The Fiscal Squeeze

The combination of subsidiarity with the principles of fiscal federalism ensures that the government has the knowledge to provide the economically efficient number and amount of public goods without either leaving too much or too little productive activity to the sphere of private exchange. In this paper, we argue that, over the last 100 years, these two design principles of federalism have slowly eroded and we highlight one of the fiscal consequences of this process of erosion: increasing budgetary pressure at the state level. We call this specific consequence the fiscal squeeze, because states have remained fiscally responsible for decisions that are now made at the level of the federal government and, as a result, are experiencing systematically greater budgetary pressures. Empirically, paying for school funding, health care funding, and pension funds, to name a few, has strained the ability of many states to keep balanced budgets and avoid debt or default.