicaid would go a long way toward enabling governors to manage their states much more effectively. In the absence of reform, the states’ share of Medicaid is projected to more than double, from $136 billion in 2007 to $290 billion by 2017. The grim prognosis could be greatly improved, however, through radical but circumscribed surgery: transplanting as much of Medicaid as possible to the federal government.

Roots of Federal-State Dysfunction

As historian Michael B. Katz documents in his book In the Shadow of the Poorhouse, states and localities have long borne the main responsibility for the stigmatized poor, while the federal government has assumed the central role of providing for citizens deemed worthy of social insurance. Before the 1930s, states and localities primarily financed and carried out what limited public services existed; domestic federal spending in 1929 amounted to only one-fifth of state and local spending.

In response to the Great Depression, in 1934 Franklin Roosevelt created the Committee on Economic Security, which made recommendations for providing support to the unemployed, needy women and children, and the indigent elderly. At the time, Roosevelt stipulated that, “Above all, I am convinced that social insurance should be national in scope, although the several states should meet at least a large portion of the cost of management, leaving to the federal government the responsibility of investing, maintaining, and safeguarding the funds constituting the necessary insurance reserves.”

The results were varied. Roosevelt’s Cabinet and its expert advisory council were deeply conflicted about whether to create a national system or a federal-state program for unemployment insurance. Ultimately it settled on a jointly run program, largely on pragmatic grounds, arguing that it would permit differing state laws “so that we can learn through variation what is best.” The committee also concluded, naïvely in retrospect, that if it became evident that a federal system would work better, “It is always possible by subsequent legislation to establish such a system.” Likewise, the committee focused on assisting existing state welfare activities for women and children through categorical grants-in-aid with matching funds, rather than creating new federal programs.

At the same time, it recommended rules intended to minimize graft and patronage, including the designation of a single state agency and plan, subsequent to federal approval, that would be in force throughout each state. Southern congressmen rebelled at such constraints, with Virginia Senator Harry Byrd denouncing them as interference in how states deal with “the Negro question.” Ultimately, the committee’s recommendations were watered down in the Social Security Act’s welfare-related provisions, enacted in 1935, leaving states with wide discretion in the use of federal support, including the determination of eligibility and benefit levels. Only the old-age pension section of the original act remained entirely a federal system.

In 1950, amendments to the Social Security Act authorized, for the first time, federal payments to states for medical services for individuals eligible for public support. Ten years later, Congress passed the Kerr-Mills Act, which extended health care benefits to the “medically indigent”: individuals over 65, not receiving Social Security’s Old Age Assistance, with income “insufficient to meet the costs of necessary medical services.” Kerr-Mills established a “federal matching percentage” ranging from 50 to 80 percent of state outlays, varying inversely with a state’s per capita income–laying the groundwork for the Medicaid formula five years later. As a result, the least populous states, which tend to be the most hostile politically to the federal government, receive far more money per capita from the feds.

In the years between Kerr-Mills and the passage of Medicare and Medicaid, advocacy groups, government studies, and media reports highlighted how rising medical costs were creating widespread hardship, especially among the elderly. State officials complained loudly about the inadequacy of Kerr-Mills, which they mocked as “Cur-Mills.” In response, in his first State of the Union address Lyndon Johnson endorsed programs that would support the “health needs” of older citizens, to be called “Medicare,” and the poor, which would be known as “Medicaid.”

Ever the politician, Johnson was far more interested in Medicare, which would immediately benefit the broad category of voters aged 65 and over, than in Medicaid, with its impoverished beneficiaries. Congress followed suit. In their prodigiously researched book on the history of that program, Medicaid Politics and Policy: 1965-2007, public policy scholars David Smith and Judith Moore report that legislative staffers could scarcely recall working on Medicaid and doubted that it took more than an afternoon of their time to draft. Johnson didn’t even mention Medicaid in his speech celebrating his signing of the legislation creating the two programs.

But one person did care deeply about crafting Medicaid: Wilbur Mills, the powerful chairman of the House Ways and Means Committee, who was eager to clear his name of the Kerr-Mills fiasco. A fiscally conservative Democrat from Arkansas, Mills feared that Medicare was the “entering wedge” for a nationwide “compulsory” system of health insurance for everyone. In response, he designed Medicaid to be both independent of Medicare and administered through a joint federal-state system, consistent with existing programs for the poor, making it less likely that Medicare would later expand to cover groups beyond the elderly.

Devolution’s Evolution

As political scientist Timothy Conlan documents in his superb book From New Federalism to Devolution, three Republican leaders–Richard Nixon, Ronald Reagan, and Newt Gingrich–defined the federalism debate in the post-Johnson era. All three made federal-state relationships a top priority, although they differed considerably in their motivations and in their particular proposals. Nixon’s sweeping “New Federalism” agenda, while partly aimed at weakening the federal bureaucracy and protecting his left flank politically, was mainly geared toward rationalizing roles and responsibilities rather than promoting anti-government ideology. That agenda included nationalizing welfare through a “family assistance plan,” consolidating fragmented and overlapping programs through federal block grants, and creating a federal revenue-sharing plan to provide support to states and localities. Of those, he succeeded in passing only revenue sharing. But he also signed into law the Supplemental Security Income (SSI) program in 1972, which established a new federal income floor for the aged, blind, and disabled. He also greatly strengthened and expanded the food stamp program with the creation of uniform federal standards for eligibility and benefits. SSI and food stamps, not incidentally, are widely considered much more effective programs than counterparts that rely more on states for funding, rule setting, and implementation. On matters related to federalism, Nixon’s legacy is one liberals generally applaud.

Reagan also had big plans for realigning federal-state relationships, built around what he called “a quiet federalist revolution.” In his case, though, the goal was ideological–to remove the federal government entirely from a broad swathe of domestic activities while discouraging states and localities from picking up the slack. Reagan eliminated Nixon’s revenue-sharing program, slashed grants to state and local governments, and slowed spending on Medicaid and other safety-net programs. In addition, the large federal deficits created by his 1981 tax cuts and heightened defense spending also became an ongoing justification for continued austerity.

One largely forgotten Reagan initiative was a 1982 grand bargain that would make the federal government entirely responsible for financing Medicaid in exchange for giving states responsibility for more than 40 other federal aid programs, including Aid to Families with Dependent Children (AFDC). Back in 1969, again in 1977, and yet again in 1981, the U.S. Advisory Commission on Intergovernmental Relations, which comprised officials in all levels of government, had recommended that the federal government assume full financial responsibility for all public assistance programs, including Medicaid. The Commission argued that its ideas would greatly improve an intergovernmental system that had grown “more pervasive, more intrusive, more unmanageable, more ineffective, more costly and above all, more unaccountable.” While Reagan’s plan proposed basically the inverse–moving programs to the states, with the lone exception of Medicaid–few disagreed with the need to do something dramatic to repair a deeply flawed system of federalism. The “sorting out” idea unraveled quickly, though, largely because of opposition from state officials.

The last big flurry of federalism activity occurred during the Clinton Administration, after the cataclysmic 1994 mid-term elections that swept Democrats out of both houses of Congress for the first time in 40 years. Although the GOP’s “Contract with America” didn’t explicitly mention federalism or devolution, almost all of its planks were intended to weaken the national government, including a Constitutional amendment to balance the budget, limits on “unfunded mandates,” welfare reform, and regulatory reform. Newt Gingrich articulated his mission in even more extreme terms than Reagan. “We have to decentralize power out of Washington, D.C., and disperse power,” he said. “That means it actually goes back to the people from whom it comes.”

Issue #15, Winter 2010
 

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