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Scaling a Fiscal Cliff and Other Contortions

March 08, 2018


There is little new under the sun. We can find close presidential races from the time of Thomas Jefferson to Al Gore. The contentiousness often spills over into governance. The divided Congress that we face will likely magnify the divide. Will this time be different? Who knows?

Still work must be done. What are some of the key priorities for the new term? How about this list:

  • Facing fiscal reality
  • Implementing the Affordable Care Act (ACA)
  • Assuring the rebuilding after Sandy
  • Rekindling the flame of federalism

You all saw the first three coming but may be surprised by the fourth. Let me try to convince you that they are all of one piece.

Facing Fiscal Reality

The coldest dose of fiscal reality following the recent recession actually came at the state and local level. For the past 18 months, I have been working with former New York Lieutenant Governor Richard Ravitch, Former Federal Reserve Chair Paul Volcker and my Co-Executive Director Don Boyd of the Rockefeller Institute on a project called the State Budget Crisis Task Force. In the Task Force’s July Report, Ravitch and Volcker stated, “The conclusion of the Task Force is unambiguous. The existing trajectory of state spending, taxation and administrative practice cannot be sustained. The basic problem is not cyclical, it is structural. The time to act is now.”

During the recession, states experienced severe revenue shortfalls. Without the more than $250 billion of aid under the American Recovery and Reinvestment Act, states would have fallen into a deeper hole. At the depth of the recession, combine state tax revenue had fallen more than 12% on average. Some states, like Illinois and New Jersey, saw tax revenues fall by more than 17%. While the immediate crisis was cyclical, the Task Force concluded that Medicaid spending growth, underfunded retirement promises, narrow and eroding tax bases, and poor legal and financial management policies all posed broad structural threats.

However, one of the major conclusions of the report was that federal deficit reduction itself threatens state economies and budgets. Further, the Task Force found, “The relationships that make up today’s federalism are perhaps best described as fractured.” Grants to state and local governments totaled approximately $600 billion in outlays in 2012. A 10 percent reduction in these grants would cost California and New York more than $6 billon each. This would force them to reduce services or increase revenues by this amount at a time when their budgets were already strained.

The Task Force found that as the federal government undertakes reducing its own deficit, it needs to have an intense dialogue with state and local governments. It also found that such a dialogue is largely absent today. In interviews with federal officials in charge of considering both tax and spending changes, it became clear that the impact on states was not particularly high on the list of concerns these officials had about deficit reductions.

As Senator Orin Hatch observed in a hearing in the spring of 2012, “The rush for new tax dollars that too often characterizes the federal legislative process, oftentimes leaves issues involving federal-state tax coordination by the wayside. But we cannot forget that the policies being discussed today touch on fundamental constitutional principles of federalism and separation of powers. And if we are to do no harm it is important to hold hearings such as this one… Issues involving the federal impact on state and local revenues impact both the Constitution’s separation of powers between the federal and state governments and the separate identity of the sovereign states.”

In 1986, we learned that tax reform at the federal level can actually benefit states that have aligned their base with that of the federal government. If the tax base is broadened by eliminating loopholes, states can get more revenue as long as they do not lower their rates. While this may or may not be true today, no one knows because there is virtually no dialogue between the states and the federal government.

Implementing the Affordable Care Act (ACA)

In the wake of the Supreme Court decision that gives states the ability to opt out of the expansion of Medicaid under ACA, states are in the process of deciding what to do. This comes at a time when spending on Medicaid is becoming the most significant cost in many state budgets. In fact, the National Association of State Budget Officers reports that in 2009, the aggregate of state spending from their own funds on Medicaid exceeded their spending on K-12 education. Medicaid spending continues to increase accounting for more than 23% of all state spending.

Governors all across America are trying to find ways to rein in Medicaid spending. Routinely, they apply for waivers of Centers for Medicare & Medicaid Services (CMS) regulations and they find themselves frustrated with the process. The Governor’s Council of the Bi-Partisan Policy Center recently prepared a report on this process and summarize both the waiver process and federalism generally as follows, “Too often, we have found the demands of federal agencies stifling state innovation. And we have seen firsthand how growing political dysfunction at the federal level adversely affects states and undermines the welfare of all our citizens.” These strong words are echoed across many of the jointly shared programs of our governments.

The Council makes five recommendations:

  1. Develop State Plan Amendment templates for effective Medicaid strategies.
  2. CMS should establish and circulate a detailed and transparent process for state-federal budget neutrality negotiations and waiver evaluations.
  3. CMS should design waiver templates that address time-sensitive and pertinent Medicaid challenges, supporting state efforts to quickly and effectively respond to changes in the marketplace attributable to provisions in the Affordable Care Act.
  4. Establish a mechanism for converting successful waivers into permanent or semi-permanent state innovations in the Medicaid program.
  5. Department of Health and Human Services (HHS) should make guidance and assistance provided to state leaders by the Medicaid State Technical Assistance Teams transparent and public.

Without taking a position of the substance of these recommendations, I think it is quite appropriate that HHS and CMS take them seriously and consult sitting governors about potential implementation. Similarly, there needs to be a constant dialogue about implementation of the ACA. Assistance should be given to states in estimating the impact of increased case loads and the potential cost consequences of all provisions of ACA.

Assuring Rebuilding after Sandy

President Obama and members of his Cabinet have demonstrated a rapid and empathetic response to tropical cyclone Sandy. Now comes the hard part the coordination of federal, state and local agencies in rebuilding homes, facilities and infrastructure. There are models available, such as those used in the American Recovery and Reinvestment Act, that feature continued joint involvement of political leaders, the private sector and federal officials working together to solve common problems.

As I have written elsewhere, a problem like Sandy needs a network for response. There are eight general principles involved in network management:

  • A network structure
  • An agreed to common mission
  • A clear governance structure
  • The availability of authority
  • Joint and clear leadership
  • Distributed accountability
  • Information sharing
  • Resources to make the network function

Invoking a network can go a long way to making the rebuilding easier.

Rekindling the Flame of Federalism

State Budget Crisis Task Force Advisory Board member Alice Rivlin has written extensively on Federalism. She observes, “The American federal system is under extraordinary fiscal pressure as both the national government and the states struggle to recover from the deep recession that followed the Financial Crisis of 2008. Unfortunately, these pressures are not all temporary. Even when the economy returns to stronger growth and unemployment recedes, serious structural funding gaps loom ahead for the federal government and beset most states as well. Both levels of government are stressed by the need to provide services to a rapidly aging population and deal with rising demand for increasingly costly health care.”

As the President and Congress begin their work in 2013, the recognition that both the states and the federal government are in this together can go a long way to dealing with fiscal and other governance challenges. Not all of the solutions to the complex problems that states, their localities and the federal government are dealing with require new legislation or new regulations from the top. What is needed most is recognition that joint effort can yield positive results. The states and their localities are the delivery mechanisms for most federal domestic programs. Without true partnerships and real jointness, both parties run the risk of ending up like the intelligence community before 911--fragmented, fractured, insular and afraid to share information.

Rekindling the flame starts with leadership from the White House, the Congress and from State Houses across America. We may have what Dick Nathan calls, “A Window of Opportunity.” Leadership must seek out a process.

G. Edward DeSeve is a Senior Lecturer at the University of Pennsylvania’s Fels Institute for Government and as a Senior Fellow at the James MacGregor Burns Academy of Leadership at the University of Maryland School of Public Policy where he was the tenured director of the Management, Finance and Leadership Program. DeSeve is also the Former Deputy Director for Management at the Office of Management and Budget.