The Problem with Federalism

Paul Krugman and many others have been talking about the “fifty little Hoovers” – state governments forced by balanced-budget rules to cut spending and raise taxes in the face of a recession, eliminating services when they are most needed and deepening the economic downturn. James Surowiecki (hat tip Matthew Yglesias) expands the attack by arguing that federalism (the idea that power is balanced between the national and state governments) in general is a problem, at least in these economic circumstances. In addition to counter-cyclical state fiscal policy, he cites political issues such as the disproportionate allocation of road spending to areas with few people and coordination problems such as the difficulty building national transportation or energy networks.

It may seem as if the balance is tilted heavily in favor of the national government – it has an army, it prints money, and so on – but the Constitution leans more toward protecting state autonomy (see the principle that the federal government is one of enumerated powers, and the Tenth Amendment), and the trend of the Reagan Revolution and the Rehnquist Court was to favor states’ rights. (Of course, “states’ rights” are not necessarily a Republican or a Democratic issue, but tend to be favored by whichever side finds the argument convenient at the moment.)

When I was young (like in high school) I thought states were silly and we should just have a national government, like in France, where the departments are mainly just administrative units. When I got a little older and became a qualified fan of Edmund Burke, I decided that the current system worked well enough most of the time that it would have to be seriously broken to justify a major structural change.

I’m not sure it qualifies as seriously broken at the moment, but I think the current recession counts as evidence that it sure isn’t the system you would design if you were starting from scratch.

By James Kwak

37 thoughts on “The Problem with Federalism

  1. It seems to me that people give great lip service to states’ rights, but federalism lost its status as the dominant paradigm in the Great Depression. The evolution of Chapter 9 bankruptcy is a great example.

  2. Simple enough. Modify state constitutions or laws to enable deficit spending during a serious recession/depression. Require balanced budgets or surpluses when the economy is booming.

    No federalism issue at all.

    The dismal results of electricity market “deregulation” in California and Texas might suggest that local energy agencies/utilities/consumers should have and own their own local power plants and forget about national networks that supposedly enhance efficiency.

    The United States seems to have an excellent interstate highway system.



  3. Like Wall Street, my state (Illinois) seems to favor leverage as the primary tool for funding its business. Don’t think we have a “balanced budget” law over here – or if we do, it’s ignored regularly.

    And the last I checked, the problem in my state was not at all the result of “federalism” but the fact that an inordinate amount of our governors seem to use that post as a springboard to jail.

    I think that the real issue in so many sectors – both in politics and in business – is an ethics issue – we seem to have devolved into a nation that accepts rampant corruption as an acceptable cost of being American.

    The energy issues of California earlier in the decade seemed to be directly related to the scams running out of Enron.

    The profits posted by Goldman have been stolen from the taxpayers. The best in the biz would have nothing to do if the feds hadn’t bailed out their sector and their very own company.

    That failed businesses would demand and receive hefty bonuses as part of a federal bailout – that’s a horribly corrupt way to look at “the free market.”

    And we’re accustomed to the rise and fall of our politicians. Happens with alarming regularity. Sex, money, ethics – these seem to be the fuel for our ambition these days.

  4. The whole reason TSHTF is because of we have a massively coupled banking/political system with power concentrated in New York and D.C. A system of local banks making local loans and holding a good part of them on their books would never have had these issues. Federalism isn’t the problem: it’s the answer. Force banks to deal with maddening individual state regulations, just like P&C insurers do. Let thousands of niche banks spring up and be amazed at how boring and stable banking becomes. Let Hong Kong deal with the boom/bust of ponzi finance.

    It’s the vision of the elites, of one centralized power to rule them all (be it a banking regulator, a government, a privately owned central bank, a rock star CEO or President, a car czar, etc.) with no “inefficient” checks and balances that repeatedly screws Joe P. Average over. We keep shrinking the power structure necessary for Big Business (and especially Big Finance) to capture and then wonder why our leaders seem so useless in the face of obvious predations. Well, I guess we’ll just have to centralize power further, then, eh?

    “In a sort of ghastly simplicity we remove the organ and demand the function.”


  5. This article has so many flawed assumptions it is DOA. The last sentence really sums it up, though. This ISN’T the system that was set up in the beginning.

  6. Historically “states rights” exists for two reasons: (1) to give the smaller colonies (like Rhode Island) a fighting chance in the national legislature (2) to protect the institution of slavery. So the Southern states (they really were the southern states, then, rather than the southeastern states) got a veto in the Senate. The veto in the Senate has turned out to be a long-term problem, giving enormous power to reactionaries at the Federal level.

    There is also the problem that the state governments are easily captured by major state, national, and international businesses. This shows up especially clearly in the finance industry, which has captured most state regulators, but also in the extractive resource industries and agribusiness.

  7. ” … state governments forced by balanced-budget rules to cut spending and raise taxes in the face of a recession … ”
    There is no rule prohibiting state governments from building cash reserves during good times to be spent “in the face of a recession.”

  8. “This ISN’T the system that was set up in the beginning.”

    That depends. It very much is the system that Hamilton wanted set up from the beginning. It’s not what Jefferson wanted though.

  9. And if it wasn’t for the legacy of Wickard v. Filburn America would REALLY be a federal system. Imagine a world where the SEC would be unconstitutional and financial firms would have to be regulated by the states. It wasn’t all that long ago!

  10. I think the real “original” justification for states was the suspicion of a far away, centralized government making all the decisions. The founding fathers, having just booted out the King of England, were in no mood to have a replacement just a tad closer. Local government is much more accountable to local voters.
    Your opinion of Federalism depends a lot on your ideological viewpoint. If, like France, you favor sophisticated elites who work for the central government and can make wise choices for all, then you are probably less federalist. If you are a bit more Darwinian, you see the benefit of “50 little experimental laboratories” (I’ve forgotten the source, but that was a quote) where things can be tried and early results obtained before implementing them for the whole country. A great example is Massachusetts and health care.

  11. I’m not buying it. The real problem is the fact that the national government runs the banking system (which was run by state banks in Albert Gallatin’s day). Many governors, legislators, and state attorneys general wanted to crack down on the worst parts of mortgage lending a few years ago but Washington wasn’t having any of that. Also, states and localities could better fund our nation’s infrastructure year-in/year-out if the fed didn’t suck up most of the available revenue, leaving states and locals to tax at the margins. If the fed chooses to take nearly 10% of our pay for nothing more productive than retirement incentives, it can’t complain that the states and locals don’t spend enough on roads or smart power grids.

  12. I believe in government entity on top of government entity on top of government entity. Ahh Burke!

    NYS is a great example of the wonders of The Feds, the State, and hundreds of little municipal entities, villages, special taxing authorities, and water and other districts. A few hundred government entities per couple of hundred miles and pretty soon it adds up to good times!

    It may just be that–gasp–our system isn’t set up to manage the present and that the built in compromise and conservatism will prevent us from reform, and thereby saving our decline.

  13. Are they seriously suggesting that the political problems of suboptimal grant and aid distribution would be better solved by larger federal government influence?! See Byrd, Robert as Exhibit A of how well that model works.

    Lost in all this debate over stimulus and economic recovery is the principal of accountability in government as a cornerstone of a self-governing society. A significant part of California’s crisis can be traced to the fact that the state effectively centralized local government finance severing crucial accountability ties and relationships. Whatever short term “benefits” might be hypothesized by junking fiscal federalism, in the long run it is a recipe for California to the power of ten.

  14. I think you can tell through most of my posts that I am a Democrat and maybe what some would label a “liberal”. I don’t feel I am a “liberal” but the way people like Newt Gingrich throw the term “liberal” around like a dirty word, I suppose some people would label me that way. BUT…. I have to say I am on the Republicans’ side on this one.

    Can you imagine what things would look like if some states weren’t required to balance their budget?? You think things are bad now?? Are you kidding me?? It would bring real meaning to the overused term “living nightmare”. Look at California now. Can you even imagine??

    I mean unless I’m missing something (I’m not the best read on this issue) you seem to be IMPLYING that states should be allowed to print money. Is that what you’re saying Mr. Kwak???
    If so, I think that would be a HUGE mistake.

  15. Federalism is like having a small blood clot loose in your arteries. If you’re lucky, you’ll never notice the problem. If you’re unlucky, it can kill you.

    Federalism, and in particular irresponsible fiscal policies, brought about the banking collapse and economic meltdown in Argentina in 2001. The EU has serious problems with federalism; the federal states see little incentive to undertake fiscal stimulation when much of it leaks beyond their borders. The ECB meanwhile worries about how to discipline governments running irresponsible fiscal policies with excessive structural deficits. Here in Canada, our incentives are probably worse; some of the largest government expenditures (health care, education) are run by the provinces, while the taxation powers are largely at a federal level. This means that one set of politicians get to determine tax levels while others determine spending levels.

    Federalism is not a first choice of intelligent people.

  16. @Simon van Norden

    Federalism has it’s problems, as you mentioned. But while some federal economies have had problems, all the centrally planned ones have outright failed.

    >>This means that one set of politicians get to determine tax levels while others determine spending levels.
    This sounds like one example of a silly way to set up a hybrid centralized/federalized system. I don’t see how this is an inherent problem in federalism.

    >>Federalism is not a first choice of intelligent people.
    Centralization is the first choice of people who either haven’t read any history, or are arrogant enough to think they’re smarter than everyone they read about.

  17. whatever may be the case, 50 state and umpteen number of county/ City governments do generate lot of employment (both in govt and lobbying)! without them unemployment scenario would have been worse!

    The problem has been rightly recognized by McCain as campaign funding and until it is addressed, companies and lobbies will control the government rather than people..

  18. Carson Gross: “A system of local banks making local loans and holding a good part of them on their books would never have had these issues. Federalism isn’t the problem: it’s the answer.”

    Wasn’t intrastate banking a feature of Glass-Steagal? That legislation was ahead of its time. :)

  19. Perhaps the President should be able to declare a state of financial emergency, which would allow states to print money for a limited time. Whether that would require a constitutional amendment is a real question.

  20. Actually, Federalism, the view that a strong central government balanced by state’s rights to administer their territories, is necessary for the survival of the nation, took it on the chin when Jefferson was elected President, and it was pummeled until Lincoln was elected (see Walter A. MacDougall, “Freedom Around the Corner”). Lincoln wasn’t a Federalist, even in disguise; it was forced on him by war. John Adams was the last of the Federalists (and he was a quasi-Federalist only because he knew the Federation would never survive), saw a brief resurgence during the Civil War (war drives power to the central government) and lasted until the end of Reconstruction. It wasn’t revived until WWI (war, again), then lapsed immediately thereafter until the FDR administrations. It survived as the dominant “philosophy” until Reagan’s second term.

    I tend to view the long-term increase in the powers of the federal government as simply the result of the state’s failure to govern well because their governments are even more susceptible to corruption and narrow self interest than the federal government. I don’t believe that’s changed, but I do see our congressional reps acting more and more as our state reps (senators, too).

  21. Federalism is simply a view of the proper balance of powers between local and central governments, not an actor responsible for fiscal policies. Without it, there would be no United States. The Federation would’ve expired of its own accord, North America would comprise many little republics and would resemble Italy during the Renaissance – a bunch of warring city-states ruled by local nobilities that eventually had to combine their fiefdoms to prevent frequent conquest by the French, Austrians and Spanish.

    Federalism isn’t an actor; it’s a political view. Hey, at least everyone in Canada has medical coverage and the banks are still standing without having to rely on taxpayer funds to prop them up. with decent regulation, consolidation hasn’t taken the sinister turn, there, that it has here. The EU’s problems with their union are much more about cultural sovereignty than they are about economics. A Federalist would be happy to see his stimulus leak across his borders to his neighbors. It means that the other guy’s stimulus is leaking across their borders, too – into his country. If this happens for all of the EU countries, then, you have a mutually beneficial stimulus package by default rather than by design. Sovereignty loses, but the people win.

  22. EXACTLY! You have it, right, RTD. Most of the commenters have this wrong. Federalism is the view that a central government needs certain powers to govern effectively (currency, regulate interstate commerce, make war, maintain a military, negotiate with and enter treaties with other sovereign nations, unimportant stuff like that). That’s why the constitution replaced the Articles of Confederation and the framers left room for the central (federal) government to maneuver into more parts of governance.

    I think James’s last sentences were intended to stimulate this discussion. I just wish he had been a little clearer about Federalism and Republicanism.

    One of my favorite ironies of the Bush administration’s tenure is that Dick Cheney co-opted Hamilton’s one-sentence suggestion about the “unitary executive” via John Woo’s unfortunate legal opinions regarding executive powers to gather considerably more power under the executive branch than had been imagined heretofore. I love it – the Republicans borrowing philosophy from the Federalists to get what they want.

  23. Your view on the reasons for “states rights” is a bit simplistic, but your comment about the ease with which special interests can capture local officials (elected and appointed) is right on. Consider how land is developed, farms are regulated (or not), local cartels are protected (the legally mandated 3-tier system of alcoholic beverage distribution and sales), water rights are distributed (or not), etc.

    This problem was big early in our history and remained huge (remember the pre-Civil War westward expansion, Reconstruction, the Gilded Age and the Roaring 20’s?). Federalism’s brief ascendancy was the result, in part, of many sectors of commerce response to their frustrations just trying to get business done and land acquired and developed without usurpation. With the Great Depression, we seemed to have learned this lesson, but with the re-emergence of movement Republicanism, we’ve been talked out of it, again.

  24. I don’t think that the principal of accountability has been lost in this discussion. Actually, it’s a big theme on the posts on this blog. Simon loves to rail against the evils of plutocracy.

    Frankly, I think you’re wrong on the source of California’s problems. If the state had achieved that result, the K-12 educational system wouldn’t have deteriorated from one of the best in the country in the sixties to one of the worst in the country, today. I do agree that public finance has become more centralized, there, but it’s a result of a populace that wants services for which they aren’t willing to pay at the local level. Proposition 13 stripped local governments of their primary source of growth financing, so the state legislature responded (not always well or appropriately) by increasing other taxes to provide the services that people want and that it could provide. So, the roads and parks and water districts and agriculture and the UC and state and junior college systems got money. But, local K-12 school districts didn’t get any because the state couldn’t subsidize them.

    I grant you it’s a mess, but Federalism has nothing to do with it. The voters do, however.

  25. This balanced budget discussion reminds of the same discussions during the Reagan administration. Remember, Carter handed his team an $8B surplus, which he and Stockman promptly turned into a $486B deficit. There ensued a gaggle of articles in all kinds of publications (Time, Newsweek, Harvard Business Review) and economists presenting closely reasoned discussions of empirical evidence relevant to hypotheses about the whether deficits are dangerous to the health of the economy and whether our parents should be hanged for saddling my generation with this “enormous” debt.

    Of course, the states can’t print their own currency. That function belongs rightly to the federal government. Would you like to return to the Article of Confederation, where you would have local currencies within the states? They can borrow from the private sector and the populace, but, right now there are no private sector lenders, so they’re SOL. They should be able to borrow from the entity that can print money, the federal government. The banks can, so why not the states? Are bankers any less culpable than bankers?

  26. Your initial premise about the national government is just dead wrong (in anything, it’s 180 degrees backward), but, it has little to do with the topic of discussion, anyway. If you actually look at the record, you’ll see that, yes, the state and local governments are pretty good at genuinely local projects, but, they suck at projects that require cooperation beyond their borders. The power grid, the highway system, rapid transit systems, the national database of criminals, the national database of registered gun owners, interstate medical records and cooperation, voting rights, educational standards – the list of wasteful, ineffective systems that have been left to the states to muck up goes on and on. Why do you think the federal government’s role has expanded so much, on balance, for so long? Because the state and local governments aren’t up to the task and never have been. They wouldn’t have spent the money, even if they had it and it wouldn’t be on nationally linked grids or roads or databases or… anyway.

    I have issues with how our governments spend money, too. But, it’s not all structural. We should look at ourselves and how we neglect our government, how we fail to communicate with our representatives, who we vote for and why we vote for them, where we get the information we use to decide on the candidates and the issues. But, we don’t. How did Duke Cunningham and Rod Blagoyevich get elected (not to mention George Bush, who was, eventually elected by the U. S. Supreme Court)?

  27. John, just curious: how do states do deficit spending? Like California by issuing IOU’s, or by developing bond issues to compete with Federal bonds? Most of them have done deficit spending recently, and to me, it appears that there is no ready remedy. I don’t think that changing state constitutions to accomodate deficit spending is a real answer. Sounds like a double negative hit on taxpayers, if their state and the federal government both dig deep holes they have to fill.

  28. Yeah, governments will build reserves about the time pigs fly, or maybe later than that. AND, it has been said that if the federal government had a surplus (not likely to happen now before winged pigs) it would be dangerous because they would have to invest it, and that would create a larger than healthy presence in the business of the country.

    Unfortunately the states are now broken, and won’t be fixed before they engender a more substantial whole for the economy to fall into.

  29. Remember that right now virtually none of the states have a chance to borrow money at anything resembling reasonable rates. Their bond and credit ratings are generally in the toilet, and, with unemployment so high and climbing, the opportunity to recover by taxation is almost impossible. It is really very scary!!

  30. competition is good… in fact we have had a corporatism of government buying the bonds of the bankrupt to persist a status quo of government… if states had been tied to there energy, income, and natural resources and not so easily exploited their political and media consumerism advantages so explosively the productivity would have gone where needed by rule of efficiency… but as the consumer was crowned king of the land by the banks and manufacturers the federal system may look to blame for the clean up… this is an acceptance that changing the rules to better accommodate the next bubble is to prevent the destruction of our economy and constitutional government, when the federal system is one of the few that shows the strengths and ability’s of separate tax systems and law…

    its the bail outs man… we needed them like a 5th arm, bailouts show the failures of corporatism and systemic exploitation at the control points of government policy and trade ‘be it state by state or nation by nation’

  31. Bond issues typically. Has been done many times.

    The notion is to allow deficit spending during an emergency such as a severe recession, depression, earthquake, war, what have you, and require a surplus otherwise.

    The issue is that the current financial crisis resembles the classic textbook “liquidity trap” in which companies, banks, and so forth are too scared to lend or purchase. They simple save what they get. So the US and the Federal Reserve can drop interest rates to 0 percent, lend or give billions of dollars to giant banks, and nothing works. In this situation, the government or someone with equally deep pockets must step in and engage in direct spending to revive the economy.

    In Keynesian economics, the customer is king. Businesses invest based on sales, on visible customer demand. They don’t invest because maybe possibly in five years the economy will rebound and someone will buy the additional widgets they can make from new capital investment now or the better widgets they can make by spending on R&D now. Of course, this is the way most businesses in the real world behave.



  32. Hmmm. It would probably be illegal to let states print money, or issue IOUs. However, suppose that the declared state of financial emergency allowed states to borrow from the Fed at the same rates that banks do? :)

  33. Ah, right. No on has ever advanced a principled argument for the wide distribution of political power. It was all slaves and national power politics. What a fantastic way to totally ignore the content of one of the primary intellectual achievements of the early American experiment.

    And, well, golly, the national government sure has proven difficult for the finance industry to capture. More power to the Fed! More centralization! And, the important thing, absolutely no checks and balances: concentrate all the power in one all knowing, all seeing entity, preferably undemocratic and filled with domain experts, our finest minds, thereby unimpeded by the inefficiencies of acquiring the consent of the governed. What could possibly go wrong?

    To update Chesterton: Big Business and Big Government are very much alike, especially Big Business.


  34. and the framers left room for the central (federal) government to maneuver into more parts of governance.

    The sure did. It was called “the amendment process.”

    Otherwise, I don’t see a lot of wiggle room in the 10th amendment: “The powers not delegated to the United States by the Constitution, nor prohibited by it to the States, are reserved to the States respectively, or to the people.”

    Seems straight forward enough. OTOH, I’m not a legal expert, so what do I know?


  35. How about a third reason………….none of the colonies would have voted in the Consitution had States rights not been included.

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