American Federalism at the Crossroads

American Federalism at the Crossroads

by Robert E. Wright, AIER Senior Faculty Fellow for the Bastiat Society of Venezuela, 23 June 2021

Nota bene: Slides unavailable. Most of my work can still be found at the AIER's Daily Economy Blog here: https://www.aier.org/staff/robert-e-wright/

[SLIDE 1] Buenas noches! Me llamo Roberto Wright y trabajo para el American Institute for Economic Research en Great Barrington, Massachusetts, en los Estados Unidos. Han pasado cuarenta años desde que estudié español, así que hablaré en inglés esta noche.

[SLIDE 2] Unlike most nations, the United States of America at its founding adopted a federal form of government whereby governance is distributed across multiple levels, from private nonprofit corporations at the bottom through local governments like towns and cities, to counties, to the now fifty state governments, to the national, or federal, government. School and other special districts add further complexity, as do tribal and territorial governments. 

[SLIDE 3] The Founders of the United States wanted a government that was strong enough to protect individual Americans from foes foreign and domestic but without creating a government strong enough to tyrannize them, as Great Britain had following the French and Indian War. That meant pitting the three branches of the national government, the legislative, executive, and judicial, against each other. It also meant pitting different levels of government against each other. 

[SLIDE 4] In other words, American governments are supposed to some degree to compete, much like businesses do. That is easiest to see at the lowest level of governance, the voluntary nonprofit corporation. Those institutions form and dissolve at the whim of the volunteers who create them to achieve specific missions, like educating people about the costs of alcohol abuse or slavery or working on Sunday or any other thing, except generating profits. 

[SLIDE 5] They obtain sanction to operate from higher levels of government, usually at the state level. They cannot directly tax the population but they can induce individuals to voluntarily divert taxes away from higher levels of government, including the national government, to them instead. They can invest some of that revenue in remunerative assets if they wish, or use it all to fund the current annual budget. 

[SLIDE 6] The line between nonprofit corporations and municipal corporations blurred yet more in recent decades as many have come to rely on government appropriations rather than individual donor dollars for much of their budgets. Nonprofit corporations typically focus on specific missions rather than geographical territories but most do, in fact, limit their activities to specific geographical areas. Even nonprofits with national or international missions are often comprised of smaller auxiliaries tied to specific states, counties, or townships. Such ties are often loose, however, and they may count as members, donors, or beneficiaries individuals not strictly resident in their geographically designed area. 

[SLIDE 7] Municipal corporations provide a range of presumed public services, from garbage collection to policing to schooling, but only in very strictly defined geographical areas. They include a hodge podge of entities, from tiny hamlets to six mile square townships to large cities. Hamlets, villages, or towns may sit wholly within other municipalities. Jenkintown, Pennsylvania, for example, is a borough located within the much larger township of Abington. Both are just a few of the municipal governments located in Montgomery County, Pennsylvania.

[SLIDE 8] As some services are thought to be better provided across jurisdictional lines, special districts have been formed to perform single functions, like schooling, fire control, mosquito abatement, or energy or water provision. Like nonprofits they are independent of local governments but, unlike nonprofits, they are not voluntary associations. They have limited taxing powers or charge use fees, as for electricity or water. There are almost 52,000 of them in America, not counting school districts. Special districts keep the costs attendant on the provision of the various services they perform off general municipal budgets and out of partisan politics to some degree.

[SLIDE 9] Were that not complicated enough, the legal relationship between local municipalities and county governments varies from state to state. What is true in Pennsylvania may not hold across the Mason-Dixon Line in Maryland. Louisiana is divided into parishes instead of counties but the difference is mainly one of nomenclature rather than function. Some states have unincorporated areas that are within counties but no other municipal government. Except in Alaska, all villages, towns, and so forth fall under the jurisdiction of a county or parish, but in a few places cities and counties have the same boundaries. In other places, like Sioux Falls, South Dakota, a single city sits within multiple counties.

[SLIDE 10] Yes, all of these overlapping jurisdictions cause confusion, which is part of the point. When jurisdiction is unclear, sometimes nobody asserts authority, creating regulatory and tax spaces where innovative activities can thrive, but also be squelched due to the uncertainties that arise in some areas of the law. In 2003, for instance, Colorado made it unlawful for municipalities to have their own gun laws because it was thought that the patchwork dissuaded people from owning or carrying guns. It just changed back, though, by allowing municipalities to enact their own firearms ordinances, so long as they are at least as strict as the statewide ones.  

[SLIDE 11] Jurisdictional overlap also allows municipal governments to check each other by offering local options. Adjacent towns might compete to provide education and parks cost-effectively lest they lose people, and hence tax base, to the other town. Or now in places like Colorado they might compete on gun regulations.

[SLIDE 12] Local revenues mostly come from personal and commercial real estate taxes but some supplement with sales taxes. A few municipalities in major metropolitan areas like Philadelphia even tax income from work, though at a relatively low rate and by piggybacking on the national Internal Revenue Service.

[SLIDE 13] State governments rely on retail sales taxes, user fees like automobile, business, and fishing licenses, and income taxes, though a few with sizable tourist industries and efficient governments, like Florida and South Dakota, are able to provide sufficient public goods without taxing incomes, in part by leaving more responsibility at the county and lower levels, including the nonprofit layer at the bottom.

[SLIDE 14] In addition to competition, federalism between state and local governments provides more nuanced, local control. A town that wants more parks or police officers than the county government allots it can raise the revenues needed to fund its own parks and rec and police departments. A county without a state university could establish its own community college, and so forth.

[SLIDE 15] From the start, America was a large and heterogeneous nation. It could never have been ruled from the top in a way that most Americans would have found worthwhile so it would have split up had it not developed a federal system with significant local autonomy. Most of its states are also too large and variegated to be completely ruled from a central location. Policies that work in cities may be entirely inappropriate for agricultural counties, and their policies would cause nothing but harm in mining and lumber districts or seashore communities.

[SLIDE 16] Of course one might imagine a country controlled from the top that nevertheless grants local governments significant autonomy without intervening provincial or county-level governments, which may simply add expensive extra levels of bureaucracy, more mouths for taxpayers to feed, so to speak. But then again there might be economies of scale that cannot be achieved at the local level. A county might be able to afford a tactical police unit that no town within the county could afford. Townships might be able to afford high schools but not community colleges. And perhaps only state governments could afford to maintain military units.

[SLIDE 17] That last point suggests that America’s federal system of governance also renders it resilient in the face of shocks. If Washington, DC were to evaporate in a thermonuclear blast, America would go on, not quite as before, but not driven to its knees by a single blow. In fact, it might improve. We know this because the national government has periodically shuttered itself for weeks at a time due to budget impasses and yet everyday life continued without interruption.

[SLIDE 18] Likewise, when state capitals have been shuttered due to natural disasters, federal and local governments take up the slack. They remain staffed by bumbling incompetent bureaucrats but no power vacuums arise to be filled by truly venal criminal elements or foreign powers.

[SLIDE 19] Most importantly, perhaps, federalism reduces the risk of tyranny by creating many centers of power and many decision makers. That was very clear during the lockdowns imposed in 2020 and 2021. Some states locked down harshly for over a year while a few, including South Dakota, put in place only a few measures designed to stop large, indoor gatherings. That allowed Americans to visit, if not move, to jurisdictions where they felt the most comfortable and also provided the policy heterogeneity necessary to prove beyond the shadow of all doubt that lockdowns and mandatory masking did not work to reduce the spread of Covid-19.

[SLIDE 20] The downside to federalism, though, was that states that removed lockdowns quickly, like Florida, allowed municipal governments and nonprofits to formulate their own policies, even ones that ran counter to state recommendations. To this day, for example, there are children in Florida forced to wear masks in school and that may be worse for students than the places that still have not returned to face-to-face instruction.

[SLIDE 21] Covid lockdowns have also exposed the fact that the U.S. national government is no longer the champion of human rights, a role it assumed during the Civil Rights Movement of the 1950s and 1960s when presidents sent federal troops to states like Arkansas and Mississippi to enforce federal court orders to desegregate schools. Instead of sending troops to states that refused to uphold the many federal laws that states were breaking in the name of public health, it complained that it could not join them in Covid tyranny or the destruction of property rights on the mantle of so-called social justice causes. When American governments join together in a phalanx instead of competing to create the best policies, they become more formidable than tyrannies that rely on a single strong man.

[SLIDE 22] If federalism still appeals in some ways, remember what Bastiat said about that which is seen and that which is not. I have described the more obvious benefits of dividing power and tax revenues in broadly rational ways. But significant costs lurk beneath. Foremost is the struggle for power between the national and state governments. If they compete to see which can most oppress some minority, woe be to its members.

[SLIDE 23] America’s Civil War was primarily about which level of government controlled fundamental labor policy. Traditionally, the matter was left to the states, some of which banned chattel slavery, some of which allowed it but didn’t subsidize it heavily, and some of which subsidized it heavily. Even before President-Elect Abraham Lincoln tried to move the national government against the institution, slave states seceded, or left the United States, and formed their own country.

[SLIDE 24] During the four-year military struggle that followed, the national government assumed additional powers from state governments and has been doing so ever since, by degrees, though not always permanently or successfully. Federal minimum wage law, for example, has been superseded by many states with their own, higher minimum wage rules. But in Wyoming and other states that do not have a state minimum wage law, the federal minimum binds local businesses.

[SLIDE 25] Similarly, for most of U.S. history, alcohol policies have been matters for state or municipal governments to decide. Well before national Prohibition in the 1920s, individual U.S. states, counties, and even towns were dry, meaning that it was illegal to manufacture, sell, or publicly consume alcohol within them. That allowed temperance advocates to live as they liked without forcing Catholics and immigrants to give up their more alcohol-tolerant cultures. When the U.S. Constitution was amended to give the national government the power to decide alcohol policy, the result was a disastrous national policy called Prohibition. After over a decade of heavy costs, the policy was eventually reversed and once again states, counties, and towns decide alcohol policy.

[SLIDE 26] The national government, however, insinuated itself into another area of policy traditionally left to the states, the regulation of substances colloquially known as drugs. Its policies were again disastrous but until recently it maintained them while asserting its legal supremacy over the states in the matter. Interestingly, however, some states challenged the national government over marijuana policy, at first legalizing its medicinal use, and now its recreational consumption. 

[Slide 27] This has created considerable confusion, as when the national government’s agents destroyed marijuana being grown on an Indian Reservation in South Dakota, where marijuana was still illegal, but for sale in Colorado, where it was legal under state law. The national government had two justifications for this. First, although called sovereign nations, Indian Reservations are ultimately simply a special type of municipality beholden to state governments in some ways and the federal Bureau of Indian Affairs in others. Second, the national government undoubtedly controls interstate commerce, which the Indian Reservation would have had to engage in for its marijuana to be legal.

[Slide 28] The contours of American federalism are in flux in other ways as well. During 2020, for example, several states blocked the free flow of American citizens from state to state, a clear violation of the U.S. Constitution, in the name of public health. The national government also allowed several state and municipal governments to flaunt federal laws and regulations by allowing protestors to secede from the United States and to attack federal office buildings, statutes, and other national property, protection of which state and local governments have traditionally provided due to scale economies.

[Slide 29] And American-style federalism is only going to get more interesting. Some scholars have called for reviving the doctrine of nullification, which almost led to a civil war in the early 1830s when South Carolina claimed the right to outlaw national tariffs in its territory. That dispute was never resolved constitutionally but rather alleviated by a political compromise that lowered tariffs, which hurt agricultural states in the South while benefiting industrialists primarily located in the North.

[Slide 30] Many of America’s unusual financial regulatory features stem from unresolved issues of federalism. To this day, insurance companies are regulated primarily by states though most are large, national organizations. Banks, by contrast, are regulated by a “crazy quilt” of regulators, some national, like the Comptroller of the Currency and the Federal Deposit Insurance Corporation, some state, and some regional, like the Federal Reserve and the regional compacts that at one time were needed to branch across state lines. Even securities regulation is federal, with so-called state-level Blue Sky Laws supplementing the national Securities and Exchange Commission’s rules. Financial regulators have incentives to work together to make their lives easier but during crises informal arrangements can break down or lead to untoward outcomes that of course regulators try to hide.

[Slide 31] In short, those seeking to create a federal system of government may want to look to Switzerland rather than the United States. In an earlier draft, I also suggested Canada but then I learned that Alberta is seeking independence right now. Quebec long did but was mollified without conflict. Albertans, though, are citing America’s Declaration of Independence, specifically the part where it says “when a long train of abuses and usurpations, pursuing inevitably the same object evinces a design to reduce them under absolute despotism, it is their right, it is their duty, to throw off such a government,” and create a new one. Albertans trace that long chain of abuses all the way back to 1870 because ever since Ottawa has assumed more and more power over their daily lives. Bilingualism and urban cosmopolitanism play well in Toronto and Montreal, but not the oil and agricultural regions of the west. Albertans now annually pay $20 billion more in taxes to Ottawa than they receive back in government services.

[Slide 32] In the U.S., significant differences in policy preferences between rural and urban counties now create dissension in many states. Several rural counties have voted to leave Oregon for Idaho, for example, and one county in Nevada just announced that it will protect its residents from the enforcement of unconstitutional state or federal laws that impinge on the freedom of speech, the right to bear arms, and so forth. 

[Slide 33] Rural and Republican states also seek to increase their ability to block national policies, from Covid restrictions to firearms laws to voting procedures, with which they disagree. Florida has taken the lead in many ways. They can only do so much, however, because the national government definitely controls what America’s founders called the power of the purse. The national government controls the individual and corporate income tax apparatus, strongly influences the printing of money, and has the best access to credit markets. It can use its immense fiscal power to bend states to its will, as it did in the 1970s and 1980s when it forced states to lower speed limits to 55 miles per hour and to raise the legal drinking age to 21 by threatening to withhold their federal highway appropriations if they didn’t comply. Thankfully, it eventually lost the speed limit battle.

[Slide 34] I have suggested that at some point states may have to interdict federal taxes rather than allow their citizens to continue to fund poor policies emanating from Washington. Several districts within America’s dysfunctional large cities have already threatened to do something similar. Businesses in the Fells Point neighborhood of Baltimore, for example, want to put their city taxes into an escrow account until the city government begins to collect trash and enforce laws again. And the Buckhead area of Atlanta threatens to secede from the city unless it provides more law enforcement and other public amenities.

[Slide 35] Similarly, Staten Islanders are again considered seceding from the rest of New York City, which is increasingly crime ridden and poorly governed. It is as populous as Atlanta but doesn’t have a single public hospital. It’s also geographically isolated from the rest of the city and hence a prime candidate for independence. Many upstate New Yorkers want to secede from downstate New York because, as New York City does to Staten Islanders, New York City, Long Island, and Yonkers take more in taxes more than they return in public goods. Many in southern New Jersey would love to leave northern New Jersey for the same reason. At the very least, they would like to see taxes and regulations shifted back to the county level and away from the state capitals of Albany and Trenton.

[Slide 36] What secession movements indicate are that people feel that the government is not being sufficiently responsive to their needs because it takes more in taxes than it returns in public goods. They feel they are being forced to subsidize those in power and their constituents. They feel tyrannized by the majority and hence want to create a new majority by cleaving off from the old to go on their own, or to join a more amenable group, or to have more local control.

[Slide 37] When the U.S. national government had relatively little power before the Civil War, secession movements remained weak because there were no clear benefits when the governments with the most direct effect on Americans’ lives were local and state ones. Moving from one town to another in pursuit of better policies was relatively cheap. Even moving from one state to another was often possible and sometimes states were cleaved from other ones, or from larger territories, rendering physical movement to more amenable jurisdictions unnecessary. 

[Slide 38] The more powerful the national government becomes, however, the more it becomes necessary to leave the nation entirely, or to secede from it, in order to enjoy better policies. The bigger states with histories as independent republics or territories, like Alaska, California, and Texas, periodically threaten secession but today entire regions appear poised to leave the Union if the national government persists in raising taxes, debasing the dollar, weakening the military and border controls, and fomenting racial animosities. The specter of national voting and zoning laws, like the specter of national labor laws in 1861, may well cause another attempt by some states to leave the United States so they can forge an independent path. 

[SAME] America has stayed together for so long by being a union of states, governed by many overlapping levels, not a single leader in Washington, DC. While some local and state officials may well capitulate to the right national leader, many others will resist further attempts at centralization and they will garner significant local support. 

[SAME] There is an old adage that the American Revolution was not about Home Rule but who would rule at home. It was not about Independence, in other words, but who would govern America. To defeat the British, coalitions formed and they all sought a share of power after independence was won, making federalism a natural governance choice. Almost 250 years after the Revolution began, Americans again wonder who shall rule at home, bureaucrats in Washington, DC or multiple layers of elected officials, from the officers of nonprofits to county commissioners and mayors to state governors to a President checked by those layers as well as by Congress and the federal judiciary. Time will tell.

[Slide 39] Gracias. ¿Preguntas?