In "Path to Prosperity," the booklet that describes his budget plan, U.S. Rep. Paul Ryan, R-Wis., expresses alarm at the size of past and projected budget deficits. He calls for urgent action to reduce the "size of government," which he measures as total spending. Part of his plan invokes President Ronald Reagan's "New Federalism," which allocates responsibility for social programs to state and local governments, partially financed with block grants from the federal government.
The theory is that those lower levels of government can make better decisions because they are closer to their community's social problems. In turn, the nation will enjoy more efficient decisionmaking since these officials have a strong incentive to evaluate the benefits and costs of the social services they are asked to deliver.
New Federalism recognizes that the states have a lesser ability to raise tax revenue; consequently, the federal government would provide a fixed sum of money to the states — the block grant — to help finance the social programs. The states can add to that grant, of course, but the grant money sets a floor that must be spent on the targeted program. The state officials determine how best to administer the programs and how much additional state money, if any, should be appropriated to supplement the grant.
Trying to gain greater acceptance among critical Catholic Church bishops and theologians, Ryan asserts that block grants mimic the church's teaching of "subsidiarity," that is, the idea that social services delivered by the church should be housed with the "most decentralized competent authority" and that higher level authorities should assist in paying some of the program costs.
The Path to Prosperity and New Federalism apply that principle to government. But does decentralization of responsibility work as well in a federal system as it does in a religious hierarchy? The church is a dictatorial system, whereas federalism must work within a market system. Will the block grant approach help or hurt the provision of a social safety net?
State governments compete with each other to attract new employers and high-income people. In their economic development efforts, they offer a variety of costly incentives, ranging from favorable tax treatment to the construction of a supportive physical infrastructure. The competition is fierce, because the firms and people they target can choose where to locate. No such strenuous effort is made to compete with other states to attract the poor and the sick. Quite the opposite: Social programs, even with the benefit of a block grant, become a drag in this interstate rivalry — a cost without a benefit in the job-creation process.
Block grants work fine if the state has a strong incentive to provide the services the block grant is designed to foster. For instance, a block grant to help states attract business will be spent gladly and, if necessary, states will provide additional funds to the cause. Why? Unlike the block grant for social programs, the intended target of this grant is compatible with the state's strategy in the interstate competition for business.
A second force working against the efficiency of New Federalism for social programs is the requirement that states balance their budgets. In economic downturns — just when safety net programs are most needed — the difficulty in balancing the state budget is greater because tax revenues are falling. Faced with an obligation to balance the budget, the state must choose between spending increasingly scarce dollars to maintain its business climate versus increased spending on safety net expenditures beyond the level provided by the block grant.
States are in a tough spot: Those that don't continually invest in a competitive business environment in a recession will find it harder to balance future budgets. Even though the need increases during recessions, the states find it harder to fill the role of "competent authority" over safety net programs; their incentive is to reduce spending just as the need increases.
The bishops and the faculty at Georgetown University have claimed that this plan won't work because it is too stingy. Economics goes even further to show that because of the combined forces of interstate tax competition and the balanced budget requirement, it cannot work.
Charles O. Kroncke is associate dean in the University of South Florida College of Business. William L. Holahan is a professor of economics at the University of Wisconsin at Milwaukee.