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Send Spending Power Back to the States

from the magazine

Send Spending Power Back to the States

A bold proposal to free local government from the shackles of federal mandates Winter 2016
Economy, finance, and budgets

The federal government is a bit like a heavily armed welfare broker. Ninety-five percent of the $3.5 trillion federal budget goes to paying directly for the military, Social Security, and Medicare and funding antipoverty and related social programs through a mix of direct payments, transfers to states, and grants to nonprofits. Everything else in the budget—diplomacy, infrastructure, law enforcement, legislation and regulation, research and development, agriculture—adds up to just 5 percent of what the federal government spends every year.

If an activity is necessary, if a national program is an efficient response, and if the government shows some capacity to execute it, placing a task in the federal portfolio makes sense. A national military plainly falls into that category. So, too, the retirement programs, at least so long as elderly Americans insist on relocating en masse to certain states. For income-support programs, development grants, and education, among other initiatives, it’s a different story. The feds rely heavily on states to manage those activities, even while still making the rules that the states have to play by if they want the money to keep flowing. This arrangement was not the result of a carefully considered policy choice. Instead, it flows from a century’s worth of power grabs by opportunistic liberals. And it is dysfunctional. The federal budget locates decision-making power in the wrong places, stifles innovation, skews incentives, eliminates accountability, and ultimately fails in its mission to better the lives of Americans—especially those living in poverty. Indeed, the arrangement provides a textbook illustration of how not to design effective organizations, as one can see in the mess that the federal government has made of housing, health care, and education policy, among other spending areas.

The way out of this mess, while politically difficult, is conceptually clear: the federal government should package up the money it spends so ineffectively and send it back to states in proportion to their populations, to allocate as they see fit. Doing so will satisfy neither the Left’s enthusiasm for expansive new programs nor the Right’s appetite for shrinking government. But the American people would benefit enormously.

The federal government, through the Department of Housing and Urban Development (HUD), spent $51 billion on low-income housing programs in 2014, with $37 billion of that total subsidizing the rents of 9.8 million people in 4.8 million households. This subsidy amounted, on average, to $3,776 per person, or $11,327 for a single mother with two children. Simply mailing these families a check in that amount would have brought them more than halfway to the poverty threshold.

Nothing so simple happens, however. HUD doesn’t actually operate its housing programs itself. Rather, it establishes extensive standardized regulations for them, addressing everything from permissible eligibility criteria (consideration of marital status strictly prohibited) to “discretionary pet rules” (“project owners may limit the number of four-legged, warm-blooded pets to one pet in each dwelling unit or group home”). Then it disburses funds to an array of state, local, and nonprofit public-housing authorities (New York State alone has 180), which must implement the regulations.

HUD’s Section 8 housing-voucher program consumes the majority of federal housing funds. The program’s rules mandate that at least 75 percent of an authority’s Section 8 recipients in a particular metropolitan area must have “extremely low income,” defined as less than 30 percent of the median for that area. The subsidy must be used to fill the gap between 30 percent of the recipient’s adjusted income and a HUD-determined “Fair Market Rent” calculated for the area. Expenses for administration are capped.

The program works poorly, to put it mildly. Housing support becomes a way of life for many recipients, and not a temporary lift up. The annual turnover rate among participants in New York City’s public housing is only 2.8 percent, meaning that over a decade, less than a quarter of residents are likely to have moved on. Subsidized housing’s rules perversely work against two of the most effective paths for escaping poverty—geographic relocation and workplace promotion; moving can mean returning to the back of the line for a subsidized apartment, and earning too much money can make one abruptly ineligible for a subsidy—and unable to pay the rent. In Seattle, for instance, after a minimum-wage hike, some workers found that higher pay threatened their housing eligibility, and they requested fewer hours to keep earnings down.

In part because recipients stay put so long, the eligible population for housing subsidies in most areas vastly outstrips the available vouchers and public-housing units, leading to years-long wait lists. Nationwide, only 25 percent of those technically eligible for the programs get to use them. New York City’s backlog is so large that it has not even accepted new applications since 2009. (Unhelpfully, under a picture of a smiling family, the city informs applicants that it is “virtually impossible to establish an average waiting time” for entering subsidized housing.)

The dynamic not only serves individual families poorly; it also undermines communities. HUD’s Fair Market Rent, applying uniformly to entire metropolitan areas, dictates the size of a voucher that a housing authority can offer. Neighborhoods with rents at the requisite low level become magnets for impoverished voucher recipients, concentrating poverty. The vouchers, as the head of one community-development corporation in Baltimore described them, act as “a catalyst in neighborhood deterioration and ghetto expansion.” The Atlantic reports that in New York City, “the Fair Market Rent for a one-bedroom is $1,249, a price that would relegate voucher-holders to the neighborhood of Brownsville in Brooklyn, one of the most dangerous places in the city, and where the most public housing is located.”

The federally designed rules for housing support work differently from those of other federal welfare programs, introducing further inefficiencies. The head of household for a family of three living in New York City must have income below $23,350 to qualify as “extremely low income,” but move a few miles north to Westchester and the cutoff jumps to $28,550. Move east to Nassau and an income up to $29,450 remains eligible for benefits. Meantime, though, the federal Supplemental Nutrition Assistance Program (SNAP, commonly called “food stamps”) sets statewide thresholds, so in any of those counties, a separate $26,124 cutoff would determine receipt of that benefit.

Some of these flaws arise from poor program design; others, however, flow almost unavoidably from the federal government taking too extensive a role. The federally designed eligibility rules, applied to widely varying economic conditions and without reference to actual budgeting, create demand for benefits far in excess of the supply of funds—since Washington makes no attempt to close the gap between the cost of the programs and the appropriations made for them. The resulting wait lists both prevent the aid from reaching those who would benefit most and strengthen the incentive for those who do get in to stay. Further, the federally calculated municipal “market” rents for housing vouchers often run at cross-purposes to local aid initiatives, such as minimum-wage increases and urban-development plans. And misaligned poverty definitions from one federal program to the next leave individuals confused and underscore the lack of coordination in addressing their needs.

Nor is an income-dependent rental subsidy the correct policy approach and best use of resources for all the situations in which HUD imposes it. Voucher recipients are split, 50-50, between the disabled and elderly versus other adults, and 53-47 between childless households and those with children. Those recipients live across the diverse housing markets of the United States, where rent-versus-buy calculations, availability and quality of housing stock, and even the fundamental nature of the economic challenges facing the poor can vary dramatically. Yet they’re all enrolled in the same program.

Housing authorities operate the program, get blamed for its poor performance, and face pressure to reform a system over which they have no real control. HUD issues rules that it doesn’t itself have to implement and that cannot possibly address each locality’s varied needs. It does all this in a vacuum, disconnected from the myriad other federal agencies with antipoverty programs that face comparable challenges.

The federal government’s ineptitude in providing aid is far from limited to housing. Medicaid, the largest, best-known, and worst-performing of the major federal antipoverty programs, places control and much of the funding in Washington—in this case, with the Department of Health and Human Services (HHS)—while leaving actual execution up to state and local agencies. But Medicaid is a mandatory entitlement, which means that it has no predetermined annual budget and no waiting list. If an eligible recipient receives an eligible medical service, the federal government automatically pays. From the states’ perspective, therefore, having more uninsured, low-income residents equates to more federal dollars flowing in—hardly the recipe for committed efforts at poverty reduction, private insurance adoption, or spending restraint.

To counter this, states must provide a share of Medicaid funding themselves—anywhere from one-quarter to one-half of the total, with the federal funds arriving as a “match.” In practice, though, states have subverted this restraint by tilting more of their budgets toward Medicaid, so as to keep the federal funds coming. Medicaid’s Disproportionate Share Hospital (DSH) payments, which compensate hospitals for the financial burden of caring for Medicaid patients at low reimbursement rates, illustrate the perverse incentives. Because the federal government matched the DSH payments that states made to hospitals, states began collecting taxes or other payments from eligible hospitals and recycling them back to those hospitals as DSH payments. The hospitals were made whole, the state budgets were unaffected, and federal money came pouring in. DSH spending exploded, rocketing from $400 million in 1988 to $17 billion in 1992.

Since 2000, despite the increasingly dire situation facing state budgets, total Medicaid spending grew faster than overall health-care spending and increased from 12 percent to 16 percent of overall state budgets. By 2014, with no strong local incentive to restrain costs, federal and state governments were spending a staggering $508 billion on Medicaid.

What good has all the spending done? Not much, apparently. A rigorous study of Medicaid beneficiaries in Oregon found that enrollees achieved comparable health outcomes to the uninsured and that each dollar spent offered as little as 15 cents of value to the recipient. Inexplicably, President Obama’s Affordable Care Act sought to achieve much of its increase in insurance coverage by aggressively expanding Medicaid, making anyone with income less than 138 percent of the federal poverty line eligible for the program and threatening to strip all existing Medicaid funding from any state that refused to embrace that new definition. As of March 2015, more than three-quarters of the 16 million Americans who gained insurance coverage under the ACA had joined the Medicaid rolls rather than purchasing private insurance.

Whether it’s long waiting lists for housing assistance or the ever-growing Medicaid rolls, the federally controlled welfare state cannot manage or balance its priorities. Alongside Medicaid and housing, the next-largest federal programs are SNAP (controlled by the Department of Agriculture), Disability Insurance (Social Security Agency), the Earned Income Tax Credit (Treasury), and Pell Grants (Department of Education). Because each program is housed in a separate agency under separate legislative authority, funding levels don’t reflect thoughtful consideration of the trade-offs between programs. Is Medicaid, proved woefully ineffective, really deserving of more funding than all those other programs combined? Don’t count on the HHS bureaucrats to suggest that poverty might be fought most effectively if their budgets were cut and sent elsewhere.

Even if health care is the most important funding priority in aggregate, does that same priority hold everywhere? Some states might prefer to reduce health spending but work their housing wait lists down to zero, say, or to shift funding from college tuition grants to job training, or even to let the individual recipient decide whether what he really needs to get back on his feet is health coverage, housing, or even a used car. Under federal control, states have no say; they must all take roughly the same allocation.

Washington has developed the habit of using its overwhelming fiscal power to try to dictate policy to the states not only through democratically enacted legislation but also through the bureaucracy of the administrative state—dangling grants in exchange for accepting federal policies and putting strict conditions on waivers to the terms of those grants, which tends to expand Washington’s role yet more.

Education policy is a dramatic example of this trend. When Congress authorized a $787 billion stimulus in 2009, for instance, it allocated more than $100 billion to education, including $5 billion for “competitive grants” that states could win from the Department of Education. Those funds became the program known as Race to the Top, in which the Obama administration waved cash under the noses of resource-starved states and then demanded that they meet certain criteria to get a share. The Washington Post provided a refreshingly blunt summary: “states (and later districts) had to promise to implement specific school reforms favored by Education Secretary Arne Duncan in order to win the cash.” Federal guidelines dictated 19 priorities that states should address in their applications; states could earn credits in several areas right away by adopting the Common Core curriculum standards.

Regardless of Common Core’s merits, this was no way to implement it. In National Affairs, Frederick Hess described what happened next: “Racing to comply with the federal priorities, states threw together bureaucratic proposals filled with empty promises and jargon. . . . Applications contained hundreds of jargon-laden pages, including slapped-together appendices replete with duplicate pages, Maya Angelou poetry, and letters of support from anyone willing to sign. The competition rewarded grant-writing prowess and token allegiance to the fads of the moment—which meant that commitment to and enthusiasm for reform in the winning states was often quite tepid in reality.” By 2012, every state that won a grant had already postponed at least part of its promised implementation.

President Obama doubled down on this federally directed approach in providing waivers to states dealing with unreasonable mandates from the No Child Left Behind Act, President George W. Bush’s signature federal education-reform initiative. In exchange for federal money, the law required, among other things, state-led reform interventions in any school where proficiency in either reading or math was less than 100 percent—which meant most schools. Under Obama, states could get the (obviously needed) waivers and keep receiving federal education dollars—so long as they adopted the White House’s new education priorities, now including the Common Core. With a somewhat Orwellian press release, the administration announced: OBAMA ADMINISTRATION SETS HIGH BAR FOR FLEXIBILITY FROM NO CHILD LEFT BEHIND IN ORDER TO ADVANCE EQUITY AND SUPPORT REFORM.

This model of federally led policymaking is counterproductive and even antidemocratic. If Washington had demonstrated superior judgment—or even proficiency—in setting education policy, perhaps the ends could have justified the means. But when the overly broad and unreasonable edicts of NCLB provide the very tool for imposing the next round of demands, the cycle is not a virtuous one. Instead, the heavy-handed federal approach produces whiplash at the local level and tends to steamroll any local education innovations that might be under way.

Complex federal laws that the states must implement, such as Obamacare, often produce layers of bureaucracy that stifle innovation and eliminate accountability. (BILL CLARK/ROLL CALL /AP PHOTO)

The challenge in rolling back Washington’s centralized policymaking is political, not technical. Sure, designing a replacement for the Affordable Care Act or constructing a regulatory regime that will prevent the next financial crisis is hard. But any number of reforms could make constructive progress toward state and local control of spending choices.

The purest solution would be a swap pairing federal tax cuts with state and local increases, granting the latter direct control of their own finances. But doing so would eliminate the benefits offered by flowing funds through the federal government—the redistribution of resources from wealthier to poorer states and the use of federal borrowing power to smooth budgets across booms and recessions. In theory, state and local governments also could just refuse federal funds, but more than $500 billion in federal money ultimately lands in state and local budgets each year, making such a rejection politically hard to imagine. Governors who refused to expand their Medicaid programs under the Affordable Care Act’s offer for the federal government to cover 90 percent of the cost, for instance, have faced withering criticism that their residents are losing “free” money. But a state has no way to anticipate which funding to accept or reject ex ante; the feds offer the quid up front and might only take the quo years later, wherever the state budget’s dependency has become most entrenched.

A better approach would raise revenue nationally—and then return it to states and localities unencumbered. The crucial mechanism for such reorganization could be a “Flex Fund,” allocating per-capita payments from the federal government back to the states. States would be responsible for subdividing their funds to individual cities. A per-capita payment ensures that states will not face conditions for receiving their funds and that they won’t lose funding by virtue of successful policies that make their populations less needy. Have you moved residents out of poverty so that they no longer need housing vouchers? Use the money for something else. Unlike a restructuring of taxation, this model need not reduce the progressivity of the federal-funding system because there is no correlation today between state income levels and per-capita federal spending. Mississippi and West Virginia are among the Top Ten recipients of federal dollars per resident—but so are Massachusetts and New York.

What to convert from federal programs to per-capita payments? Antipoverty programs—already administered within the states and, in some cases, partially funded by the states—would be the obvious starting point. They’re also where the federal government has failed most demonstrably and where dramatic reforms are most needed. Education also fits the rubric of state- and locally administered programs to which the only constructive federal contribution is funding. But any other form of government-to-government grant-making should go, too.

The Flex Fund could also facilitate a broader, more conceptual shrinking of the federal government by reducing the scope of activities that government controls. Eliminating even small programs can have an enormous effect on the government’s influence. Stopping Race to the Top would have done little for the budget deficit but might have significantly limited Washington’s influence on local education.

To take another politically charged example: there would be no national “Defund Planned Parenthood” fight over $500 million of federal spending if that $500 million had long ago been shifted into the Flex Fund. Individual states might still choose to send their share straight to the local Planned Parenthood affiliate. But states could also choose not to—and one less polarizing issue would preoccupy the attention of the federal government.

A Flex Fund would also help facilitate any more significant budget adjustments that the federal government might want or need to make. For instance, Congress could tackle the federal deficit through a substantial Flex Fund cut and not have to decide for the entire country on the incidence of the cuts, leaving it up to the states as to how they would make their spending reductions. Each state could adapt accordingly, including by raising local taxes to make up for the reduced revenue if it so chose. Conversely, a stimulus program could be implemented more quickly—and would be far more likely to reach the most productive uses in each state—if sent through a Flex Fund to state coffers.

Finally, a Flex Fund would create stable future cash flow for entrepreneurial governments to invest in policies that might save money over time. Social scientists regularly produce studies showing that an investment in some policy initiative could repay itself many times over in future savings. More health education today, for instance, means fewer diabetes cases tomorrow, and so forth. In some cases, they may actually be right. Right now, however, a state investing in smart public policy that reduces poverty or improves health outcomes is effectively penalized with less federal funding down the road. With a Flex Fund, the state still would have the money to spend and reap the rewards.

If centralized policy control offered functional benefits, these might at least be weighed against the structural costs. It does not. The federal government is incapable of administering its programs in any of the areas discussed, which is why it forces implementation down to states and cities. Scale might in theory provide efficiency, like greater negotiating power, or less reinventing of the wheel in each jurisdiction; but in practice, the federal-state interaction tends to increase bureaucratic burdens. A significant portion of HUD’s regulations aims at dictating the contents that each housing authority must put into its particular administrative plan.

Nor is the federal government elevating effective programs from around the country to ensure the adoption of best practices—as the appalling performance of existing national programs indicates. Besides, best practices are traditionally shared, not imposed. States are capable of observing the results of policies and borrowing from what works. Each can translate proven principles into the form most appropriate for its own challenges and political preferences. If a policy is so obviously a good idea that every state would benefit, why would a federal law be needed to ensure its spread?

A Flex Fund proposal would be politically potent. It would entail no budget cuts. No state would be forced to change its programs. Indeed, states that support today’s housing vouchers or Medicaid structure could band together and continue operating multistate programs. But they could not command that all other states contribute their resources to the same efforts.

How to bring the Flex Fund about? A single piece of enabling legislation could create the Flex Fund, repeal existing programs, and appropriate their projected budgets into the fund. A bold approach would redirect the entire antipoverty apparatus at once. Alternatively, a pilot to show the mechanism’s workability could focus solely on grant-making authorities or on a particular policy area, like education, with broader areas addressed over time. States might initially choose to opt in to consolidated, no-strings-attached funding, with federal programs continuing to operate by default.

But critically, the Flex Fund will realize its full potential only by encompassing the greatest possible scope and being applied nationwide. If large programs like Medicaid were left out, states would lack the flexibility to reallocate resources. Even small programs left under federal control would preserve Washington’s leverage to hold funding hostage to tangential policy demands. Similarly, all states must move into the Flex Fund before any federal programs can be shut down and before Congress can use the mechanism to pursue deficit reduction or provide economic stimulus.

With reestablished state and local policy autonomy, state capitals and city halls might once again become places where ambitious people work to achieve things. No doubt, some will fail, but others—working on a scale where action is possible, with control over the necessary resources and accountability for the outcome—will make progress. Over time, individual states’ useful innovations would benefit their residents more directly and provide an example for others to adopt.

For at least a century, politicians seeking to impose nationwide solutions have expanded federal power repeatedly. The nationalization of policy has nothing to do with effective government and everything to do with a federal-level political majority entrenching its preference for bigger government in federal law and imposing that preference on regions of the country where it lacks power in local institutions. Not by coincidence, the two great expansions of the federal welfare state since 1900—FDR’s New Deal and LBJ’s Great Society—arrived during the two fleeting moments in that period when Democrats held congressional supermajorities. The Affordable Care Act squeaked through the barely cracked window in 2009 when Democrats held 60 votes in the Senate. Since the ACA’s passage, RealClearPolitics has logged into its database the results of more than 400 polls regarding the law’s popularity. Not one shows a majority of Americans supporting it. The Obama administration’s use of grants and waivers represents the next logical step: a Democratic party lacking control of both local- and state-level institutions and even of the national legislature can still impose policy nationwide through White House control of the administrative state.

The resulting structure has been a disaster for public policy generally and for the possibility of innovation at the state and local level in particular. Instead of trying to develop new policies that might somehow work within those confines, reformers should focus on reversing a federal-funding ratchet that only cranks upward. That we cannot predict which policies cities and states will pursue on their own is the best sign that they might succeed—or, at least, that decision making is in the right hands.

Top Photo: Through housing subsidies, Medicaid, and other programs, Washington has exercised increased control over the way that states spend money. (MICHAEL REYNOLDS/EPA/CORBIS)

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