In my judgment, the present system of complete reliance on fragmented and over-controlled programs: -has not worked, -is not working now, and -never will work unless we reform and restructure our approach. We do not need more of the same. We need to try something else. A third alternative suggested is to offer citizens a Federal tax credit for the State and local income taxes they pay. This approach, we believe, is substantially inferior to revenue sharing. Tax credits are, in the first instance, tax relief to taxpayers, not to needy local governments. Any benefits to State and local governments-which is our concern today-would only occur to the extent that Federal tax credits encourage State and local governments to raise income taxes faster than they otherwise would. States without an income tax would be forced to enact one in order to realize any benefit. High-income States would be permanently advantaged due to their larger concentration of highincome individuals. City governments would receive little or no benefit, since they depend largely on property-not income taxes. The major alternatives to general revenue sharing do not meet our needs as effectively or as equitably. The analysis appended to my statement examines each of these optional approaches in more detail. This analysis was delivered to you earlier this week. (The analysis referred to follows:) GENERAL REVENUE SHARING AN ANALYSIS OF THE ISSUES AND ALTERNATIVES SUMMARY Our system of democratic government faces severe challenges. Foremost among our concerns is the growing lack of confidence which citizens have in their government. Many Americans are confused by government or do not understand it or they think that it is inefficient and unresponsive. Frequently, they are frustrated by their inability to influence its decisions. Much of this confusion and frustration results from some basic imbalances in our Federal system of government. Power and resources flow more readily to the Federal Government-a direct consequence of its superior revenue structure. Yet major domestic problems, the responsibility for their resolution, and the demands for services thereby created reside with our state and local governments. As a result, a strong fiscal case exists for transferring Federal resources to states and localities. This has been documented, and has served as the basis for a substantial and growing Federal commitment to the financial support of domestic services provided by state and local governments. But financial transfers only respond to one dimension of the problem. Financial aid can help redress the fiscal imbalances within the system. Depending on the nature of such assistance, the power imbalance and the social frustration remain. Many existing Federal aids retain far too much authority and control in Washington. Moreover, they are fragmented into an astounding number of narrow, uncoordinated programs. As a result, current and past Federal efforts to respond to state and local needs have not been completely successful. This paper defines the nature of the existing problems caused by imbalanced Federalism. It explores alternative Federal actions for resolving those problems. It evaluates those alternatives according to widely accepted criteria. And it concludes that the general revenue sharing approach offers the most promise for effectively resolving our problems. DEFINITION OF THE PROBLEM In its broadest terms, the problem we seek to address is the “imbalance" of our system of government as it operates today. Our Constitution, established "to form a more perfect Union", provides for a Federal system of government—a government in which power and responsibility are shared between Federal and State partners in the system. In turn, the states have determined to share power and resources with their local governments. In their wisdom, the Founding Fathers purposefully designed a system which did not concentrate all power and responsibility at one level. Inherent in a Federal system of government is the concept of "balance." This means balance in the allocation of power, in the concentration of resources, and in the assignment of responsibilities. Early American Federalists were concerned with maintaining balance. They sought to strengthen the national government without sacrificing state powers. In the same spirit, modern American Federalists today seek to strengthen states and localities without sacrificing national goals. The absence of "balance" in the Federal system is manifested in several important dimensions-financial, political, and social. To be effective, efforts to redress the problem must recognize all these elements. The financial imbalance has received the most prominent mention in discussions about revitalizing American Federalism. This is not surprising since it is the most easily quantified and perhaps the most pressing aspect of the problem. The general nature of this financial situation has been described as the "fiscal mismatch." This term refers to the basic budgetary forces operating at the Federal level versus the State and local levels of government. At the source of this mismatch is the dominant position in our public financial life occupied by the Federal income tax. As Figure 1 makes clear, the Federal Government has a virtual monopoly on the income tax. This fact takes on extreme significance when we realize that the income tax is the revenue producer most sensitive to economic expansion. Relying heavily on growth responsive income taxes, Federal revenues grow faster than the economy. Over the past 20 years, healthy growth in Federal revenue collections has been accompanied by three major income tax reductions (1954, 1964, and 1969). At the state and local level the picture is reversed. Over the past 20 years economic growth has accounted for less than one-half the rise in state and local revenues. The remainder has come from countless separate increases in State and local taxes. At the state level alone, 450 new taxes or tax rate increases have been instituted since 1959. State and local taxes have risen from 5.6 percent of gross national product in 1950, to 7.2 percent in 1960, to 8.5 percent in 1968-69. In 1960, 19 states were imposing both general sales and personal income taxes. Today, this number has grown to 35. (See Figure 2.) Yet despite this impressive revenue growth, expenditure demands related to the need for more and better domestic services have been even greater. On the expenditure side of the ledger, demands for public services have been increasingly focused on state and local governments. In 1960, states and localities purchased 46.3 percent of all government goods and services. By 1970, this percentage had risen to 54.8. And during the first quarter of this year, state and local purchases were 56.9 percent of all government purchases of goods and services. The result of these budgetary cross-currents is the "fiscal mismatch." One level of government has the superior revenue system. The other levels of government have the major domestic expenditure requirements. The Federal Government has responded to this clearly defined financial need. It has done so, rather than leaving states and localities to "solve their own problems" for two major reasons. First, states and localities differ substantially in their relative capacities to tax. Without some element of resource distribution, the quality of such basic services as education, law enforcement, fire protection, and sanitation is uniquely dependent on the wealth and income level of a community. But these are not wholly local concerns. Failure to provide such basic services in one part of the country eventually creates social difficulties in other parts of the country. FIGURE 2-STATE AND LOCAL GOVERNMENTS Percent. of G.N.P. State and Local Taxes As A Percentage of Gross National Product, No. of Number of States With General Sales and Broad-Based Personal Income Taxes, As of January 1, 1950, 1960 and 1970 Second, state and local tax sources generally are both regressive and relatively unresponsive to economic growth. Hence a continued pattern of Federal tax reduction coupled with state and local tax increases leads to a reduction in the overall equity of our tax system. But the Federal response to this need has been a distinctly one-sided and imbalanced one. It has been a response which emphasized the financial need for intergovernmental assistance while ignoring the political and social needs for balance in the distribution of power and influence. Federal grants-in-aid to states and local governments have grown from $1 billion in 1946 to $30 billion this year. Unfortunately, all of this financial assistance has been channelled through a proliferating maze of narrow, categorical grant programs. Today, somewhere in the neighborhood of 500 individual grant authorizations exist. The growth in numbers of programs has been even more dramatic than the growth in dollar outlays (see Figure 3). The adverse consequences of this fragmentation of Federal assistance efforts have been numerous. Excessive controls and administrative overhead, overlapping programs, lack of coordination, absence of local flexibility, and endless red tape have robbed many conceptually sound programs of their potential effectiveness. Senator Edmund S. Muskie has noted of the categorical grant technique: "Its proliferation has threatened to create as many problems as it was intended to solve.": Professor Walter W. Heller has pointed up the dangers of the trend toward centralized power represented by exclusive reliance on categorical aids: "Unless this trend is reversed, Federal aids may weave a web of particularism, complexity, and Federal direction which will significantly inhibit a state's freedom of movement.” 2 1 U.S. Senate, Committee on Government Operations, Federal Programs of Grants-in-Aid to State and Local Governments, 91st Congress, 1st Session, 1969, p. vi. Walter W. Heller, New Dimensions of Political Economy, Cambridge, Harvard University Press, 1966, p. 142. |