Who’s Afraid of Fiscal Federalism?

In the 2005 case Gonzales v Raich, the Supreme Court pulled back on its federalism jurisprudence and ruled that the federal government may prosecute someone for growing marijuana at home for personal use under the authority of the Commerce Clause of the U.S. Constitution, which grants Congress the right to regulate commerce among the several states. This year, Congress passed a bill essentially federalizing Massachusetts’ health insurance regulations, mandating pure community rating, guaranteed issue, and individual purchase of health insurance, fairly extreme left-wing policies previously unknown to much of the country.

Oddly, these blows to the remnants of American fiscal federalism are coming just as scholars have recognized the virtues of the system. In the 1990s, Barry Weingast’s market-preserving federalism research agenda showed how mobility of people, goods, and capital across borders of a fiscal federation defined by decentralized policy-setting under hard budget constraints could restrain the growth of government and promote economic development. In the 2000s, scholars such as Jonathan Rodden, Erik Wibbels, and Sebastian Saiegh have investigated the economic consequences of federal institutions. What they found was that when subnational governments are responsible for “paying their own way” with own-source revenues, debt is lower and government is smaller. The reason why fiscal federalism constrains Leviathan is that it allows taxpayers to seek low-tax jurisdictions, which in turn encourages these jurisdictions to compete with each other.

Among the true fiscal federations in the developed world – Canada, Switzerland, and the U.S. (that’s it!) – the U.S. is the most centralized. The chart below shows tax decentralization (subnational own-source revenues divided by total government revenues) in 1999, the latest year for which data are available, for a number of OECD countries.

In Switzerland and Canada, over half of all government revenues are raised by provincial/cantonal and local governments through taxes over which they control either the rate or the base. In the U.S., that figure has generally been around 35-40%. Sweden and Japan actually score higher on tax decentralization than the U.S., although subnational units in those countries don’t enjoy nearly the policy and political autonomy that American states do.

Will Americans eventually realize that fiscal federalism actually works and reverse the decades-long trend toward greater centralization? For that to happen, voters and federal politicians would have to realize that the things they want to have done, from gun control to health care policy, are best handled at the state and local level. They would have to take a stand on principle to reject one-size-fits-all federal solutions. Either that, or the Court is going to have to acquire the nerve and intellectual honesty to realize that it’s their job to safeguard important institutions from marauding politicians, regardless of what their personal views might be on the issue before them.