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Competitive Federalism



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I have argued for several years that fiscal federalism is bad shape. Economist tend to like federalism because it promotes interstate competition. When states can differentiate themselves on the basis of taxes, spending and regulation, or even social policies, Americans get 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. 

Unfortunately, there is little competition between states these days. First, no matter where you live, you are subjected to Washington’s tax burden, which has grown so large that differences in state tax rates mean much less than they used to. Further, federal spending represents a larger share of states’ budgets, but this money comes with pretty expensive strings attached.

This is why I was interested to read about a new project by the newly launched Liberty Foundation, called Competitive Federalism: Leveraging the Constitution to Rebuild America. First and foremost, the project lays out the intellectual case for competitive federalism. For instance, it looks at the issues such as the overwhelming involvement of the federal government Medicaid, education, and transportation, examining the consequences it has not just for taxpayers, but also for states’ autonomy and ability to experiment.

As the author of the report, Matt Mayer, explained to me in a recent e-mail exchange:

States don’t need DC to tell them how to take care of their poor, educate their kids, or maintain their roads (and a whole host of other issues)–states need to keep their tax money and the power and let the 50 laboratories of competition get to work. Nationalization of issues means when DC fails, 305 million Americans are harmed; under CF, if a state fails, only its taxpayers are harmed and success in other states will force it to reform. All boats rise via competition. As I say in speeches, if Jerry Brown wants to open Medicaid to 160% of the poverty rate, then let him but let’s make sure Californians pay for it and when the tax rate in CA goes higher to pay for it, businesses and citizens will leave to more cost effective states.

The policy recommendations in the report are different than the reforms often pushed in Washington. Take Medicaid, for instance: The report moves away from block-granting the program and instead making anti-poverty aids an entirely state function. Again, Mayer explains:

As the report lays out, cut federal taxes by the amount the states send to DC for Medicaid (for example–see appendix detailing each state’s amount) and let each state raise state taxes as they deem necessary to directly fund a Medicaid program that they have total control to design. States can then compete on providing the best service at the lowest cost. Because .15-.35 of every dollar sent to DC currently goes to bureaucracy and waste, the net tax impact (fed cut + state hike) will be lower taxes because states won’t need to replace every $1.

This report is a welcome challenge to the status quo, especially at a time when states are considering expending the influence of the federal government in their lives. While this call for returning to federalism may be dismissed by many in Washington as a theoretical exercise with no chance at being implemented, some 30 top state groups from 29 states have endorsed it, and want to push the idea with their governors and state legislators.

America is at a crossroads where we might start seeing big ideas, like this one, get some traction and bring some much needed changes.

The whole report is here.



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