The Dependent States of America

In light of the Supreme Court's ruling upholding the Affordable Care Act, many claim that the choice of states' ability to opt out of Medicaid expansion requirements without losing all Medicaid funding was a big victory for federalism. That may be true, but federalism is still seriously in jeopardy.

As the theory goes, states can differentiate themselves on the basis of taxes, spending and regulation, or even social policies that give Americans more leeway in deciding the rules under which they want to live. If you don't like the level of taxes or the policies in your state, you can vote with your feet and move to another jurisdiction. In theory, this competition for residents helps keep lawmakers in check, giving them an incentive to keep taxes and other intrusions modest.

While this is a great theory, that's all it is. First, no matter where you live, you are subjected to Washington's tax bite, which has grown so large that differences in state tax rates mean much less than they used to.

Second, the federal government is pouring billions of dollars each year into the states' coffers. In fiscal 2011, total spending for federal grants to the states was $514.6 billion, up from $45.3 billion four decades ago. This money pays for everything from infrastructure to fiscal relief to Medicaid. In fact, today federal grants are the third largest item in the budget after Social Security and national defense, and the largest source of state revenue. Tad DeHaven recently noted "state officials have become addicted to federal subsidies because they allow them to spend money taken from taxpayers across the country instead of having to ask their voters to pony up the funds." And in fact, it is federal funding that allowed states to increase spending during the recent downturn.

This money isn't free. It comes with strings attached -- mandates and rules dictating how the states should spend their money, what services they should provide and how they should provide it. In a recent article in Governing the States and Localities, George Mason University Professor Paul Posner explains that "there are more than 950 federal grants that provide the vehicle for most federal mandates, rules and regulations affecting the states. They also are the principal constitutional vehicle that allows Congress to adopt policies beyond its enumerated powers in such areas as education, law enforcement, community development and social services."

These requirements weaken states' independence, especially since the federal government can bully states into doing what it wants by threatening them with "cross-over sanctions." The classic example was the threat to withhold highway grants for states that failed to adopt a national drinking age above 21, or adopt federal clean air requirements.

And if the funding is temporary but the requirement permanent, this "aid" becomes even more expensive. Using data from 50 states over a 13-year period, a 2010 paper by economists Russell Sobel and George Crowley shows that temporary grants from the federal government to state and local governments cause the latter to increase their own future taxes by between 33 and 42 cents for every dollar in federal grants received.

Obviously, the choice of where to live is never solely about a state's fiscal policies. But today, state policies are practically irrelevant, because so much of state and local policy is decided at the federal level. So although fiscal federalism is a great weapon to hold our state and local governments in line in theory, it won't happen in practice as long as states' dependency on the federal government persists.