Government Case Study: Fiscal Federalism Assignment

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Congressional Research Service https://crsreports.congress.gov

R46382

Congressional Research Service

Fiscal Federalism: Theory and Practice

R46382

June 3, 2020

Grant A. Driessen Analyst in Public Finance

Joseph S. Hughes Research Assistant

Fiscal Federalism: Theory and Practice

Congressional Research Service

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Fiscal Federalism: Theory and Practice

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1 For a basic introduction to fiscal federalism, see Richard A. Musgrave, The Theory of Public Finance (New York: McGraw Hill, 1959). 2 Simplified formulas corresponding to the theoretical discussion are provided in Appendix A, along with relevant outside research where applicable. A summary of recent trends and levels in U.S. fiscal federalism can be found in Appendix B. 3 Both provisions were created by the CARES Act (P.L. 116-136). For more information on the CARES Act, see CRS Report R46299, Coronavirus Aid, Relief, and Economic Security (CARES) Act: CRS Experts, by William L. Painter and Diane P. Horn.

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4 Extensions of this basic model can prioritize the welfare maximization of certain segments of the population (e.g., low-income households or households with children, elderly, and/or disabled persons). 5 Fiscal federalism models can also be constructed to allow for ordered choices (e.g., either the federal government or state governments choose first). A simultaneous structure is presented here for sake of simplicity.

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Table 1. Highest and Lowest Effective Tax States, 2017

State State and Local Taxes

($ billions) Personal Income

($ billions) Effective Tax Rate

New York 177.8 1,281.1 13.9%

District of Columbia 7.5 55.5 13.4%

North Dakota 5.0 39.5 12.7%

Hawaii 9.5 75.4 12.6%

Vermont 3.8 32.6 11.7%

United States Total 1,652.8 16,820.3 9.8%

Alabama 16.4 198.9 8.3%

Oklahoma 13.9 174.4 8.0%

6 This does not mean that all

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Florida 77.7 1,000.6 7.8%

Tennessee 22.9 305.7 7.5%

Alaska 3.0 42.3 7.2%

Sources: Census Bureau, 2017 State & Local Government Finance Historical Datasets, and Bureau of Economic Analysis, Regional Economic Accounts.

7 http://www.alaskabudget.com/ revenue. 8 North Dakota tax collection grows since Great Recession tops all states Bismarck Tribune, April 28, 2019, at https://bismarcktribune.com/news/state-and-regional/north-dakota-tax-collection-grows-since-great- recession-tops-all/article_c09ae687-fe54-5976-bcc2-2ddfc75d83cb.html. 9 Public Finances: Needs, Sources, and Utilization, National Bureau of Economic Research, 1961, p. 79.

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Table 2. Percentage Composition of Tax Revenue by Government Level, 2017

Type Federal State Local

Individual income 51.8% 37.2% 4.7%

Corporate income 6.9% 4.7% 1.1%

Other taxes 41.2% 58.1% 94.2%

Sources: Census Bureau, 2017 State & Local Government Finance Historical Datasets, and Office of Management and Budget, Historical Tables, Table 2.1.

Notes: Federal other taxes includes social insurance and retirement receipts, excise taxes, and estate and gift taxes. State and local other taxes is calculated as total taxes less income taxes.

Journal of Urban Economics, vol. 56, no. 3 (November 2004), pp. 397-407. 11 National Tax Journal, vol. 52, no. 2 (June 1999), pp. 269-304. 12 For a general discussion of behaviors motivated

Review of Economics, vol. 69, no. 2 (June 2018), pp. 169-181.

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13 More detail on how equilibrium outcomes vary with spatial characteristic

Public Finances: Needs, Sources, and Utilization, National Bureau of Economic Research, 1961.

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Table 3. Education Spending by Government Level, 2017 (billions of dollars)

State and Local State Local Federal

Elementary & secondary 660.4 7.0 653.5 40.6

Higher education 296.5 253.1 43.4 71.8

Sources: Census Bureau, 2017 State & Local Government Finance Historical Datasets, and Office of Management and Budget, Historical Tables, Table 3.2.

Note: Federal elementary and secondary education includes vocational education.

14 Conclusion

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Table 4. Excise Tax Collections by Government Level, 2017 (billions of dollars)

State and Local State Local Federal

Excise taxes 191.3 157.1 34.2 83.8

Sources: Census Bureau, 2017 State & Local Government Finance Historical Datasets, and Office of Management and Budget, Historical Tables, Table 2.1.

Note: State and local excise tax collections include amounts reported as selective sales taxes.

15 For more on excise taxes, see CRS Report R43189, Federal Excise Taxes: An Introduction and General Analysis, by Sean Lowry.

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Table 5. Transportation Spending by Government Level, 2017 (billions of dollars)

State and Local State Local Federal

Highways 182.0 109.8 72.2 45.8

Air 26.0 2.3 23.6 16.8

Water 6.4 2.1 4.3 4.4

Source: Census Bureau, 2017 State & Local Government Finance Historical Datasets, and Congressional Budget Office Public Spending on Transportation and Water Infrastructure, 1956 to 2017.

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16 American Economic Review, vol. 77, no. 2 (May 1987), pp. 130- Fiscal Shocks in a Globalized Worl IMF Economic Review, vol. 64, no. 1 (2016), pp. 177-215. 17

5, 2017, available at https://www.ecb.europa.eu/explainers/tell-me- more/html/25_years_maastricht.en.html.

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Figure 1. Federal and Combined State and Local Expenditures FY2005-FY2012 (as a percentage of combined expenditures)

Source: Federal Reserve Bank of St. Louis.

Note: Shaded area denotes period of the Great Recession, as identified by the National Bureau of Economic Research.

18 For more information on the Coronavirus Relief Fund and a brief discussion of the State Fiscal Stabilization Fund, see CRS Report R46298, The Coronavirus Relief Fund (CARES Act, Title V): Background and State and Local Allocations, by Grant A. Driessen. 19 For more information on the Municipal Lending Facility and policy issues related to state and local debt, see CRS In Focus IF11502, State and Local Government Debt and COVID-19, by Grant A. Driessen.

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Table 6. Summary of Relative State or Federal Government Responsibilities from Extended Assumptions to the Basic Model of Fiscal Federalism

Factor Implication of Relative Responsibility of Level of Government

Varying Preferences State role increases (and federal role decreases) with level of variation across states.

Mobility Depends on context. High mobility would exacerbate variation in preferences and result in a larger state role,

larger federal role.

Spatial Effects Depends on context. Highly concentrated spatial effects tend to increase state role, while broadly dispersed effects tend to increase federal role.

Externalities Depends on the level of these effects across state lines. The federal government may more efficiently address large spillover effects that spread far into other jurisdictions, whereas other cases are ambiguous.

Government Effectiveness Increase in the role of the government with relatively smaller information and administration costs.

Budget Imbalances Federal role increases as there is more variation in economic conditions across states. Federal role may also increase with relatively greater flexibility in budget outcomes (as is true in the United States).

Source: CRS analysis.

20 For more on how cooperation between the federal government and state and local governments operates in practice, see CRS Report R40638, Federal Grants to State and Local Governments: A Historical Perspective on Contemporary Issues, by Robert Jay Dilger and Michael H. Cecire. 21 The GRS program was established by the Local Fiscal Assistance Act (P.L. 92-512). For more on the GRS program, see CRS Report RL31936, General Revenue Sharing: Background and Analysis, by Steven Maguire.

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22 European Economic Review, vol. 50, no. 3 (September 2006), pp. 647-668.

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Appendix A.

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23 John Doug National Tax Journal, vol. 52, no. 2 (June 1999), pp. 269-304. 24 Public Finances: Needs, Sources, and Utilization, National Bureau of Economic Research, 1961, p. 79.

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Appendix B.

Figure B-1. Federal and State and Local Expenditures, 1970-2019 (as a percentage of combined annual expenditures)

Sources: U.S. Bureau of Economic Analysis, State and Local Government Current Expenditures and Federal Government Current Expenditures retrieved from FRED, Federal Reserve Bank of St. Louis. Percentage calculation by Congressional Research Service.

Note: Shaded areas denote years with an economic recession, as identified by the National Bureau of Economic Research.

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Table B-1. Federal and State and Local Revenues by Source, 2017 (as percentages of total revenue)

State Property

Tax General

Sales Tax Income

Taxes Federal

Transfers Other

Revenue

Federal 0.0% 0.0% 52.6% n/a 47.4%

All State and Local 13.4% 9.9% 11.2% 18.1% 47.4%

Alabama 5.7% 10.2% 8.6% 22.0% 53.6%

Alaska 11.0% 1.6% 0.6% 24.6% 62.1%

Arizona 11.5% 15.4% 6.7% 23.6% 42.8%

Arkansas 7.1% 14.5% 10.1% 26.1% 42.2%

California 10.3% 8.0% 15.3% 16.4% 50.1%

Colorado 14.0% 12.1% 11.8% 15.9% 46.2%

Connecticut 21.8% 8.6% 17.9% 16.4% 35.4%

Delaware 7.4% 0.0% 11.9% 20.5% 60.2%

District of Columbia 16.2% 9.1% 16.7% 26.7% 31.3%

Florida 14.5% 14.4% 1.2% 15.6% 54.2%

Georgia 13.3% 10.2% 13.1% 17.9% 45.5%

Hawaii 8.7% 17.0% 11.2% 15.2% 47.9%

Idaho 11.3% 10.7% 12.1% 17.9% 48.1%

Illinois 19.3% 9.7% 10.9% 15.6% 44.6%

Indiana 11.0% 12.0% 11.3% 24.0% 41.6%

Iowa 12.4% 8.6% 10.2% 14.9% 53.9%

Kansas 14.0% 13.4% 8.5% 13.8% 50.3%

Kentucky 8.2% 7.7% 14.4% 26.9% 42.8%

Louisiana 8.1% 16.5% 6.2% 24.9% 44.3%

Maine 19.8% 10.0% 11.8% 21.2% 37.2%

Maryland 13.3% 6.3% 21.0% 19.2% 40.2%

Massachusetts 17.5% 6.5% 17.7% 18.0% 40.2%

Michigan 13.2% 8.6% 10.5% 21.4% 46.4%

Minnesota 12.1% 8.3% 16.6% 16.0% 46.9%

Mississippi 9.3% 10.6% 6.7% 26.0% 47.3%

Missouri 10.4% 10.5% 11.4% 19.6% 48.2%

Montana 14.1% 0.0% 11.0% 27.7% 47.2%

Nebraska 15.3% 9.1% 10.1% 14.1% 51.4%

Nevada 9.5% 17.4% 0.0% 17.7% 55.3%

New Hampshire 31.6% 0.0% 4.5% 17.2% 46.6%

New Jersey 25.0% 8.2% 13.8% 15.6% 37.4%

New Mexico 6.4% 12.9% 5.5% 28.4% 46.8%

New York 15.0% 8.0% 17.6% 17.6% 41.8%

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State Property

Tax General

Sales Tax Income

Taxes Federal

Transfers Other

Revenue

North Carolina 9.7% 10.2% 12.4% 19.8% 48.0%

North Dakota 11.7% 10.4% 3.6% 18.2% 56.2%

Ohio 11.0% 10.8% 10.3% 18.7% 49.2%

Oklahoma 7.7% 12.4% 8.8% 20.4% 50.7%

Oregon 10.6% 0.0% 15.7% 18.5% 55.2%

Pennsylvania 13.1% 7.7% 13.3% 21.6% 44.3%

Rhode Island 19.3% 7.6% 10.4% 21.9% 40.8%

South Carolina 11.4% 7.2% 8.5% 18.7% 54.1%

South Dakota 15.6% 15.8% 0.3% 18.3% 50.0%

Tennessee 9.4% 14.9% 3.1% 19.0% 53.6%

Texas 19.2% 14.6% 0.0% 16.6% 49.6%

Utah 10.0% 10.3% 12.3% 15.7% 51.7%

Vermont 20.3% 4.8% 10.4% 24.9% 39.7%

Virginia 15.2% 5.9% 15.1% 12.9% 50.9%

Washington 11.1% 18.3% 0.0% 15.6% 55.0%

West Virginia 8.7% 6.9% 9.7% 25.9% 48.8%

Wisconsin 14.9% 8.7% 13.6% 19.5% 43.2%

Wyoming 12.5% 6.7% 0.0% 31.8% 49.0%

Sources: Census Bureau, 2017 State & Local Government Finance Historical Datasets and Tables, and Bureau of Economic Analysis, National Income and Product Accounts.

Notes: CRS calculations. State and local government figures draw from Census data, while federal results draw from Bureau of Economic Analysis data.

Table B-2. Federal and State and Local Expenditures by Function, 2017 (as percentages of total expenditures)

State Education Social Services Transportation Defense and Public safety

Environment and Housing

Other Expenditures

Federal 3.1% 24.2% 2.4% 15.0% 2.3% 53.0%

All State and Local 27.9% 26.6% 5.9% 7.0% 5.8% 26.8%

Alabama 29.1% 32.3% 5.7% 5.4% 4.3% 23.2%

Alaska 22.2% 22.0% 13.0% 6.5% 6.9% 29.4%

Arizona 26.1% 27.5% 5.2% 9.5% 5.0% 26.7%

Arkansas 30.4% 32.7% 7.9% 5.7% 5.0% 18.4%

California 23.4% 29.1% 3.9% 8.2% 6.1% 29.3%

Colorado 29.1% 19.8% 6.8% 7.2% 7.1% 29.9%

Connecticut 33.3% 15.5% 5.7% 6.2% 5.3% 34.0%

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State Education Social Services Transportation Defense and Public safety

Environment and Housing

Other Expenditures

Delaware 33.6% 25.8% 7.6% 6.8% 5.1% 21.1%

District of Columbia 16.2% 25.0% 2.6% 6.4% 9.6% 40.3%

Florida 24.5% 24.7% 8.4% 10.1% 9.0% 23.4%

Georgia 33.2% 22.6% 6.4% 7.3% 5.9% 24.6%

Hawaii 20.5% 25.6% 7.2% 6.1% 8.6% 31.9%

Idaho 27.5% 26.3% 7.2% 8.8% 8.2% 22.0%

Illinois 26.3% 19.1% 7.4% 7.0% 5.6% 34.6%

Indiana 31.0% 32.9% 4.6% 6.0% 4.9% 20.5%

Iowa 31.9% 28.6% 8.2% 4.6% 5.4% 21.3%

Kansas 32.5% 27.6% 6.7% 6.1% 5.0% 22.2%

Kentucky 28.3% 32.6% 5.7% 5.0% 4.7% 23.7%

Louisiana 25.6% 30.0% 6.3% 7.2% 7.2% 23.7%

Maine 28.0% 29.0% 8.2% 6.1% 6.7% 21.9%

Maryland 30.1% 22.1% 5.7% 8.7% 8.1% 25.2%

Massachusetts 25.3% 27.7% 4.9% 5.5% 5.7% 30.9%

Michigan 31.5% 27.0% 5.0% 6.5% 6.0% 23.9%

Minnesota 29.3% 26.7% 7.9% 5.5% 6.8% 23.8%

Mississippi 27.4% 36.0% 6.2% 5.5% 4.3% 20.5%

Missouri 28.1% 28.8% 4.9% 6.7% 5.8% 25.6%

Montana 27.4% 25.9% 8.6% 6.9% 7.0% 24.1%

Nebraska 32.0% 18.2% 7.3% 5.6% 5.0% 31.9%

Nevada 26.0% 20.9% 9.1% 10.6% 6.4% 27.0%

New Hampshire 33.3% 20.9% 6.4% 7.6% 5.4% 26.4%

New Jersey 33.6% 21.1% 4.6% 6.5% 4.8% 29.3%

New Mexico 27.9% 32.0% 4.1% 7.4% 5.2% 23.5%

New York 24.8% 27.2% 4.3% 6.3% 4.9% 32.6%

North Carolina 29.6% 31.4% 5.9% 7.1% 5.5% 20.5%

North Dakota 28.2% 16.9% 17.0% 5.8% 8.3% 23.8%

Ohio 28.1% 28.9% 5.1% 6.3% 5.2% 26.4%

Oklahoma 30.6% 26.4% 8.0% 7.1% 5.1% 22.7%

Oregon 26.0% 27.9% 5.0% 7.2% 5.8% 28.2%

Pennsylvania 28.8% 29.4% 7.1% 5.9% 4.9% 24.0%

Rhode Island 27.2% 26.8% 4.3% 8.0% 5.5% 28.2%

South Carolina 30.2% 32.1% 5.7% 5.5% 4.8% 21.7%

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South Dakota 30.6% 18.9% 13.0% 6.2% 8.1% 23.3%

Tennessee 24.7% 27.9% 4.6% 6.7% 5.3% 30.8%

Texas 34.2% 24.0% 7.0% 7.1% 4.4% 23.3%

Utah 33.1% 22.4% 7.4% 5.6% 5.4% 26.0%

Vermont 35.3% 27.7% 8.3% 5.9% 5.5% 17.3%

Virginia 32.5% 23.4% 7.5% 8.1% 5.8% 22.7%

Washington 27.3% 25.2% 6.1% 6.5% 7.3% 27.7%

West Virginia 29.5% 31.5% 6.9% 5.1% 5.3% 21.7%

Wisconsin 29.3% 20.4% 8.8% 3.0% 1.1% 37.5%

Wyoming 30.1% 8.5% 6.7% 2.2% 1.9% 50.6%

Sources: Census Bureau, 2017 State & Local Government Finance Historical Datasets and Tables , and Office of Management and Budget, Historical Tables, Table 3.2.

Notes: CRS calculations. State and local government figures draw from Census data, while federal results draw from Office of Management and Budget data. State and local figures taken from calendar year 2017, while federal figures are from fiscal year 2017.

Grant A. Driessen Analyst in Public Finance

Joseph S. Hughes Research Assistant

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