Topic: Tax and Budget Policy

New Study on Fiscal Federalism

The federal government spends $750 billion a year on 1,386 different subsidy programs for state and local governments. The number of aid programs has tripled since the 1980s as shown in the chart below.

My new Cato study describes 18 harmful effects of the federal aid system. The system undermines responsible and efficient governance. It encourages excessive and misallocated spending. And it reduces accountability for failures while generating costly bureaucracy and regulations.

The federal aid system stifles healthy policy diversity and undermines democratic control. And by imposing one-size-fits-all policies when there is no national consensus, the aid system divides society and increases political conflict.

 

Read the full study here

Federal Disaster Spending Boosted by Politics/Population

Despite rising federal deficits, Congress is set to pass another budget-busting spending bill. This time it is a $19 billion package of disaster-related subsidies.

The Washington Post reports “taxpayer spending on U.S. disaster fund explodes.” It documents increases in disaster spending by the Federal Emergency Management Agency (FEMA). In a typical recent year, “spending on the federal disaster relief fund is almost 10 times higher than it was three decades ago, even after adjusting for inflation.”

The story identifies two causes of the spending increases: climate change and population growth in disaster-prone areas. But it ignored perhaps the most important cause: increased federal intervention in the sorts of emergencies that used to be handled by the states, as I discuss here.

The Post is correct that more Americans are moving into disaster-prone areas:

Many more Americans have moved into harm’s way, with growth exploding in the Gulf Coast region and along the Continental Divide, where tornadoes frequently occur, according to a study on the “expanding bull’s eye effect” by Stephen M. Strader of Villanova University and Walker S. Ashley of Northern Illinois University.

Since 1970, 35 million more people and their homes have moved to coastal shoreline “in the direct path of potentially devastating storm surges,” the researchers found, a 40 percent increase.

“We’ve put more stuff in the wrong place the wrong way,” said W. Craig Fugate, a former FEMA administrator under President Barack Obama. “We’ve got a lot more stuff — bigger houses, multiple cars, more people — in high-hazard areas.”

More people are also living in fire-prone areas of California.

The Post does not explore an important reason why Americans are moving into these areas: government subsidies. Federal subsidies for flood insurance, flood control structures, beach replenishment, and disaster rebuilding have encouraged development in coastal areas, as I discuss here. Meanwhile, state policies have contributed to building in California’s fire-prone areas.

American governments are not alone in pursuing policies that increase disaster hazards. A World Bank / United Nations study identified such policies in numerous countries and discussed market-based reforms to mitigate risks.

In the United States, federalism is supposed to undergird our system of handling disasters, particularly natural disasters. Under the 1988 Stafford Act, the federal government is supposed to get involved in disasters only if they are of “such severity and magnitude that effective response is beyond the capabilities of the state and the affected local governments.”

However, presidents and congresses have increasingly ignored this limit. The number of presidential disaster declarations has soared and the costs of disaster bills have increased as politicians shoe-horn subsidies unrelated to immediate emergency response into bills.

Growing federal intervention is undermining the role of the states and private institutions in handling disasters. This intervention stems from politics not practical benefits. State and local governments and the private sector are better positioned to handle most disaster response. Also, states, cities, and private utilities aid each other during disasters.

Rising FEMA spending is not a good metric for measuring the severity of natural disasters striking the United States. Rather, it reflects growing populations living in risky areas and growing disregard for federalism in disaster-related response and rebuilding.

Montana Governor Bullock Is a Tax-Hiker

Montana Governor Steve Bullock is entering the Democratic race for the White House.

NPR reports that “Bullock’s more moderate positions could be problematic in a party that’s been moving more toward the left.” But Bullock’s frequent pushing for tax hikes since he entered office in 2013 puts him squarely in the Democratic fold.

Cato scores the tax and spending policies of the nation’s governors in its biennial fiscal report cards. We assign letter grades from A to F.

Bullock received a C in 2018, a C in 2016, and a D in 2014. The governor’s grades were pulled down by his support for tax increases. He advocated tax increases on individual income, gasoline, cigarettes, beer, wine, and other items. Bullock also vetoed tax reforms passed by the state legislature.

Does Bureaucracy Count as Economic Development?

The Economic Development Administration (EDA) is a small agency within the Department of Commerce. Its purpose is to give money to governments and businesses to fund local activities, such as $2 million to “repurpose the West Frankfort Mall” in Illinois and $150,000 for the Brick River Cider company in St. Louis to make “authentic hard cider.”

The EDA has never made sense, as Tad DeHaven and I discuss here, and the Trump administration is right to propose eliminating it.

Funding local activities from the federal level creates unneeded bureaucratic costs, which are a loss to the overall economy. According to the federal budget, the EDA handed out $240 million in grants in 2018 for various local and business activities.

The agency’s expenses for salaries, benefits, and other office costs were $39 million. That spending did not go to “economic development,” but rather to support the comfy lifestyle of inside-the-Beltway bureaucrats. Thus, the federal “overhead” costs of the $240 million were 16 percent. The chart shows the overhead cost ratio in recent years.

In an upcoming Cato study, I discuss 18 reasons why federal aid for state and local activities should be cut. One of the reasons is the bureaucratic costs. In 2018, taxpayers living across the nation sent $279 million to D.C. to fund the EDA, of which $39 million stayed in D.C. and only $240 million was distributed back across the nation. Why don’t communities just keep their own money and spend the whole amount?

By the way, if billionaire Wilbur Ross wants to invest in malls and cider companies, he can afford to do so with his own money.

O Zones and HUBZones: Aimed at the Poor, Aid the Rich

The Republican Tax Cuts and Jobs Act of 2017 created 8,700 “opportunity zones” across the country which receive special capital gains tax breaks. O Zones have balkanized American cities into winner and loser zones, while encouraging corruption and making the tax code more complex.

O Zones are supposed to alleviate poverty, but the main beneficiaries are the landlords who own development sites within the politically chosen zones.

From the Wall Street Journal the other day:

A new federal incentive program designed to help low-income neighborhoods is adding fuel to Miami’s real-estate boom.

When President Trump signed the Opportunity Zone program into law as part of the 2017 tax overhaul, the administration said the goal was to incentivize investment in economically distressed areas.

But in the case of Miami and other U.S. cities, many of the opportunity zones are in gentrifying neighborhoods that were already attracting plenty of investment from hotel and luxury apartment developers.

Sales of development sites within opportunity zones in the Miami metropolitan area increased by 45% to $238.3 million in the first quarter of 2019, while sales were down outside the area’s opportunity zones, according to research company Real Capital Analytics.

… Some critics say there is evidence that Opportunity Zone money is pouring into Miami neighborhoods that already had developers’ money and attention.

The problems with O Zones are discussed further here, here, here, here, here, and here.

HUBZones is another federal program that is based on geographical discrimination.

The Washington Post reported that HUBZones were “created as Congress sought to stimulate development in economically distressed areas nationwide by steering billions of dollars worth of federal contracts. There are more than 6,500 businesses in the program across the country.”

The Post looked at who benefits from HUBZones:

A federal program created to boost small companies in disadvantaged areas has funneled hundreds of millions of dollars into some of Washington’s most affluent areas, where a handful of businesses have grown while reaping most of the program’s benefits.

The Historically Underutilized Business Zones program began in 1997 with a promise of stimulating distressed communities by using federal contracting incentives to reverse unemployment, reduce poverty and create jobs. Some businesses that have secured contracts have seen annual revenue triple or quadruple.

HUBZone was designed to offer firms a path to securing federal contracts based on geography — not veteran, gender or race-based qualifications used by some other programs. But the program appears to have inadvertently fostered a new divide. A Washington Post analysis of 20 years of HUBZone data shows that about $800 million earmarked for firms enrolled in the program was awarded to just 11 D.C. businesses.

Those 11 firms accounted for 70 percent of HUBZone dollars allocated in the District since the program’s debut. The money usually went to firms in wealthier areas of the city, such as Dupont Circle, Navy Yard and downtown Washington.

… Businesses in wealthier parts of the city have grown larger through securing HUBZone contracts, while those in the city’s poorest areas — locations the program was designed to help — have largely been left behind.

… The Post’s analysis found that, in 2018, more than $49 million was awarded to 40 D.C. businesses, with seven businesses receiving more than 70 percent of the money. Those seven companies have their main offices downtown or in wealthier neighborhoods where unemployment rates are lower and household incomes higher than much of the city.

… The disparity within the HUBZone program extends nationally. The Post analyzed data from several cities, with many having results similar to those in the District.

… GAO investigations spanning several years have found problems with the program, including inadequate vetting of firms that submitted falsified documents, misrepresenting the number of employees who lived in HUBZones. That led to numerous fraudulent contracts being awarded.

 

Postal Service: Meltdown of the Mails

The U.S. Postal Service is in a growing financial crisis as mail volume continues to plunge. The Government Accountability Office says that a “comprehensive package of actions is needed to improve USPS’s financial viability.”

In House testimony last week, I argued that such a package should include privatizing the USPS and opening postal markets to competition. Background on the USPS is here.

The USPS is being squeezed by rising costs and falling mail volumes. My testimony proposes ways for the USPS to cut costs including closing post offices, reducing delivery from six to five days, and cutting employee retirement benefits.

The chart below shows the falling mail volumes. First-class mail per capita has dropped 53 percent since 2000. First-class mail is the USPS’s most profitable product. It includes personal letters, bills, bank statements, greeting cards, some advertising mail, and other items.

 

Source: First-class mail volume from here divided by U.S. population.

Infrastructure Lovefest Bad for Taxpayers

Amidst the constant animosity between the Trump administration and Democratic congressional leaders there appears to be a rare glimmer of bipartisanship. In a recent meeting, President Trump, Senator Schumer, and Speaker Pelosi agreed to a $2 trillion infrastructure plan. While the specifics are not yet hashed out and it’s anyone’s guess whether the plan comes to fruition, the initial details of the agreement seem to spell bad news for taxpayers.

At the core of the plan is a mutual rejection of public-private partnerships (P3s), arrangements between state and local governments and private companies where the company agrees to fund and manage infrastructure in return for payments from users. Last year’s $1.5 trillion infrastructure plan, masterminded by former Trump economic advisor Gary Cohn, relied extensively on P3s and offered only $200 billion in federal funding. The Democrats and Trump, who reportedly said about the last plan, “That was a Gary bill…. That bill was so stupid,” both agreed that the new plan would rely on federal funding. (And Trump also reportedly noted that he wanted to increase funding $100 billion because $2 trillion sounds better than $1.9 trillion. As my colleague Ryan Bourne argues, coming up with a number and then deciding how to spend it is not an effective way to determine an appropriate amount of federal spending.)

Despite both sides’ skepticism of P3s, and a recent New York Times editorial that described them as “gimmickry,” P3s offer a real option for financing infrastructure building and maintenance without burdening taxpayers with the costs. As I have previously discussed, there are currently a number of P3 projects across the United States and the arrangements have been increasingly embraced around the world. While there have been some legitimate concerns about early P3 projects, experience has helped policymakers and experts learn how to structure partnerships that reduce risk for companies and protect taxpayers and users.

Further use of P3s would help us transition to a more efficient way to finance infrastructure: a user pays model. Richard Bird and Enid Slack explained the benefits of having infrastructure users pay the costs in the spring 2018 issue of Regulation. There are two choices for infrastructure funding, either those who use the infrastructure pay for the service or the costs are borne by taxpayers. Unlike taxes, user charges are not distortionary, they provide signals to consumers about the true costs of the service, and they allow the public to more easily assess the performance of service managers and politicians. However, though user fees are more efficient, and economically and technically feasible, political concerns about distribution and providing “free” public services have been an obstacle to expanding their use.

P3s and user charges offer a more effective way to pay for infrastructure without a huge price tag for taxpayers. Unfortunately, though the bipartisanship of the $2 trillion infrastructure plan may seem like a breath of fresh air it looks like it will be the usual case of billing all taxpayers for services enjoyed by a few.

Written with research assistance from David Kemp.

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