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Federal Funds: Uncle Sam’s Gravy Train to the States

In his 1981 inaugural address, President Reagan reminded us of the separation of powers embedded in the U.S. Constitution. This separation goes in two directions: laterally by separating legislative, executive, and judicial branches, and vertically by separating federal, state, and local governments.

A lot of attention has rightly been focused on the blurring of the demarcation lines between lateral powers. Today it is difficult to distinguish executive powers from legislative powers. This is especially true when it comes to the notorious Affordable Care Act where the Secretary of Health and Human Services is granted very far-reaching powers to shape the health care system.

Less attention is focused on the blurring of the vertical separation of government powers. This is unfortunate. Our Founding Fathers were very wise in designing the constitution in such a way that – as Reagan again reminded us – the sovereign states created the federal government. While the states are still formally sovereign, their actual status has changed dramatically in only a few short decades.

The force at work eroding state sovereignty goes under the rather inconspicuous name of “Federal Aid to States” (FAS). It is an umbrella for a long list of federal spending programs where the U.S. government and the states jointly pay the bill. Medicaid is largest, and perhaps the best known, of the FAS programs. Another hotly debated program is No Child Left Behind.

About 80 percent of the FAS spending goes to programs that easily fall in the welfare state category. Medicaid is obviously a welfare-state program, and it is joined by numerous others. Some examples:

  • Temporary Assistance to Needy Families (TANF);
  • Food Stamps/Supplementary Nutritional Assistance Program;
  • Women, Infants and Children (WIC) welfare checks;
  • Low Income Home Energy Assistance Program (LIHEAP);
  • Child Care and Development;
  • Fair Housing and Equal Opportunity;
  • HUD Public Housing Programs

FAS is a multi-billion dollar operation. The welfare-state part, which again is about 80 percent of FAS, exceeded $500 billion in 2011. Add to that approximately $250 billion in state MoE funds, and we have a welfare state that spends three quarters of a trillion dollars every year.

This is before we add Social Security and Medicare, the federal-only welfare state programs.

The welfare state hidden under the FAS umbrella is bigger than our annual defense budget. And it is growing fast: the average growth rate for entitlement programs under FAS has been 6.5 percent over the past ten years.

This obviously causes a number of problems, the most important of which is the steady erosion of state sovereignty. As an indicator of what this means for the future, the ARRA Stimulus Bill added so much more federal dollars in state pockets that 13 states now get more than 40 percent of their total revenues from the federal government.

In 2008 only three states depended that heavily on Uncle Sam.

The ARRA funds are set to expire in 2011-12, but that does not mean that state dependency on FAS money will fall. In February 2011 the National Governors Association practically begged the federal government not to turn off the stimulus faucet. The nation’s governors talked about serious budget problems in their states if Congress did not let the extra cash keep coming.

Federal aid to states is not a new phenomenon. It has been around for at least a century, though on a very small scale initially. In 1929 FAS accounted for 2 percent of state expenditures. It spiked in the early 1930s, increasing to 12 percent, where it remained until the early 1960s. After Medicaid was introduced in 1965 states have gradually grown more and more dependent on the federal government.

Notably, the only period when states actually saw a little bit of relief in their dependency on federal dollars was in the Reagan years. The dependency rate dropped from 33 percent of total state spending to 25 percent. That rate is back up again: it was 34.1 percent in 2010, not counting state MoE spending.

Some states are worse off than others. The preliminary estimate of state spending for 2011 by the National Association of State Budget Officers shows that South Carolina gets 50 percent of all its revenues from the federal government.

This raises an urgent question. Who is actually to be held accountable for state spending in South Carolina? Is it the legislators who are legislatively responsible for the state budget? Or is it U.S. Congress, who has created and decided to fund the FAS programs?

Put bluntly: is the South Carolina state government an independent jurisdiction, or a federal spending agency?

The consequences of eroded state fiscal independence go beyond simply controlling the budget. With FAS programs come a truck load of regulations. Among the most notorious these days are the regulatory incursions into children’s school lunches, even those brought in from home. But other regulations can be just as harmful, such as the coverage mandates that come with Medicaid funds. States have to dole out more and more money for health insurance to low-income families, regardless of whether or not the state can afford it.

Welfare programs are also tightly regulated as a result of federal funding. Uncle Sam de facto controls everything from what people can buy for their food stamps to city-level zoning and housing (partly under the new Unified Development Code). All of this brings new costs to states and local governments, but every new federal dollar also nibbles away at state and local independence.

The importance of being governor, state legislator, mayor or city council member is withering away. Instead of being the representatives of the will of local and state voters, these elected officials are becoming administrators of a federally sponsored, one-size-fits-all welfare state.

Furthermore, with each new program and each new dollar that Congress puts on the gravy train to the states, the welfare state gets more and more solidified. More people become dependent on it, and with more enrollees in federally sponsored programs, the more difficult it is to roll back those programs.

The worst part, at least for our state and locally elected officials, is that Uncle Sam is borrowing four dimes of every dollar he spends. Soon enough Congress will have to slam the spending brakes. When that happens, there will be noticeable cuts in FAS programs. That will force states to execute the cuts, even though they are not the ones who are ultimately pulling the trigger on the cuts. State lawmakers and governors will pay the political price.

There is a better way forward. It involves rolling back the welfare state, gradually phasing out entitlements and returning responsibility for welfare to the private sector. It can be done, but time is running out.

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