Federal-State-Local Relations: Trends of the Past Decade and Emerging Issues

Published by the Government Accountability Office on 1990-03-22.

Below is a raw (and likely hideous) rendition of the original report. (PDF)

Trends of the Past
Decade and Emerging

     United   States
     General Accounting Office
     Washington,       D.C. 20648

     Human Resources        Division


     March 22,199O

     The Honorable James Sasser
     Chairman, Subcommittee on General Services,
       Federalism and the District of Columbia
     Committee on Governmental Affairs
     United States Senate

     The Honorable Ted Weiss
     Chairman, Subcommittee on Human Resources
       and Intergovernmental Relations
     Committee on Government Operations
     House of Representatives

     This report provides information to the Congress on the key changes in the federal
     government’s relationship with states and localities over the past decade. It also identifies
     emerging issues concerning these intergovernmental partnerships, which may be useful for
     the Congress to consider as federal policymakers approach the next decade.

     Copies of this report are being sent to other congressional committees and subcommittees;
     the Director, Office of Management and Budget; the Chairman, U.S. Advisory Commission on
     Intergovernmental Relations; and other interested parties.

     This report was prepared under the direction of Linda G. Morra, Director, Intergovernmental
     and Management Issues, who may be reached on (202) 276-1655 if you or you staff have any
     questions. Other major contributors are listed in appendix III.

     Lawrence H. Thompson
     Assistant Comptroller General


                   Federal-state-local relations have changed significantly over the past
P$rpose            decade. Events and trends causing these changes have had both positive
                   and negative effects on the capacity of state and local governments to
                   carry out their responsibilities across a range of domestic programs and
                   policies. This report discusses how changed federalism policies and fed-
                   eral budgetary retrenchment have worked to broaden the role of the
                   states in the intergovernmental system, while federal regulatory trends
                   have lessened state discretion but not state responsibilities. The report
                   then links these factors to three emerging issues that the Congress
                   should be aware of as it seeks to address the budget deficit and pursue
                   other national priorities.

                   Apart from a few programs, such as the administration of the social
Bqckground         security system, the federal government is not a direct provider of
                   domestic public services. Instead, the majority of national domestic pro-
                   grams are implemented through a complex partnership among federal,
                   state, and local governments. Traditionally, grants-in-aid have formed
                   the principal means of tying the intergovernmental system together.
                   However, while federal grants-in-aid to states and localities totaled $95
                   billion in fiscal year 1989, they peaked in real terms in 1978. As a share
                   of total state-local expenditures, federal aid shrank by one-third over
                   the 197848 period. This decline contributed to a search for new ways to
                   meet continuing demands for public services by many of the more than
                   83,000 units of government comprising the intergovernmental system
                   and by the federal government itself.

                   During the past decade, changing federalism policies and federal budget-
Results in Brief   ary retrenchment resulted in an increase in the role of the states in the
                   intergovernmental system. Subsidies to local governments were reduced
                   and state authority over some kinds of federal aid was increased. States
                   became more prominent over the decade as a result, but not without
                   some adverse effects. The first emerging issue identified by GAO is that
                   the fiscal gap between wealthier and poorer communities became larger
                   over this period.

                   In contrast, trends in federal regulation lessened state discretion but not
                   state responsibility. Despite certain Reagan administration efforts to
                   minimize it, federal regulation of states and localities grew over the past
                   decade. New regulations governing domestic programs were created,
                   and federal preemption powers were expanded. This situation was cited
                   by state and local officials whom GAO interviewed as the most negative

                   Page2                                 GAO/HRD9034FederalState-LocalRelations
                                 Executive Summary

                                 trend of the past decade. It raises the second emerging issue GAO identi-
                                 fied: while regulation is an important mechanism for the federal govern-
                                 ment to use to attain statutory objectives, its success often depends on
                                 the goodwill and cooperation of state and local governments to imple-
                                 ment these federal regulatory programs. Yet, in this respect, tensions
                                 between the federal and state and local governments are mounting.

                                 States have increased their prominence over the past decade and now
                                 stand at the threshold of the 1990s as highly visible leaders in a broad
                                 range of domestic policies. In part, this is due to the increased institu-
                                 tional and administrative capacity of states. Federal budgetary
                                 retrenchment has also thrust states into new and expanded roles. Sus-
                                 tained national economic growth has also contributed.

                                 The third emerging issue that GAO identified, however, is that the combi-
                                 nation of federal budgetary retrenchment and expanding regulation
                                 could place too much fiscal pressure and program responsibility on
                                 states, especially during periods when national or regional economies
                                 are weak. This, in turn, could slow-or even reverse-the trends in
                                 state prominence.

Principal Findings

Decentralization Driven by       Changing federalism policies, tax cuts, and efforts to reduce the size of
Changing Federalism              the budget deficit have helped to decentralize the intergovernmental
                                 system and increase the role of the states. In particular, federal aid for
Policies and Growing             community and economic development, housing, and public infrastruc-
Fedyral Deficit                  ture has been cut significantly, while program funding benefiting poor
                                 people has been largely maintained, and in some cases expanded.
                                 Because local governments have been the primary recipients of the for-
                                 mer categories of aid, federal-local relationships, which developed in the
                                 1960s and 1970s were reduced (see pp. 15-19).

Increased Concerns About         Beginning in the 1970s budgetary pressures led federal policymakers to
Intergovernmental                further national objectives through nongrant strategies, notably:
Regulation                       regulatory requirements, in which the federal government calls on
              Y              l

                                 states and localities to administer federal rules;

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                             Executive Summary
                                   ,.     ’

                           . preemptions, in which state or local policies are preempted by national
                             action; and
                           . direct orders, in which the national government directly orders state
                             and local governments to take specified actions (see pp. 26-27).

                             Regulation is one of a number of fundamental powers the federal gov-
                             ernment has to attain statutory objectives. Even so, over the past dec-
                             ade, national regulatory trends lessened state discretion without
                             reducing the scope of state responsibilities. Notwithstanding some Rea-
                             gan administration efforts to reduce overall levels of intergovernmental
                             regulation, the Congress, federal agencies, the courts, and the adminis-
                             tration continued to use all three forms of regulation to expand and
                             strengthen federal regulatory efforts (see pp. 27-31).


St&e Government Was          States as a whole became more capable of responding to public service
Stiengthened                 demands and initiating innovations during the past decade. Many fac-
                             tors account for strengthened state government. Beginning in the 1960s
                             and 197Os, states modernized their governmental structures, hired more
                             highly trained individuals, improved their financial management prac-
                             tices, and diversified their revenue systems (see pp. 33-37). Also con-
                             tributing was the Reagan administration’s philosophy of focusing
                             program responsibility on states, thrusting these governments into new
                             or increased leadership responsibilities (see pp. 40-41). Finally, since
                             1983, sustained national economic growth has provided many state and
                             local governments greater financial stability. This, in turn, has given
                             them more flexibility to plan for the future and address existing prob-
                             lems (see pp. 41-42).

Implications for Federal     The events and trends of the past decade have created a paradox in
Po)icymakers                 intergovernmental relations with important implications for federal
                             policymakers. Federal budgetary realities and changing federalism poli-
                             cies helped to cast states in a more prominent role in domestic policy in
                             the 1980s than in the 1970s. At the same time, regulatory instruments
                             provided alternative means to achieve national objectives when budget-
                             ary strategies proved untenable. In combination, these changes suggest
                             that, overall, state fiscal health and institutional capacity to carry out
                             domestic responsibilities may become more entwined with the actions of
                             the federal government in the 1990s than was true in the 1970s.

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                          Jkecutive Summary

                          Based on these past events and trends, GAO identified three broad issues
                          that the Congress should be aware of in the coming decade:

                      l    First, the federal government depends heavily on the institutional and
                           financial capacity of state and local governments to administer its pro-
                           grams. Yet over the past decade, federal budget cuts helped to widen the
                           fiscal gap between wealthier and poorer communities. This, in turn, is
                          one warning sign that inequities in the levels of basic state and local
                          public services (e.g., police, primary and secondary eduction, and infra-
                          structure) may be increasing.
                      l   Second, while regulation of states and localities is an important tool for
                          the federal government to attain its statutory objectives, tensions among
                          levels of government have mounted over the past decade as regulatory
                          requirements, preemptions, and mandates increased (see pp. 48-49). The
                          cumulative effect of these increases-coupled with decreasing federal
                          aid-could force state and local governments to choose between meeting
                          their service responsibilities and fulfilling national regulatory objec-
                          tives. This kind of divergence between state, local, and national priori-
                          ties is likely to reduce the effectiveness of these governments as agents
                          of national regulatory policies and public service providers, especially
                          during periods of economic decline.
                  l       Third, by the end of the 1980s states had reemerged as principal domes-
                          tic partners with the federal government and policy leaders and pro-
                          gram innovators in their own right. However, because states occupy an
                          increasingly central place in the intergovernmental system, the combina-
                          tion of federal fiscal and regulatory trends poses a special threat to their
                          leadership because it might slow- or even reverse-recent progress
                          (see pp. 49-50).

                          GAO   is making no recommendations.

                          The contents of this report were discussed with national and state inter-
Agency Comments           governmental experts and agency officials with responsibility for inter-
                          governmental programs. Their comments are reflected throughout the

                          Page 5                                 GAO/HRD-90-34Federal-State-LocalRelations
          Summary                                                                                    2

Chapter 1                                                                                          10
Introduction           Background                                                                  10
                       Objectives, Scope, and Methodology

Ctiapter 2                                                                                         14
F&era1 Budgetary       Deficit Reduction Strategies Drove Retrenchment
                       Federal Aid Cuts Fell Most Heavily at the Local Level
R ‘trenchment          Two Key Tax Subsidies Were Cut                                              19
In1 reased the State   States Step In, Providing More Aid to Local Governments                     23
Role in the
Chapter 3                                                                                          26
Trends in Federal      Past Growth and New Forms of Intergovernmental
Regulation Lessened    Reagan Administration Efforts to Decentralize and                           27
State Discretion but       Simplify Federal Regulation
Not Responsibility     Regulation Increased, Funding Was Cut                                       28

Chapter 4                                                                                          32
Increased State        State Agendas Are Broader and Programs More                                 32
Prominence in          Improved State Capacities Contributed to State                              33
Domestic Affairs:           Prominence
                       National Policy Directions Contributed to State                             40
Progress and                Prominence
Prospects              National and State Economic Recovery Contributed to                         42
                            State Prominence

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Chapter 5                                                                                           44
Tretids of the Past     Federal Budget Trends Exacerbated Growth in State and                       45
                             Local Fiscal Disparities
De&de Raise             State and Local Officials and Intergovernmental Experts                     48
     rtant Issues for        Believe Regulatory Trends Cause Problems
        Policymakers    Federal Budget and Regulatory Trends Could Adversely                        49
                             Affect State Prominence

Apppdixes               Appendix    I: Key Intergovernmental Events: 1978-88                        52
                        Appendix    II: Persons Interviewed to Develop Issues in                    58
                            This   Report
                        Appendix    III: Major Contributors to This Report                          61

Bibliography                                                                                        62

Tables                  Table 1.1: State and Local Government Expenditures                          10
                        Table 2.1: Percentage Decrease in Federal Aid as a Share                    18
                            of Total Revenues, by Type of Government (1980-86)
                        Table 2.2: Tax Expenditures Aiding State and Local                          20
                            Governments (Fiscal Year 1988)
                        Table 3.1: Administration and Oversight Budgets,                            30
                            Selected Intergovernmental Regulatory Programs
                            (Fiscal Years 1978-88)
                        Table 3.2: Federal Preemption Statutes, by Date of                          31
                        Table 4.1: Adoption of Major Taxes Since 1961                               35

Figures                 Figure 1.1: Distribution of Federal Outlays and Forgone                     11
                             Revenues for Intergovernmental Programs (Fiscal
                             Year 1988)
                        Figure 2.1: Federal Grants-in-Aid as a Percentage Share of                  16
                             Total State-Local Spending (1978-88)
                        Figure 2.2: Trends in Federal Aid to States and Localities                  17
                        Figure 2.3: Changes in the Composition of Federal Aid to                    19
                             States and Localities (1978-88)
                        Figure 2.4: Federal Revenues Forgone Through Subsidies                      21
                             Favoring State and Local Governments (Fiscal Years

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I   Content9

    Figure 2.5: Growth in State-Local Revenues, Excluding                     24
         Federal Aid (1978-87)
    Figure 4.1: State Personal Income Tax Revenues Per $100                   36
         of Personal Income (1978-87)
    Figure 4.2: State and Local Tax Revenue Per $100 of                       38
         Personal Income (1978-87)
    Figure 4.3: State Spending Per $100 of Personal Income,                   39
         Excluding Federal Aid (1978-87)
    Figure 4.4: State Income and General Sales Tax Revenues                   42
         (Fiscal Years 1978-86)
    Figure 4.5: State Year-End Fund Balances (1978-88)                        43
    Figure 5.1: Number of Counties Above or Below the                         46
         National Per Capita Mean Income in 1978 and 1987
    Figure 6.2: Population of Counties, Classified by County                  47
         Per Capita Personal Income as a Percentage of U.S.
         Per Capita Income (1977-87)


    ACIR       U.S. Advisory Commission on Intergovernmental Relations
    AFDC       Aid to Families With Dependent Children
    CRS        Congressional Research Service
    DEFRA      Deficit Reduction Act of 1984
    EPA        Environmental Protection Agency
    ERTA       Economic Recovery and Tax Act of 1981
    FISA       Fair Labor Standards Act
    GAO        General Accounting Office
    GRH        Gramm-Rudman-Hollings Act
    GRS        General Revenue Sharing
    IDB        industrial development bond
    NGA        National Governors’ Association
    OBRA       Omnibus Budget and Reconciliation Act of 1981
    OMB        Office of Management and Budget
    TEFRA      Tax Equity and Fiscal Responsibility Act of 1982
    TRA-84     Tax Reform Act of 1984
    TRA-86     Tax Reform Act of 1986
    USDA       Department of Agriculture

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Page 9   GAO/HRD-90-34FederalState-Local Relations
Chadter 1


                                        Nearly all public services in the United States are jointly financed and
Background                              delivered through the 50 state, 39,000 general purpose, and 44,000 spe-
                                        cial purpose local governments. This approach to public service delivery
                                        reflects the fact that the United States is a federal system in which
     I                                  responsibilities are both divided and shared among separate levels of
                                        government, each possessing a base of legal and fiscal authority.

                                        Historically, responsibilities were more divided than shared. The states
                                        and, through them, local governments were preeminent in domestic pol-
                                        icy. However, in the aftermath of the Great Depression the federal gov-
                                        ernment increased its domestic commitments, creating a host of new
                                        programs and helping to finance the delivery of many more public ser-
                                        vices at the state and local level. Beginning in the Great Society period
                                        of the 1960s and continuing into the 1970s the federal government
                                        again stepped up its efforts, adding substantially more local government
                                        grant programs to the existing mix of federal aid. Having examined
                                        these trends in detail, in 1981, the U.S. Advisory Commission on Inter-
                                        governmental Relations (ACIR) concluded that “. . . the federal role has
                                        become bigger, broader, and deeper- bigger within the federal system,
                                        both in the size of its intergovernmental outlays and in the number of
                                        grant programs, broader in its program and policy concerns, and the
                                        wide range of subnational [state and local] governments interacting
                                        directly with Washington; and deeper in its regulatory thrusts and pre-
                                        emption proclivities.“l

                                        States and localities spent $926.7 billion in 1987, as table 1.1. shows.

Table 1.1: State and Local Government
Expenditures (1987)                     Dollars in Billions
                                        Type of government
                                        ..---I___-__                                                              Number         expenditures
                                        State            .--                                                            50               $455.7
                                        General purpose local governments                                           38,933                281.8
                                        Counties                                                                     3,042                103.0
                                        --____-.__                     -__~                                         19,200                164.1
                                        _--__ --.-.__-                                                              16,691                 147
                                        Special purpose governments                                                 44,253                189.2
                                        School districts-.                                                          14,721                138.3
                                        .%ecial districts                                                           29,532                 50.9
                                        Source: Bureau of the Census, Statistical Abstract of the United States, 1989, p. 266; and Governmental
                                        Finances, 1986-87, table 2.

                                        ‘1J.S.Advisory Commission on Intergovernmental Relations, The Federal Role in the Federal System:
                                        The Dynamics of Growth, A-86 (Washington, D.C.: U.S. Government Printing Office, June, 1981) p. 1.

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                                      Chapter 1

                                      Federal financial assistance to states and localities takes the form of
                                      grants-in-aid, tax subsidies, loans, and loan guarantees, Federal
                                      grants-in-aid were about $115.3 billion in fiscal year 1988. In addition
                                      nongrant aid-in the form of tax subsidies, loans, and loan guaran-
                                      tees-amounted to nearly $50 billion (see fig. 1.1).

Figure 1.1: Distribution of Federal
Outlay and Forgone Revenues for
lnterg ,”vernmental Programs
(FiscalJYear 1988)                                                                         Loans and Loan Guarantees ($0.7)
                                                            I                              n4%

                                                                                           Tax Expenditures ($42.5)

                                      Source: Office of Management and Budget, The United States Budget, Special Analysis G and H, Fiscal
                                      Year 1990.

                                      The federal role in financing programs and services provided by state
                                      and local governments is relatively small when compared with spending
                                      for these purposes, which is derived from revenues raised by state and
                                      local governments. Yet, federal aid is important because it often signifies
                                      strong federal interests (e.g., in health care) or because it is designed to
                                      encourage innovation or stimulate spending for particular kinds of ser-
                                      vices (e.g., in primary and secondary education). Until 1986, federal

                                      Page 11                                            GAO/HlUHO-34 Federal&ate-Local Relations
                        Chapter 1

                        aid-in the form of general revenue sharing-also was designed to mod-
                        erate differences in fiscal capacities between wealthier and poorer

                        Some Reagan administration efforts to simplify the intergovernmental
                        system notwithstanding, the federal relationship with states and locali-
                        ties has continued to grow in complexity over the past decade. The fed-
                        eral government’s reach has been extended in ways not traditionally
                        considered grant or grant-connected, including new actions in policy
                        areas affected by tax subsidies, regulations, and preemptions. At the
                        same time, the federal government has more explicitly recognized the
                        state role in domestic policy development and administration and deem-
                        phasized its connection with local governments. These changes occurred
                        in part because changed federalism policies and constraints imposed by
                        a large federal deficit increased pressure for cuts in federal aid to states
                        and localities as part of an overall effort to reduce the deficit. Yet,
                        because actions were not part of a single plan for reforming the inter-
                        governmental system, their aggregate impact was not explicitly

                        Given the magnitude of change in the intergovernmental system over
                        the past decade and the fact that the federal government depends pri-
                        marily on state and local governments to achieve its domestic policy
                        objectives, we sought to examine recent trends and changes in the rela-
                        tionship between federal and state and local governments in order to
                        identify the principal challenges these trends pose for achieving national
                        policy goals and program objectives.

Objectives, Scope,and   over the 1978-88 period and to describe their consequences with respect
M&hodology              to issues federal policymakers are likely to face in the near future. To
                        set the context for this analysis, we first identified nine major events
                        affecting intergovernmental relations since 1978 (see app. I). We then
                        analyzed key trends and identified emerging issues that the Congress
                        should be aware of in the coming decade.

                        The year 1978 was selected as the baseline for measuring changes in the
                        intergovernmental system because in this year federal aid to states and
                        localities peaked in real terms, and because it was a turning point in
                        public attitudes toward taxation as reflected in the passage of Califor-
                        nia’s property tax limitation proposition, Proposition 13 (see app. I).
                        These two events signaled the beginning of a fundamental redirection in

                        Page 12                                GAO/HRD-SO-34
                                                                           Federal&ate-Local Relations
Chap&x 1

intergovernmental relations, which for the two preceding decades had
emphasized growth in the size and range of federal-state and federal-
local programmatic partnerships. This pattern of federal expansion was
reversed in the 1980s by President Reagan’s policy of devolving pro-
gram authority to the states as well as by the sustained fiscal pressures
associated with the growing federal budget deficit.

In part, our analysis is based on a series of interviews with expert
observers of the intergovernmental system, both inside and outside the
federal government. In addition, we interviewed selected state and local
officials in Colorado, Florida, Massachusetts, North Carolina, and Texas
(see app. II). We chose these states so as to balance geographic location
and size as well as political party affiliations of governors and majorities
in legislatures. Our analysis is also based on an extensive review of rele-
vant research conducted over the past decade. Finally, we drew on our
earlier work on block grants and other intergovernmental programs and
our recent work on intergovernmental regulatory issues (see bibliogra-
phy). Interviews were conducted between March and October 1988.

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Chanter 2

Federal Budgetary RetrenchmentIncreasedthe
State Role in the Intergovernmental System

              Federal budgetary retrenchment increased the role of states in the inter-
              governmental system by reducing subsidies to local governments and
              increasing state authority over some kinds of federal aid. Changing pri-
              orities, tax cuts, and mounting deficits drove federal policymakers to cut
              budget and tax subsidies to both states and localities. These cuts fell
              more heavily on localities, however, because the Congress placed sub-
              stantial importance on those “safety net” programs in health and wel-
              fare that help the poor, which generally are federal-state partnerships.
              In contrast, the Congress placed less importance on those “nonsafety”
              net programs in infrastructure and economic development, which gener-
              ally are federal-local in nature.

              The Congress also made cuts in two large federal tax subsidies affecting
              state and local governments: the deductions for state and local sales
              taxes paid by taxpayers who itemize on their federal income tax returns
              and the exclusion of taxpayers’ interest earnings on tax exempt bonds.
              The deductions for sales taxes were eliminated.’ And there were major
              changes in the area of tax exempt bonds, a primary source of capital for
              state and local infrastructure and community and economic develop-
              ment projects. In this respect, rules on federal tax treatment were tight-
              ened. Existing limits on the total dollar amount of private activity bonds
              that may be issued in a single year were lowered significantly.Z,3 And the
              power to allocate private-activity bond authority (within these federally
              imposed ceilings) was taken from local governments and given to states,
              increasing their authority over local public finance.

              During this period of federal budgetary retrenchment, states increased
              their aid to local governments by nearly 24 percent (in constant dollars),
              although this growth did not keep pace with the growth of revenues
              generated from local sources. Moreover, state aid to some kinds of local
              governments grew more than others. Thus, for example, while state aid

              ‘The benefit that states and localities received from this deduction had always been indirect, pre-
              sumed to flow from an increased willingness of citizens to pay higher sales taxes at state and local
              levels than they would in the absence of the federal deduction. However, because estimates of this
              benefit depend on economic assumptions, estimates of it vary.

              ‘In many, although not all, instances, private-activity bonds are used by state and local governments
              to provide capital for private sector enterprises and economic development projects. For federal tax
              purposes, tax exempt bonds are divided into three groups: (1) governmental tax exempt, (2) private
              activity tax exempt, and (3) private activity taxable. For a detailed discussion of the differences
              among these see Margaret T. Wrightson, “Intergovernmental Tax Immunity and the Constitutional
              Status of Federalism,” Publius: The Journal of Federalism 19 (Summer, 1989), p, 40.

              ‘IThe benefit of exclusions of interest earnings on tax exempt bonds to the state-local sector is the
              difference between the interest rate on taxable bonds, which these governments would pay in the
              absence of the exemption, and the interest they actually pay.

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                    chapter 2
                    Federal Budgetary Retrenchment Increased
                    the State Role in the
                    Intergovernmental System

                    to school districts rose as a share of school district revenues, counties
                    and especially cities became more fiscally self-reliant.

                    The 1981 tax cuts and indexation of income taxes to inflation did not
Deficit Reduction   cause federal revenues to decline over a 5-year period, but revenues
Str+egies Drove     grew more slowly in the 1980s than in the previous decade. In the
Retrenchment        absence of correspondingly large spending reductions, the slower
                    growth in tax revenues and increased defense spending led to a dra-
                    matic growth in the budget deficit and ultimately to the adoption of the
                    Gramm-Rudman-Hollings Act of 1985 (GRH) (see app. I).

                    The intergovernmental impacts of federal deficits and changing national
                    priorities were visible well before GRH, however. Even though federal aid
                    in the form of grants to state and local governments totalled $95 billion
                    in 1989, this kind of aid peaked in real terms in 1978. This was also the
                    year California’s property tax limitation proposition, Proposition 13,
                    was passed (see app. I). Thereafter, the Omnibus Budget Reconciliation
                    Act of 1981 (OBRA) resulted in domestic spending cuts of $35 billion in
                    fiscal year 1982. Grants to state and local governments fell $6 billion in
                    nominal terms that year and 13 percent below anticipated or baseline
                    expenditures. Altogether, OBRA eliminated 59 grant programs and con-
                    solidated nearly 80 narrowly focused categorical grant programs into
                    nine broad-based block grants. Significantly, many of the grants elimi-
                    nated by OBRA had been federal-local, while all of the block grants cre-
                    ated were state-administered (see app. I). After OBFtA'S passage,
                    aggregate levels of federal grants-in-aid continued to decline, but more
                    slowly. Overall, during the 1978-88 period, federal aid to state and local
                    governments decreased by $17.2 billion in constant dollars. As a share
                    of state-local expenditures, federal aid shrank by about one-third, from
                    27 to 18 percent, as shown in figure 2.1.

                    Page 15                                    GAO/HRD-90-34FederalStateLocal Relations
                                              Chapter 2
                                              Federal Budgetary Retrenchment Increased
                                              the State Role in the
                                              Intergovernmental System

Figure 2.1: Federal Qrantr-in-Aid   as a Percentage Share of Total State-Local Spending (1978-88)
35 Porcantagr

                                                                                      L          L
    1078         1979   1980                                        1965      1986       1987      1988

                                              Source: ACIR, Significant Features of Fiscal Federalism, 1989 Edition, vol. I, p, 21

                                             Although total federal aid to states and local governments declined, the
Federal Aid Cuts Fell                        decline affected states and localities differently. Total aid fell at an
Most Heavily at the                          annual rate of 1.6 percent between 1978 and 1986 in constant dollars.
Local Level                                  However, it grew at a 1.3-percent rate for states, while decreasing at a
                                             5.5percent rate for local governments over the same period. In effect,
                                             states were enjoying a larger share of a smaller pie, as is shown in figure

                                             Page 16                                                 GAO/HRD-90-34FederalState-Local Relations
’          /                              Chapter 2
                                          Federal Budgetary Retrenchment Increased
                                          the State Role in the
                                          Intergovernmental System

St&$           and Localities (1978-66)
(Consfant 1982 Dollars)                   100    Dollar8   In Bllllona










                                                 1         1 states

                                          Source: ACIR, Significant Features of Fiscal Federalism, 1988 Edition, vol. II, p. 81.

                                          There also were relative differences among local governmental fiscal
                                          “losers.” As a Congressional Research Service (CRS) analysis found,
                                          counties were among the hardest hit, experiencing a 73-percent decrease
                                          in direct federal aid as a percentage of total revenues between 1980 and
                                          1986 (see table 2.1). The same analysis also puts growth in state aid in
                                          clearer perspective. Moreover, while federal assistance to states
                                          increased in absolute terms between 1980 and 1986, this aid did not
                                          keep pace with state revenue raising efforts over the same period. Thus,
                                          even among the “winners,” federal assistance declined by 11 percent
                                          when expressed as a proportion of total revenue, as table 2.1. shows.

                                          Page 17                                                GAO/HRD-90-34FederalState-Local Relations

                                        Chapter 2
                                        Federal Budgetary Retrenchment Increased
                                        the State Role in the
                                        Intergovernmental System

    Table 12.1:Percentage Decrease in
    Federal Aid as a Share of Total                                                                Federal aid as a
    Revenues, by Type of Qovernment                                                           percentage share of total
    ( 1960-86)                                                                                        revenues                   Percentage
                                        Type of government                                           1980           1988             change
                                        State                                                           26.5             23.6              -11
                                        Special districts                                               20.8             15.0              -28
                                        School districts                                                 8.9              6.1              -31
                                        Cities                                                          14.3              6.2              -57
                                        Townships                                                        7.4              2.1              -72
                                        Counties                                                         9.1              2.5              -73
                                        Note: General Revenue Sharing program funding was netted out from the fiscal year 1985-86, to reflect
                                        its elimination in fiscal year 1987.

                                        Source: Lillian Rymarowicz and Dennis Zimmerman, Federal Budget and Tax Policy and the State-Local
                                        Sector: Retrenchment in the 1980s (Congressional Research Service Report, 88-600 t, September 9,

    Types of Programs                   Expenditures for entitlement programs such as Medicaid, which are typ-
    Receiving Federal A id              ically administered by states, increased over the 1978-88 period, while
                                        aid for economic development, housing, and other nonsafety net pro-
    Have Changed                        grams, which almost exclusively goes to local governments, declined.
                                        Furthermore, states assumed greater responsibilities and increased pro-
                                        gram discretion in the areas of health and welfare under newly enacted
                                        block grants (see app. I). While total 1982 program funding was cut by
                                        15 percent below the 1981 categorical grant level under the block
                                        grants, states experienced a net increase in funds overall because many
                                        of the programs eliminated had been federal-local.

                                        These same trends can be seen in another way. Federal aid for govern-
                                        mentally administered programs designed to meet the needs of
                                        individuals increased, while aid directed to governments to meet com-
                                        munity-wide or public service needs declined. For example, Medicaid
                                        has increased every year since fiscal year 1978, a trend projected to con-
                                        tinue. On the other hand, those forms of aid to governments that gener-
                                        ally support capital improvements or public services were cut, resulting
                                        in the contrasting trendlines depicted in figure 2.3.

                                        Page 18                                             GAO/HRlMO-34 Federal&ate-Local Relations
                                          Chapter 2
                                          Federal Budgetary Retrenchment Increased
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                                          Intergovernmental System

Flgura 2.3: Changes in the Composition
of Feqeral Aid to States and Localities
                                           80      Dollar8   In Bllllona
(1978.TO) (Constant 1982 Dollars)


                                            1978         1979          1980    1951      1962   1953    1934    1985      1955     1987      1983
                                            FlScal Y8W

                                                   -          Payments for Individuals
                                                   - - - -    Capital Investment
                                                   m          Remainder

                                          Source: Office of Management and Budget, Historical Tables, Budget of the United States Government
                                          (fiscal year 1990), p. 240.

                                          An indirect form of federal assistance to states and localities is tax sub-
Two Key Tax                               sidies, whereby the federal government forgoes collecting revenues it
Subsidies Were Cut                        would otherwise receive from corporations and individuals.4 The total of
                                          these subsidies increased during the 1978-88 period, but two large tax
                                          subsidies-the deductions for state and local taxes and the interest
                                          exemption for tax exempt bonds-were cut back. These changes
                                          reduced the rate of growth in state and local tax subsidies beginning in
                                          1988. However, because these changes are recent their impacts are not
                                          yet entirely clear.

                                          4Tax subsidies (many of which are reported in the Office of Management and Budget estimates of tax
                                          expenditures) are losses to the treasury resulting from provisions in the federal income tax code that
                                          give preferential treatment to individuals, corporations, and non-profit entities. Common preferences
                                          include differential rates for taxing different forms of income as well as deductions, credits, exclu-
                                          sions, and exemptions for some kinds of business and personal expenses.

                                          Page 19                                                 GAO/HRD-90-34Federal-State-LocalRelations
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Pas/tGrowth of Tax                           Tax subsidies aiding states and localities are generally of two kinds:
Subsidies                                    exclusions of interest (almost entirely comprised of tax exempt bond
                                             interest) and deductions for taxes paid by individuals and corporations
                                             to state or local governments (see table Z.Z).”

Table’ 2.2: lax Expenditures Aiding State
and IIlocal Governments (Fiscal Year 1988)   (Dollars in Billions)
                                             Description                                                                                      Value
                                             Exclusion of interest on:
                                             Industrial development bonds (IDB) for certain energy facilities                                    0.3
                                             Pollution control/waste disposal facilities                                                          1.6
                                             Small issue IDBs                                                                                    2.7
                                             Mortgage bonds for owner-occupied housing                                                            1.8
                                             Debt for rental housing                                                                              1.2
                                             --      for mass commuting vehicles                                                                0.01
                                             Bonds for airports, docks, etc.                                                                     0.7
                                             Bonds for student loans
                                             ~--                                                                                                 0.4
                                             Debt for private, nonprofit education facilities
                                             -~                                                                                                  0.3
                                             Debt for private, nonprofit health facilities                                                       2.2
                                             f%bt for veterans housing                                                                           0.3
                                             Debt for state/local public purpose bonds                                                          10.4a
                                             Deductibility of:
                                             Nonbusiness state and local taxes other than owner-occupied           housing                      17.3
                                             Property taxes for owner-occupied housing                                                          10.1
                                             aThe estimate of total tax expenditures reflects interactive effects among the individual items. There-
                                             fore, the individual items cannot be added to obtain a total.
                                             Source: Office of Management and Budget, United States Budget, Special Analysis G, Fiscal Year 1990.

                                             Tax subsidies aiding state and local governments grew rapidly over the
                                             1978-86 period, as is shown in figure 2.4.

                                             “On these points see Lillian Rymarowlcz and Dennis Zimmerman, The Effect of Federal Tax and
                                             Budget Policies in the 1980s on the State-Local Sector (Congressional Research Service Report 86-2 E,
                                             January 2, 1986); Daphne A. Kenyon, “Implicit Aid to State and Local Governments Through Federal
                                             Tax Deductibility”; and Dennis Zimmerman, “The Intergovernmental Struggle Over Tax-Exempt Bond
                                             Reform” in State and Local Finance in an Era of New Federalism (Greenwich, CN, 1988), pp. 63-101.

                                             Page 20                                              GAO/HRD-90-34FederalState-Local Relations
                                                   chapter 2
                                                   Federal Budgetary Retrenchment Increased
                                                   the State Role in the
                                                   Intergovernmental System

          A Federal Revenue8 Forgone Through Subsidies Favoring State and Local Governments
             197&88)(Dollars in Billions)

      lam In Billlone

   1979       1979      1990    1991        1922    1982      1994      1965     1999        1997    1988
   Flocd   YOM

                                                   Source: Special Analysis G of the Budget of the United States, 1978-88editions

SalebTax Deductions                                A large share of the recent and projected decline in tax subsidies can be
Eliminated, Tax Exempt                             attributed to the elimination of deductions for state and local sales taxes
                                                   and restrictions on tax exempt bonds contained in the Tax Reform Act
Bonds Restricted                                   of 1986 (TRA-86) (see app. I).

                                                   The loss of the deduction for state sales taxes constituted the largest of
                                                   cuts in tax subsidies. Because its impacts on state taxing and spending
                                                   abilities are indirect, however, its consequences are difficult to deter-
                                                   mine. On the other hand, with respect to the increased role of the states,
                                                   the changes in tax exempt bonds are significant for two reasons. First,
                                                   much of the federal revenue loss associated with tax exempt bond
                                                   growth can be traced to the vigorous use of these bonds for purposes
                                                   other than traditional local and state infrastructure projects. Second,
                                                   states were given greater authority to control the issuance of private-
                                                   activity bonds within the limits of a single federally imposed volume

                                                   Page 21                                             GAO/HRD-90-34FederalState-LocaJRelations
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Intergovernmental System

By the late 1970s and early 1980s tax exempt bonds were being used to
fund many more kinds of activities than they were traditionally used for
(e.g., public schools or road construction). They were being issued for a
variety of loosely defined public-private partnerships, including some
for business development and for construction of pollution-control,
trade-show, convention, and sports facilities. Private-activity bonds also
were issued to subsidize consumer borrowing, especially for low-cost
college tuition loans and below-market-rate home mortgages primarily
for first-time homebuyers.

As uses multiplied and volume expanded, private-activity bonds came to
be regarded by federal policymakers with increased skepticism. The
Congress began to restrict the use of tax exempt bonds, but with mixed
success. The Revenue and Expenditure Control Act of 1968 defined
industrial development bonds (IDBS) and specified the circumstances
under which such bonds were to receive preferential federal tax treat-
ment. Later, the Mortgage Subsidy Bond Tax Act of 1980, the Tax
Equity and Fiscal Responsibility Act of 1982 (TEFRA), and the Tax
Reform Act of 1984 (TRA-84) commonly considered as part of the Deficit
Reduction Act of 1984 (DEFRA) eliminated a number of abuses (e.g., use
of proceeds from small issue IDB'S to finance race tracks, variety stores,
and fast food restaurants) in the area of private sector investment and
consumer borrowing.)6 However, these limitations proved not to be very
effective, and bond volume continued to grow as figure 2.4 shows.

The passage of ~~-86, most noted for lowering marginal income tax
rates, reversed this trend in dramatic fashion. Altogether, the act’s
intergovernmental impacts were considerably greater than those of
other recent tax legislation, notably TEFRA and TM-84. In addition to new
provisions affecting the use of bond proceeds,7 ~~-86 provided a single
state volume cap set at $50 per capita or $150 million per annum in

 On these and other examples of congressional action to curb abuse see Dennis Zimmerman, “The
Intergovernmental Struggle Over Tax Exempt Bond Reform,” in Michael E. Bell, State and Local
Finance in an Era of New Federalism, (Greenwich, CN: JAI Press, 19SS),pp. 101-124.

7These included, for example, provisions restricting the use of bonds to encourage business invest-
ment, bonds for some kinds of public transportation projects, and the use of bonds in advanced
refunding and arbitrage practices (see app. I).

Page 22                                             GAO/HRD-90-34Federal&ate-Local Relations
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                        the State Rule in the
                        Intergovemmental System

                        1988. With limited exceptions, this cap applies to all types of private-
                        activity bonds.s


                        As the federal government became a less dependable source of local gov-
States Step In,         ernment financial assistance, expectations about the role of the states in
Prcviding More Aid to   d omestic policy shifted. The fact that states moved to replace some lost
Local Governments       federal grant funds to local governments contributed to a widespread
                        sense among observers of the intergovernmental system that states were
                        “on the move.” In fact, state aid to cities increased 2.5 percent in real
                        terms between 1978 and 1986. State aid to counties increased 15.5 per-
                        cent over this same period.

                        Notwithstanding this increase, however, state aid did not keep pace
                        with local revenue raising. During this same 7-year period, general reve-
                        nues derived from local sources increased 37 percent for cities and 52
                        percent for counties. On average, cities received about 36 cents from
                        state government for every dollar raised in 1979. But, by 1986, this fig-
                        ure was only 29 cents. In 1979, counties received 69 cents, but by 1986
                        they received less than 51 cents. An important exception to this trend
                        was school districts. In 1978, they counted on the state for 97 cents for
                        every dollar they raised from their own sources, but by 1986 this figure
                        had risen above $1.17. Altogether, state-local revenues (exclusive of fed-
                        eral aid) grew substantially over the decade we examined, as figure 2.5.

                        sThe impacts of TRA-86 on states were not entirely negative. In particular, the passage of federal
                        income tax reform laws provided a potential windfall of tax revenues to the states that coupled their
                        income tax systems to the federal tax system. To the extent that these states left their own income
                        tax systems untouched, the elimination of tax preferences from federal income tax would also elimi-
                        nate them as preferences for purposes of determining state income tax liability. Thus, for example,
                        ACIR estimated that federal income tax reform would create a windfall in tax revenues of over 18
                        percent in six states. At the other end of the spectrum, ACIR estimated that 14 states would receive a
                        windfall of less than 5 percent of total revenues from individual income tax increases. Altogether,
                        state tax liabilities after federal tax reform were estimated to increase $5.2 billion by ACIR. In fact,
                        states have begun to modify their income tax systems ln the aftermath of TRA-86, in some cases
                        returning a large share of revenues to taxpayers. Because modifications are recent, however, their
                        impact is not yet fully known,

                        ACIR also found that, in the absence of states modifying their income tax systems, federal income tax
                        reform would produce a tax shortfall in some states. ACIR estimated that 16 states would lose tax
                        revenues as a result of TRA-86, ranging from 12 percent in North Dakota to less than 1 percent in
                        South Carolina. On all these points see ACIR, The Tax Reform Act of 1986-Its Effect on Both Fed-
                        eral and State Personal Income Tax Liabilities, SR-8, January, 1988; and ACIR, Preliminary Estimates
                        of the Effect of the lQS6 Federal Tax Reform Act on State Personal Income Tax Liabilities, December
                        8, 1986.

                        Page 23                                              GAO/H&D-go-34FederalState-Local Relations
                                    Chapter 2
                                    Federal Budgetary Retrenchment Increased
                                    the State Role in the
                                    Intergovemmental System

Figure P.5: Qrowth in State-Local
RevenjCes, Excluding Federal Aid
(1978.8p)                           750    Doll8ro   In   8lllion8




                                            1978          1979       1980   1981     1982      1983       1984      1985    1986   1987

                                    Source: ACIR, Significant Features of Fiscal Federalism, 1989 Edition, vol. I, p, 13.

                                    Our examination of trends in state aid to local governments during this
                                    period showed that states were most apt to make up losses of federal-
                                    local aid in programs that already were within their traditional domains
                                    or in which they previously had made significant financial or political
                                    commitments. Moreover, the replacement of federal aid and the growth
                                    of state and local revenues were often linked to the strength of state and
                                    local economies. For example, in Massachusetts, where the economy was
                                    strong during most of the past decade, local governments looked to the
                                    state for increased assistance when federal revenue sharing funds
                                    lapsed, and the state responded in 1987, partially offsetting the loss
                                    with state funds. However, 2 years later, when Massachusetts expe-
                                    rienced a budget crisis, this aid was cut substantially.

                                    Communities in states that were economically depressed during the past
                                    decade were less fortunate. For example, Texas made no effort to com-
                                    pensate local communities when federal revenue sharing was termi-
                                    nated. While the loss of these funds was only one contributing factor, in
                                    1987, fiscal pressure forced 58 percent of Texas cities to raise user fees,
                                    47 percent to postpone planned capital construction projects, 45 percent
                                    to raise property taxes, 15 percent to lay off employees, and 10 percent
                                    to reduce services. Nearly 57 percent of these communities collected less

                                    Page 24                                                 GAO/HRDW-34 Federal-State-LocalRelations
chapter 2
Federal Budgetaxy Retrenchment Increased
the State Role in the
Intergovernmental System

revenue in 1987 than projected, and 43 percent anticipated even lower
revenues in 1988. As would be expected, the most common strategy for
coping with fiscal problems was to defer capital projects, including those
required to maintain current service levels. So much so that, by one esti-
mate, in 1987 Texas had an $8 billion backlog of such projects with an
additional $8 billion projected by 1992.g

“Texas Municipal League, “Capital Spending in Texas Cities,” August 8, 1988.

Page 25                                            GAO/~9034        FederalStHehcal   Relations
Cha$ter 3

           in Federal RegulationLessenedState
      cretion but Not Responsibility

                      Federal budget cuts broadened the role of the states in the intergovern-
                      mental system. In contrast, trends in federal regulatory activities over
                      the past decade lessened state discretion without reducing state respon-
                      sibility. By the late 197Os, the growth of intergovernmental regulation
                      had increased fiscal tensions between federal and state and local gov-
                      ernments significantly. An important part of the Reagan administration
                      strategy to reduce the federal role in the intergovernmental system was
                      to limit regulation of state and local governments as well as the private
                      sector. Anticipating a reduction in regulatory relationships, the adminis-
                      tration also deemphasized intergovernmental grants and traditional
                      grant management techniques designed to create intergovernmental
                      cooperation and consultation. Yet the effectiveness of administration
                      efforts was negated by increased state and local responsibilities stem-
                      ming from added program standards and administrative requirements
                      created during the 1980s and by reduced levels of federal aid for state
                      and local oversight and administration of regulatory programs. Coupled
                      with new federal preemptions of state authority in some policy areas,
                      the overall pattern has been more federal involvement with less finan-
                      cial support.

                       $ince the passage of the first annual cash grant to states under the
Past Growth and New   ‘Hatch Act of 1887, the federal government has regulated various state
Forms of               and local government activities by attaching program and administra-
Intergovernmental      tive requirements as conditions of intergovernmental aid. The rapid
                       expansion of grants and grant requirements in the 1960s and 1970s led
Regulation             every president since Lyndon Johnson to make efforts to improve the
                       management of this system. Meanwhile, other kinds of regulatory rela-
                       tionships blossomed during the 1960s and 1970s and gained attention.’
                       In particular, as part of its own stepped-up agenda of social regulation,”
                       the federal government enlisted state and local governments in national
                       efforts on behalf of particular disadvantaged groups or to advance poli-
                       cies, such as environmental protection. In addition to the use of program
                       and administrative regulations issued as direct or indirect conditions of

                      ‘See ACIR, Regulatory Federalism: Policy, Process, Impact and Reform (Washington, DC.: U.S. Gov-
                      ernment Printing Office, February, 1984).

                      “As noted in George C. Eads and Michael Fix, Relief or Reform? Reagan’s Regulatory Dilemma (Wash-
                      ington, DC.: Urban Institute, 1984), p. 12, the term “social regulation” is widely applied to the set of
                      federal programs that *‘use regulatory techniques to achieve broad social goals such as a cleaner
                      environment, equal employment opportunity, or safer and more healthful workplaces.” In contrast,
                      “economic regulation” refers to programs that “attempt to control prices, conditions of market entry
                      and exit, and conditions of service,” usually in particular industries where activities affect the public
                      interest. Nearly all social regulatory programs involve a partnership between national and state or
                      local governments, while programs of economic regulation generally do not.

                      Page 26                                               GAO/HRD-90-34Federal-State-LocalRelations
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                  Trends in Federal Regulation LessenedState
                  Discretion but Not Responsibility

                  aid, other devices used during the past decade have included preemp-
                  tions, in which federal policies and standards supercede state and local
                  ones, and direct orders, in which the national government directly
                  orders states and local governments to take certain courses of action.”

                  The Reagan administration attempted to slow the growth of social regu-
                  lation and reduce regulation of states and localities and the private sec-
                  tor. Upon taking office in 1981, the administration froze all pending
to Decentralize   rulemakings, and the President created a task force on regulatory relief
                  to eliminate or modify the most burdensome regulations. Finally, presi-
                  dential review of agency rulemaking was strengthened in 1981, and
                  mechanisms for the Office of Management and Budget (OMB) involve-
                  ment in agency regulatory planning were instituted in 1985, both by
                  executive orders4 These undertakings applied equally to all executive
                  branch rulemaking activities, including those affecting state and local

                  With respect to regulation affecting states and localities in particular,
                  the Reagan administration was the first in recent years to make system-
                  atic efforts to reduce the number of regulations and their costs. Among
                  other administration actions, the Presidential Task Force on Regulatory
                  Relief canvassed state and local governments specifically, generating a
                  long list of regulations these groups perceived to be onerous. Eventually,
                  24 actions were taken to reduce state and local burdens. According to
                  White House estimates, these saved $4-6 billion in total investment costs
                  and $2 billion in annually recurring costs.

                  The administration also directed agencies to examine the intergovern-
                  mental impacts of proposed regulations in 1981, as part of its general
                  guidance on agency rulemaking. In the case of the OBRA block grants, the
                  administration worked to minimize the regulations attached to these,
                  reducing some 600 pages of program rules and regulations under the

                  aACIR’s typology of intergovernmental regulations includes full and partial preemptions, direct
                  orders, indirect conditions of aid comprised of crosscutting and crossover regulations, and direct con-
                  ditions of aid. For our analysis we grouped partial and full preemptions under the heading of preemp-
                  tions and direct and indirect regulations under the heading of regulatory requirements. These
                  techniques are described in detail in ACIR, Regulatory Federalism: Policy, Process, Impact and
                  Reform (Washington, DC.: U.S. Government Printing Office, February, 1984) ch. 1.
                  41n lQ81 Executive Order 12291 was issued, creating a system of presidential oversight of agency
                  rulemaldng. In 1986, Executive Order 12498 was issued, creating a system of presidential oversight
                  of agency regulatory planning. For a description of these two programs see Marshall Goodman and
                  Margaret Wrightson, Managing Regulatory Reform: The Reagan Strategy and Its Impact, (New York:
                  Praeger Publishers, 1987) pp. 38-46.

                  Page 27                                              GAO/HRD-9034 Federal&ate-Local Relations
                          Trends In Federal Regulation LessenedState
                          Discretion but Not Besponslbility

                          folded-in categorical grants to less than 10. In 1985, the White House
                          renewed its review of existing rules, this time working directly with the
                          National Governors’ Association (NGA) to identify burdensome regula-
                          tions and revise them.

                          At the same time, the administration deemphasized traditional intergov-
                          ernmental management mechanisms (e.g., intergovernmental review and
                          consultation procedures for coordinating grant programs), especially at
                          OMB. Thus, in 1981, the Intergovernmental    Affairs Division of OMB had
                          21 staff members, By 1984, this division was eliminated and its respon-
                          sibilities divided among other OMB offices. The Administration also
                          stopped work on a proposed OMB circular to manage so-called crosscut-
                          ting regulations that apply to all federal grants-in-aid. Moreover, it
                          rescinded OMB Circular A-95, which provided for intergovernmental
                          advance notice and comment on intergovernmental grant and regulatory
                          programs. This circular was replaced with a decentralized process of
                          review and comment, to be managed by the states. Finally, the adminis-
                          tration made staff cuts in intergovernmental affairs’ offices across exec-
                          utive branch agencies.

                          In retrospect, the administration was unable to reduce significantly the
                          number of regulations affecting state and local governments or to sub-
                          stantially simplify regulatory programs. Thus, while the statutory objec-
                          tives governing the regulatory system remained largely unchanged, the
                          mechanisms for intergovernmental cooperation in the management of
                          this system were reduced as a result of administration actions.

                          Notwithstanding these administration efforts to reduce regulation of
Regulation Increased,     state and local governments, intergovernmental regulation increased
Funding Was Cut           over the past decade, but the growth of regulatory requirements and
                          preemptions was most notable. Conversely, funding for state and local
                          government administration and oversight of regulatory programs was

Reghlatory Requirements   In a review of 18 major areas of regulation affecting state and local gov-
Increased                 ernments, we found that the number of regulations increased in most of
                          these areas between 1981 and 1986. Other studies of intergovernmental
                          regulation have come to similar conclusions and also pointed to the often
             ”            prescriptive character of the new rules and requirements. Overall, state
                          and local governments became subject to hundreds of new program
                          standards and administrative requirements. Thus, during the period we

                          Page 28                                      GAO/HRD-90-34Federal&ate-Local Relations
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   DLecretionbut Not Responsibility

   examined, states became subject to federal mandates in a wide variety
   of areas, including education, construction projects, health and safety,
   aged and handicapped rights, and penal institutions, The following are
   examples of changes affecting state and local governments.

   Clean Water: municipalities are now required to monitor “nonpoint” pol-
   lution from thousands of storm sewers and to implement testing for 77
   additional chemicals in municipal water supplies. In 1986, the Congress
   added 83 new drinking water contaminants to be controlled by local gov-
   ernments under the Safe Drinking Water Amendment of 1986.
   Education: school districts were required to identify asbestos hazards
   and then to remove them from local schools.
   Clean Air: the Congress modified requirements in the Clean Air Amend-
   ments of 1977. In response to these amendments and court decisions, the
   Environmental Protection Agency (EPA) reinstated emission standards
   for asbestos control in 1984 in the areas of provisions for spraying,
   fabricating, and insulating materials as well as for demolition and
   Endangered Species: 152 new species were added to the endangered and
  threatened lists. These additions required states to prepare status
  reports on each newly added species and also assigned states monitoring
  and enforcement responsibilities for protecting these species.
  Consumer Safety: the Department of Agriculture (USDA) created new
  requirements affecting the entry of packaging materials to meat
  processing plants across the entire meat processing industry. Also new
  procedures for inspection, tagging, and retention of cattle and for
  inspecting for contaminants were created. These affected states because
  under title III of the 1967 .Wholesome Meat Act states have inspection
  and enforcement responsibilities.
. Occupational Health and Safety: state monitoring and enforcement
  responsibilities were affected by Occupational Safety and Health
  Administration actions requiring businesses and industries to establish
  and maintain hearing conservation programs, ethylene oxide exposure
  protection and asbestos protection programs, standards for the use of
  electricity at construction sites, and a safety program for organizations
  that respond to environmentally hazardous situations.
. Transportation: after much controversy, in 1984 President Reagan
  signed legislation that required states to adopt a minimum drinking age
  for alcohol of 21 years old or face reductions of 10 percent in federal
  highway aid in 1987.

  At the same time, federal funding for administration and oversight in
  many of the areas of social regulation declined. Federal grants for

  Page 29                                       GAO/HRD90-34 FederalStateLocal Relations
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                                          Discretion but Not Responsibility

                                          administration and oversight in some areas, such as bilingual education
                                          and clean air programs, declined by nearly 37 percent in constant dol-
                                          lars between 1978 and 1988, as shown in table 3.1.

Table ‘-1: AdministratIon and Oversight
Budge s, Selected intergovernmental                                                                                                    1978-l 988
Regul tory Pro rams (Fiscal Years 1978-                                                                                               Percentage
88) (Co,
      I stant 19‘152 Dollars)                                                                             1978              1988          change
                                          Handicapped education                                       $645,788       $1,159,269                   79.5
                                          Safe drinking water                                           37,975            56,431                  48.6
                                          Clean air                                                     93,108           125,384                  34.7
                                          Occupational safety and health                               195,129           182,920                 -6.3
                                          Bilingual education                                          189,565           112,792                -40.5
      I                                   Surface mining                                               115,162            62,163                -46.0
                                          Clean water (total)                                        4,578,094         2,085,645                -54.4
                                          Direct assistance                                          4,482,173         1,964,423                -56.2
                                          ‘For any given year, totals may vary due to change in the number of state administering   programs.
                                          Source; Office of Management and Budget, United States Budget.

Preemptions Increased                     The Congress has broad authority through, for example, the commerce
                                          and supremacy clauses of the Constitution, to preempt state and local
                                          laws and ordinances. Traditionally, this authority has been applied to
                                          areas of economic regulation, although examples of preemption in social
                                          policy areas ntay also be found. In the category of economic preemp-
                                          tions, the Airline Deregulation Act of 1978 stipulated that state and
                                          local governments may not regulate the routes, rates, or services of air
                                          carriers. The Motor Carrier Act of 1980, which deregulated the trucking
                                          industry, and the Bus Regulatory Reform Act of 1982, which deregu-
                                          lated the busing industry, contained similar preemptions. ACIR examined
                                          trends in preemption statutes and found that in every area except bank-
                                          ing and civil rights federal preemption was on the rise in the 198Os, as
                                          table 3.2 shows.

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                                          Trends in Federal Regulation LessenedState
                                          D&wreUonbut Not Responsibility

Tablej3.2: Federal Preemption Statutes,
by Dafe of Enactment                                                                                           Health and
                                          Date                       Civil rights    Money         Business        safety      Other     Total
                                          Before 1900                           4           l             9                1         l       14
                                          isoo-1909                              .          .             6               3          l           9

                                          1910-1919                              .         1              8               3         3        15
                                          1920-1929                              .         1              8               4          l      13
                                          1930-1939                              .         8             27               2         4       41
                                          1940-l 949                             .         1              8               4         1       14
                                          1950-1959                             1          3             11               3         1       19
                                          1960-1969                             8          3              8              19         1       39
                                          1970-1979                            13         15             20              45         2       95
                                          1980-1988                             8          8             22              50         3       91
                                          Total                                34         40            127             134        15      350
                                          Source: ACIR, Federal Preemption of State and Local Authority (Washington, DC.: ACIR draft document,
                                          May 1989, Appendix A, Inventory of Federal Preemption Statutes),

Direct Orders Increased                   Direct orders issued by the federal government must be complied with
                                          by state or local governments or both under threat of civil or criminal
                                          penalties. While these kinds of direct orders are not common, over the
                                          past decade the federal government has issued new ones. For example,
                                          in 1979, the Department of Labor extended Fair Labor Standards Act
                                          regulations to state and local government employees. In 1985, these reg-
                                          ulations were upheld by the Supreme Court in Garcia v. San Antonio
                                          Metropolitan Transit Authority (see app. I).

                                          Page 31                                               GAO/HRD-90-34Federal-State-LocalRelations
InqreasedState Prominencein DomesticAffairs:
PMgressand Prospects

                                  Intergovernmental relations have changed significantly over the past
                                  decade as states increased their prominence in domestic affairs. The
                                  states have progressed from a period in which they were sometimes dis-
                                  missed as mere administrative agents of the federal government to a
                                  period in which they are touted as key innovators. They stand on the
                                  threshold of the 1990s as highly visible leaders in a broad range of pol-
                                  icy areas where the federal government was once seen as peerless.

                                  There are a number of reasons for this transformation. First, states
                                  improved their capacities by modernizing their institutions and adminis-
                                  trations and strengthening their revenue systems. Second, federal
                                  budget cuts, tax cuts, and block grants accelerated the rising role of
                                  state government in domestic policy in contrast to federal retrenchment.
                                  Finally, beginning in 1983, sustained economic growth helped to rebuild
                                  state treasuries, providing revenues to fund new initiatives.

                     During the past decade, states broadened their agendas and addressed
StaticAgendas Are    their social and economic needs in innovative ways. Not all state actions
Brobder and Programs have been uniform. However, many states have been active, and state
Mor’eInnovative      leadership is now widely recognized and reported. Examples of such
                     leadership include the following, from both traditional and nontradi-
                                  tional state functions.

                              lInternational Trade: State delegations, often headed by governors, now
                               routinely travel to meet with foreign business leaders to secure new
                               markets and solicit investment. Not all such efforts are ad hoc. By a
                               recent NGA count, 41 states maintained offices in 24 countries world-
                               wide. In fact, by 1989, there were more state offices in Japan (39) than
                               there were in Washington, D.C. (38).
                             . The Environment: At least 29 states have implemented their own
                               Superfund programs and others have created commissions, such as the
                               Chesapeake Bay Commission, to protect and restore the environment.
                             . Housing: States, such as Massachusetts, have established a trust fund,
                               creating a pool of capital for low- and moderate-income housing. Others,
                               including New York, have formed public-private partnerships to achieve
                               these same ends.
                             l Economic Development: Texas has created a Department of Commerce
                               to encourage and coordinate efforts among both public and private insti-
                               tutions with a stake in Texas’ economy. To combat urban economic
                               decline, Pennsylvania has created a regional consortium of labor-
                               management committees to improve cooperation, heighten labor’s role in

                                  Page 32                              GAO/HRD-W-34FederalState-Local Relations
                          Chapter 4
                          Increased State Prominence in Domestic
                          AfMrsz Progressand Prospecta

                           industry decision making, and increase productivity. Michigan has cre-
                           ated a public venture-capital fund; using 5 percent of the state’s public
                          pension funds, this development fund promotes new business and eco-
                          nomic enterprises. Arkansas has experimented with a development bank
                          in its efforts to counter rural economic decline. Altogether, 13 states
                          have venture- capital programs, 30 have established business loan
                          funds, and 31 have created research grant programs to encourage eco-
                          nomic development.
                          Growth Management: Florida has enacted legislation aimed at ensuring
                          that adequate infrastructure exists to meet the demands of rapidly
                          growing communities.
                          Health Care: Arizona is experimenting with the use of health mainte-
                          nance organizations to provide quality health care to the poor under the
                          Medicaid program, while also holding down health care costs.
                          Education: States across the nation and especially in the South have
                          taken measures to improve their primary and secondary systems. They
                          are raising performance standards; allocating more funds; reducing fis-
                          cal disparities; and establishing new modes of delivery, such as
                          expanded parental choice and specialized curricula.

                          This record of state action was in large part made possible by a much
Improved State            longer history of improving state governmental capacities. Since World
Capacities Contributed    War II, states have made substantial progress in modernizing their insti-
to State Prominence       tutions and administrative procedures and they have improved their
                          revenue systems. Among other things, these improvements helped state
                          revenues remain fairly stable over the past decade, holding a constant
                          share of overall economic activity. At the same time, state spending
                          increased and expenditure patterns changed. In part, these differences
                          reflect changing state priorities. But they also reflect shifts in national
                          policy and federal court actions.

States Modernized Their   Having surveyed the administrative, fiscal, and political condition of the
Institutions and          states, in 1985, ACIR concluded that they had been “transformed” over
                          the previous 25 years. According to the commission, an examination of
Administration            state “constitutions, legislatures, governors, executive organization
                          structures, courts, personnel, budgeting, financing, and financial admin-
                          istration and openness all attest to this.” In particular, four-fifths of all
                          constitutions were revised between the mid-1960s and 1977. By 1986,
            *             state policymaking was more centralized in the governor’s office
                          because 37 states created cabinets and because many reduced the
                          number of elected state administrative officials. State administrators

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                          Chapter 4
                          Increased State Prominence in Domestic
                          Affidm Frogress and Prospects

                          are better educated, with 61 percent holding graduate degrees in 1984,
                          compared with 40 percent 20 years ago. ACIR evaluated state legislatures
                          against 73 recommendations made by the Citizens’ Conference on State
                          Legislatures in 1970 to improve functionality, accountability, represen-
                          tativeness, and independence. Thirty-eight of 43 recommendations for
                          which assessments existed had been adopted by a majority of state leg-
                          islatures. Finally, courts in almost all states underwent changes to
                          improve the quality of judges, administration, and structure.l

States Improved Their     Along with modernizing governmental institutions and administrative
RevenueSystems            processes, nearly all states improved their revenue systems, sometimes
                          substantially. In addition to reflecting state-based initiatives, these
                          changes also may be seen as a response to factors outside the immediate
                          purview of state government, notably the tax revolt of the late 197Os,
                          back-to-back national recessions in the early 198Os, a 16-percent decline
                          in federal grants-in-aid, and the passage of federal tax reform in 1986
                          (see app. I). Overall, during the past decade two general trends in reve-
                          nues can be identified: a diversification and balancing of state revenue
                          systems and a mixture of tax increases and decreases producing little, if
                          any, net change in total revenues as a percentage of personal income.

Balancing State Revenue   Since 1961, many states have turned to new kinds of taxes, as shown in
Systems                   table 4.1, Such diversification is viewed as one way to strengthen tax
                          systems because governments become less reliant on any one source of
                          tax revenue.

                          ‘ACIR, The Questions of State Government Capability, A-98 (Washington, DC., U.S. Government
                          Printing Office, 1986).

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                                           Chapter 4
                                           Increased State Prominence in Domeetic
                                           AfYahx Progressand Pro~pecta

Table 4-l: Adoption of Major Taxes Since
1961 /                                                                                                         Additional states
                                           Tax                                                                       levying tax’                Total
      I                                    Personal income                                                                        11               --40
                                           Corporation incomeb                                                                     9                44
      I                                    Sales                                                                                  10                45
                                           Gasoline                                                                                0                50
                                           Cigarettes                                                                              3        -___-- 50
                                           Distilled sDiritV                                                                       0                33
                                           aThree additional states levy a tax on capital gains, interest, and/or dividends only. Alaska repealed its
                                           income tax in 1979.

                                           bMichigan repealed its corporate income tax in 1976 and replaced it with a single business tax

                                           ‘Exclusive of the excises by the 16 states that own and operate liquor stores, and exclusive of North
                                           Carolina where county stores operate under state supervision.
                                           Source: ACIR, Significant Features of Fiscal Federalism, 1988 Edition.

                                           An important consequence of this activity was that personal income
                                           taxes-which    are regarded as the most progressive-now       comprise a
                                           larger share of total tax revenues than was true historically. In 1987,
                                           these taxes were $2.16 per $100 of personal income whereas in 1978,
                                           they were $1.82, as figure 4.1 shows.

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                                        Chapter 4
                                        Increased State Prominence in Domestic
                                        AfTairs: Progressand Prospects

       State Personal Income Tax
    88 Per $100 of Pewonal Income
                                        2.S    Dollam   nor $190 Dollam     of Parsonal   Income



                                        1 .o
                                               1970          1979    1990          1981       1992     1993    1994    1985    1996
                                               Fiscal Year

                                        Source: Steven D. Gold, State Finances in the New Era of Fiscal Federalism, National Conference of
                                        State Legislatures, March, 1989.

                                        During the past decade states have also turned to nontax sources as
                                        alternatives to raising tax revenues. These included user fees, lotteries,
                                        special assessments, and increased interest earnings from improved cash
                                        management. As a result, in 1986, nontax revenues comprised a larger
                                        share of state-local own source revenue than was true in 1978. In fact,
                                        between 1975 and 1986, these revenues rose from 3.5 to 4.7 percent of
                                        personal income.

Reforming Income Taxes                  Not only did states diversify their revenue systems over the 1978-88
                                        period, they also took steps to reform their income tax systems. As of
                                        1987, the combination of federal tax reform and the recommendations
                                        of state tax commissions had produced what one observer called a “bliz-
                                        zard” of actions, ranging from modest changes in tax rates and base-
                                        broadening to wholesale restructuring. Such reforms have:

                                    l   made state income taxes more progressive by removing many working
                                        poor from state tax rolls,

                                        Page 36                                                      GAO/IiRD90-34 FederalState-Local Relations
                       Chapter 4
                       Increased State Prominence in Domestic
                       Affainx Pro@essand Proupecta

                   . simplified state income taxes by increasing conformity with federal pro-
                     visions and by eliminating many taxpayers from the roles or the ranks
                     of itemizers,
                   . provided for more equal treatment of taxpayers with similar incomes,
                   l improved the competitiveness of state tax systems through rate reduc-
                     tions in the highest tax states.2

RevenuesRemained       Diversification of state revenue systems and income tax reform did not
Conftant               cause the state-local sector to increase its share of overall state eco-
                       nomic activity during the past decade. Instead, total revenues held their
                       own at about 14 percent of personal income in 1986. Constancy was the
                       norm because while nontax revenues increased, tax revenues declined.
                       In particular, in 1978-the year Proposition 13 was passed-state-local
                       tax revenue was $12.08 per $100 dollars of personal income (see fig.
                       4.2.). But, during the next 5 years- a period in which the political
                       impacts of the tax revolt became apparent and in which two national
                       recessions occurred-the      level of these same revenues dropped to
                       $10.59 by 1982, Thereafter, revenues rebounded, in part due to tempo-
                       rary tax hikes and in part to sustained economic growth since 1983. As
                       a result of these factors, by 1987, tax revenues had made up about one-
                       half of their earlier decline, as figure 4.2 shows.

                       “Steven D. Gold, “The Blizzard of 1987: A Year of Tax Reform Activity in the States,” Publius 18
                       (Summer, 1988), pp. 17-36.

                       Page 37                                            GAO/HRD-90-34FederalState-Local Relations
                                          Chapter 4
                                          Increased State Prominence in Domestic
                                          Af-faim Progressand Prospects

Figur4 4.2: State and Local Tax Revenue
Per $l/OOof Personal Income (1978-87)
                                           15    Dollam

     I                                     14


                                          12 -





                                                 1978       1979    1999      1981     1982      1983      1984      1995     1988      1987
                                                 Flacal   Yearn

                                          Source: Steven D. Gold, State Finances in the New Era of Fiscal Federalism, National Conference   of
                                          State Legislatures, March 1989.

                                          Not all states and communities participated to the same extent in the
                                          national economic recovery. As a result, aggregate revenue patterns
                                          described in this chapter can mask important differences among states
                                          and communities, with some governments enjoying substantial increases
                                          and others experiencing very little. These differences notwithstanding,
                                          with respect to changes in state revenue systems overall, the past dec-
                                          ade has been one in which states have moved away from a strategy of
                                          “putting their eggs in one basket.” In so doing, they strengthened their
                                          revenue systems by lessening dependence on any one source of tax reve-
                                          nue and by exploiting more sources of nontax revenue. At the same
                                          time, while state and local tax and nontax revenues (as a percentage of
                                          personal income) increased during the most recent 5-year period, these
                                          increases have not yet returned revenues to their 1978 levels when
                                          expressed as a proportion of overall economic activity.

State Spending Patterns                   State spending followed a path similar to that of state revenues,
                                          although, by 1987, spending had slightly exceeded the rate of economic
Changed      v                            growth over the period. Exclusive of federal aid, state spending was

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                                          Chapter 4
                                          Increased State Prominence in Domestic
                                          Affairs: Progressand Prospecta

                                          $8.12 per $100 of personal income in 1978, compared with $8.77 in
                                          1987, as figure 4.3 shows.

Figur 4.3: State Spending Per $100 of
PersoI al Income, Excluding Federal Aid
                                          9.0   oollsrs

       I                                  8.6











                                                 1979     1979      1980      1981     1982      1982      1984      1988     1988      1987

                                          Source: Steven D. Gold, State Finances in the New Era of Fiscal Federalism, National Conference of
                                          State Legislatures, March, 1989.

                                          Examining differences within categories of spending, the overall
                                          increase in the decade is the product of large gains in two categories of
                                          spending, Medicaid and corrections. In 1978, states spent 38 cents per
                                          $100 of personal income to meet their share of Medicaid costs. In 1987,
                                          this same figure was 58 cents. Similarly, in 1978, states spent 21 cents
                                          per $100 of personal income for criminal justice and law enforcement, in
                                           1987, they spent 33 cents. Much of this growth can be explained by fac-
                                          tors outside the purview of states. With respect to Medicaid, for exam-
                                          ple, high rates of inflation were at work as well as federally mandated
                                          changes in eligibility and coverage. With respect to criminal justice and
                                          law enforcement, fast-paced growth is the product of more stringent
                                          state sentencing policies, but also of federal court mandates to relieve
                                          inmate crowding and improve prison conditions.

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                          chapter 4
                          Increased State Prominence in Domestic
                          Affairs: Progressand Prospects

                          In summary, the relative stability of overall state spending obscures the
                          more uneven pattern across areas of state budgets. Some of these differ-
                          ences reflect state priority setting, as in the case of education. But they
                          also reflect changes in outside factors, principally economic cycles and
                          federal policy actions. Lastly, state spending trends should be viewed
                          with some caution. Variations exist among states, And, as experts we
                          interviewed noted, spending is not the only way states affect domestic
                          policies. Indeed, many of the innovations described in this chapter illus-
                          trate the impacts that can be made from improvements in management
                          or changes in the manner in which services are delivered.

                          Improved state institutional and administrative capacity was not the
National Policy           only factor contributing to the rising role of the states in the intergov-
Ditiections Contributed   ernmental system. Two national policy trends accelerated this process.
to State Prominence       First, cuts in federal aid and reduced tax revenues limited the federal
                          government’s ability to undertake new initiatives or to maintain federal
                          commitments in existing ones (see app. I). Second, and equally impor-
                          tant, was the Reagan administration’s philosophy of greatly increasing
                          the states’ role in the intergovernmental system. This philosophy was
                          put into action through a few highly publicized initiatives-notably
                          block grants and regulatory relief- as well as through a number of less
                          visible administrative measures,

Block Grants              An important step taken by the Reagan administration was its initiation
                          of the block grants created in the Omnibus Budget Reconciliation Act of
                          1981. Although block grants comprised only about 10.5 percent of total
                          intergovernmental aid in fiscal year 1989, they give greater program
                          authority and responsibility to states. At the time OBFtA was passed,
                          there were concerns about the abilities of states to implement these pro-
                          grams prudently. However, to a great extent, the states were able to rely
                          on existing state systems for management of the block grants. And sub-
                          sequent studies of the implementation of these programs, including ours,
                          have been generally favorable.

Regulatory Relief         A second Reagan administration effort was to reduce regulatory burden
                          on states and localities as described more fully in chapter 3 of this
                          report. In this area, intergovernmental initiatives were part of a larger
               Y          administration effort to reduce social regulation through greater presi-
                          dential oversight of rulemaking. Among other actions, the administra-
                          tion created a task force to identify and revise a number of the most

                          Page 40                                  GAO/HRD-90-34Federal&ate-Local Relations
                       Chapter 4
                       lncreaaed State Prominence in Domestic
                       Affalm Fro@wssand Prospecta

                       burdensome federal regulations. In particular, the administration
                       responded positively to an effort by the nation’s governors to bring
                       what they perceived as meddlesome regulations to the federal govern-
                       ment’s attention. The President created a process of presidential over-
                       sight of proposed and planned executive branch agency regulations,
                       including those that affect state and local governments.

                       As chapter 3 also showed, the results of these efforts were mixed; in
                       some cases relief was achieved, especially where there was agreement
                       between the administration and state and local officials about appropri-
                       ate courses of action. This included, for example, speeding delegation of
                       authority to states in many environmental programs. In other cases,
                       efforts failed to bring relief, especially where there was disagreement
                       between levels of government or substantial opposition from other inter-
                       ested groups.

Other Administrative    Finally, there was a series of less visible executive actions that were
Means                   designed to change the tone of the relationship between state and fed-
                        eral governments. In 1983, the President issued Executive Order 12372
                        requiring federal agencies to make efforts to accommodate state and
                        local government recommendations concerning federal programs in their
                       jurisdictions. This order, which revoked OMB Circular A-96, effectively
                       shifted the loci of review for some 100,000 grant applications to the
                       states by encouraging states to develop their own procedures and priori-
                       ties with respect to federal financial assistance, and requiring federal
                        agencies to defer to them whenever possible. Likewise, in 1988, the
                       basic circular for management of grants to states and localities, OMB Cir-
                       cular A-102, was revised to require agency reliance on state systems and
                       procedures for monitoring grants.

                       In addition, in 1987, the President issued Executive Order 12612. It
                       requires all federal agencies, among other things, to determine when a
                       proposed policy has implications for states and localities and to prepare
                       a federal assessment discussing such implications where they are

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                                            Chapter      4
                                            Increased State Prominence in Domestic
                                            Affibc      Pro@ese       and Prospects


                                            Like improved state capacity and shifts in national policy directions,
   ional and State                          national and state economic recovery from the 1982 recession contrib-
     omit Recovery                          uted to the increasing role of states in the intergovernmental system.
   tributed to State                        Sustained economic growth has provided state and local governments
                                            with important flexibility. The resulting rise in state revenues was a key
Prqninence                                  factor driving increased state spending. In fact, it allowed a number of
                                            states to reduce taxes without decreasing spending.

                                            While states diversified their revenue bases over the 197888 period,
                                            they remain highly dependent on sales and income taxes, sources that
                                            fluctuate with the economy. In 1986, income and sales taxes comprised
                                            nearly 87 percent of all state own-source revenue. Because most states
                                            balance their yearly operating budgets, economic cycles have significant
                                            short-run effects. As figure 4.4 suggests, during the past decade many
                                            states experienced generally flat sales and income tax collections in the
                                            aftermath of the 1982 recession,

Sales Tax Revenues (Fiscal Years 1978-86)
(CorMant 1982 Dollars)                      149      Dollam   In Bllllons



                                                     1979        1979                       1992       1993      1994      1995     1996
                                                     Fiscal Yearn

                                            Source: ACIR, Significant Features of Fiscal Federalism, 1988 Edition, vol. II, p. 60

                                            For example, sales tax receipts were generally flat from fiscal years
                                            1978 to 1984. The impact of this was immediately reflected in state
                                            budgeting. In fiscal year 1982,25 states cut budgets after enacting them.

                                            Page 42                                                 GAO/HRD-9034 FederalState-Local Relations
                                                          Chapter 4
                                                          Increased State Prominence in Dome8tic
                                                          Mfaim Progressand Prospects

                                                         In fiscal year 1983,39 states did so. State Policy Reports, a publication
                                                         monitoring state governmental fiscal policies, recently estimated that
                                                         states’ receipts would have decreased by $11 billion if a mild recession
                                                         were to have occurred in 1989, and by $22 billion in a severe recession.

                                                         States have attempted to protect themselves from the slower revenue
                                                         growth that would likely result from a recession by creating special
                                                         reserve funds. While 29 states have established such stabilization or
                                                         “rainy-day” funds that could be used if a recession or other event
                                                         caused state revenues to decline, reserves are not sufficient to weather
                                                         an economic downturn. Additionally, states’ year-end general fund bal-
                                                         ances were substantially lower as a percentage of general expenditures
                                                         in 1988 than in 1978, as figure 4.5 shows. As the figure also makes
                                                         clear, in both percentage and absolute dollar terms, fund balances fol-
                                                         lowed a ragged trend in the 198Os, but one that generally declined.

Figu+ 4.5: State Year-End Fund Balances (1978-88)













     flaoal Years

               Dollars in billions
               As a percentage of general expenditures

                                                         Source: State Policy Reports, vol. 5, no. 8, April 26, 1987, p. 5.

                                                         Page 43                                                  GAO/HRD-90-34FederalState-Local Relations
ChapterI 6

Trkmdsof the Past DecadeRaiseImportant
Is&es for Federal Policymakers

               Over the past decade, federal budget and regulatory trends have moved
               the intergovernmental system in different directions. While budget
               trends helped to elevate the states to the center of domestic policymak-
               ing and leadership, regulatory trends lessened state authority without
               reducing state responsibility. Both raise important issues for federal
               policymakers. As a result of the high degree of shared responsibility
               among federal, state, and local governments in the intergovernmental
               system, the success of federal domestic programs depends on an effec-
               tive partnership among these governments. Thus, federal fiscal and reg-
               ulatory trends that significantly affect states and localities also may
               have important implications for the federal government. Based on our
               review of these trends, we identified three emerging issues that have
               such implications.

             . First, the fiscal gap between wealthier and poorer states and localities
               has widened. Although the federal government depends heavily on the
               institutional and financial capacity of state and local governments to
               administer its grants-in-aid programs, over the past decade federal
               budget cuts helped to widen the fiscal gap between wealthier and poorer
               states and localities, This, in turn, is one warning sign that inequities in
               the levels of basic state and local public services (e.g., police, primary
               education, and infrastructure) may be increasing. It also may indicate
               that some communities lack sufficient revenues from their own sources
               to meet their share of federal program costs, thereby undermining
               national goals and objectives.
             . Second, tensions have mounted over the past decade as regulation of
               states and localities increased. The federal government depends heavily
               on the goodwill and cooperation of state and local governments to imple-
               ment its regulatory programs. Thus, it is in the federal interest for these
               governments to share federal objectives. States and localities should also
               be in overall agreement with federal program structure and manage-
               ment. Yet state and local officials we interviewed were disturbed by the
               growth and cumulation of federal mandates and regulatory require-
               ments. Over the same period, federal funding supporting the programs
               declined, and traditional management techniques used to create coopera-
               tion and consultation among levels of government atrophied, adding to
               these tensions.

               We believe that intergovernmental regulation plays a very useful role in
               the achievement of federal goals and objectives. Yet, we also believe
               that the cumulative effect of these increases-coupled with decreasing
               federal aid-ultimately   could force state and local governments to
               choose between meeting their service responsibilities and fulfilling

               Page 44                                GAO/HRD-90-34FederalState-Local Relations
                          Chapter 6
                          Trende of the Past DecadeRaise Important
                          Ieaueefor Federal Policymakers

                          national regulatory objectives, This kind of divergence in state and
                          national priorities is likely to reduce the effectiveness of these govern-
                          ments as agents of national regulatory policies, especially during periods
                          of economic decline. Given the importance of providing basic state and
                          local services and attaining federal regulatory objectives, neither situa-
                          tion would be asfactory.

                        . Third, fiscal and regulatory trends pose concerns for growing state lead-
                          ership. By the end of the decade we examined, states had reemerged as
                          principal domestic partners with the federal government and had
                          become policy leaders and program innovators in their own right. How-
                          ever, precisely because states occupy an increasingly central place in the
                          intergovernmental system, these trends may eventually place too much
                          fiscal pressure and program responsibility on states, especially during
                          periods when national or regional economies are weak. This, in turn,
                          might slow- or even reverse-the aforementioned progress.

                          Neither fiscal circumstances nor the need for public services are uni-
Federal Budget Trends     form across states and localities. Both vary, often so that communities
Exacerbated Growth        with the greatest needs have the least resources to meet them. Fiscal
in State and Local        disparities characterize the situation in which different jurisdictions
                          must tax their citizens and businesses at different levels to obtain simi-
Fiscal Disparities        lar amounts of revenue. These disparities-both      among states and
                          across localities-increased   during the past decade.

                          Per capita income is commonly used to measure fiscal disparities
                          because it captures revenue raising capacity and the relative ability to
                          bear tax burdens. Using per capita income to assess fiscal disparities,
                          figures 6.1 and 6.2 show that, after decreasing in the late 197Os, dispari-
                          ties among counties began to grow in the 1980s.

                          Page 45                                    GAO/HRD-90-34FederalState-Local Relations
                                          Chapter 6
                                          Trends  of the Past DecadeRak Important
                                          Issues for Federal Policymakera

Figutb 5.1: Number of Counties Above or
BeloG the Natlonal Per Capita Mean
                                          Numbor    of Countlos
Incode in 1979 and 1987

                                                   Below 70%               7950%              120-130%           Above   130%
                                                   Poroontage     of per Capita Mean Income

                                          Source: GAO calculations       based on U.S. Department of Commerce Bureau of Economic Analysis data.

                                          For example, figure 5.2 shows that the number of very poor counties
                                          (where per capita income was below 70 percent of the national average)
                                          rose from 711 to 871, a 22-percent increase. In contrast, the number of
                                          very wealthy counties (where per capita income was above 130 percent
                                          of the national average) rose from 54 to 72, a 33-percent increase. More-
                                          over, figure 5.3 shows that over the past decade the U.S. population has
                                          become increasingly concentrated in wealthier or poorer counties, with
                                          fewer people living in middle-income counties in 1987 than in 1977.

                                          Page 46                                                 GAO/HRD-90-34Federal-State-LocalRelations
                                            Chapter 6
                                            Trend8 of the Past Decade Raise         Important
                                            hues  for Federal Polkymakere

Figure 4.2: Population of Countlea,
Classiflied by County Per Capita Perronal
Income!as a Percentage of U.S. Per           Perwnl   of U.S. Population
Capita i ncome (1977-87)

                                            Percentages in the legend represent percentages     of the average per capita personal income for the
                                            United States.

                                            Source: GAO calculations       based on US Commerce Department Bureau of Economic Analysis data.

                                            The increases in disparities between wealthier and poorer communities
                                            are chiefly attributable to changing economic conditions, but reductions
                                            in federal grants-in-aid have exacerbated their impact because, by and
                                            large, grants have constituted a greater proportion of total revenues of
                                            poor communities than of wealthy ones. As a result, federal aid reduc-
                                            tions when expressed as losses in shares of total government revenues
                                            may be taken as an indicator that disparities are growing.

                                            Page 47                                                GAO/HRD-90-34Federal&ate-Local Relations
                          chapter 5
                          Trend@of the Past DecadeRake Important
                          Ieeueafor Federal Policymakers

                          There was a consensus among the state and local officials and experts
Stakeand Local            we interviewed that recent federal regulatory trends pose a problem to
Off6icialsand             their leadership. In particular, the expectation that regulatory require-
Int ’ rgovernmental       ments, mandates, and preemptions would accelerate was identified as an
                          important negative trend on the intergovernmental horizon. Not only did
Ex erts Believe           experts foresee accelerating financial burdens that would stem from
Re ulatory Trends         new federal requirements and mandates as problematic from the per-
Cai se Problems           spective of state and local fiscal systems, they also see the prospect of
                          nonconsultation in the design of programs as a counterforce to the prog-
                          ress of states as leaders and program innovators.

                          Yet the trend could continue for the following reasons:

                      .  Regulation of states and localities is a relatively easy strategy for the
                         federal government to use to achieve national objectives without
                         increasing federal fiscal commitments, and
                      . judicial protection against at least some forms of federal intervention
                         had been presumed to flow from the Tenth Amendment. But this was
                         laid to rest by the Supreme Court as a result of its recent holdings in the
                        Garcia v. San Antonio Metropolitan Transit Authority and South Caro-
                        lina v. Baker decisions (see app. I).

                          State and local officials and experts we interviewed told us that the bur-
                          den associated with all forms of federal regulation affecting state and
                          local governments has increased over the past 10 years. A number of
                          those we interviewed attributed some of the rise in intergovernmental
                          regulation to the fact that it provided federal policymakers an attractive
                          way to achieve national objectives without adding to the deficit. For
                          example, Governor Michael Castle of Delaware has concluded that-
                          through intergovernmental regulation -the Congress can shift the tax
                          burden for its decisions to the states, forcing them to be tax collectors
                          for federally mandated programs.

                          Those we interviewed also regard insufficient consultation in the design
                          of regulatory programs as a problem. With respect to formal mecha-
                          nisms, the decline of traditional management techniques that encourage
                          intergovernmental cooperation and consultation has most likely exacer-
                          bated the problem. While the Reagan administration regarded these
                          kinds of management tools as unnecessary given its plan for simplifying
                          intergovernmental relations, a streamlined system for such relations
                          was never achieved. As we found, the intergovernmental system was

                          Page 48                                  GAO/HRD-90-34FederaLStatehcal Relations
                     Chapter 6
                     Trenda of the Past DecadeRaise Important
                     Issues for Federal Policymakers

                     more complex in 1988 than in 1978. Thus, the abandonment of tech-
                     niques designed to promote consultation and cooperation in the develop-
                     ment and implementation of domestic programs seems premature.

                     Overall, there appears to be a growing paradox in the intergovernmental
                     system stemming from increased intergovernmental regulation. As one
                     intergovernmental expert we interviewed said, there is a perception of a
                     “state renaissance” on one hand, but a lack of “political respect” at the
                     national level for state authority on the other. This expert said that:

                     “The states are perhaps more qualified and professional than they have ever been,
                     yet simultaneously are treated worse at the national level.”

                     Out of its concerns about these trends, the National Governors’ Associa-
                     tion (NGA) has undertaken studies of how to address its “balance of
                     power” concern. While NGA identified a range of possible solutions,
                     many states are seeking a constitutional amendment to better protect
                     their role in the federal system. The association took the first step at its
                     August 1988 meeting by asking the Congress for an amendment that
                     would allow the states to initiate constitutional amendments without
                     calling a convention. This, NGA believes, would make the threat of consti-
                     tutional change more credible, in turn making the Congress more respon-
                     sive to state concerns. According to the association, such an amendment
                     would provide a new “check-and-balance” tool in lieu of institutional
                     protection accorded by the Court before the Garcia and South Carolina

                     By the end of the decade we examined, states had reemerged as princi-
Federal Budget and   pal partners with the federal government and domestic policy leaders
Requlatory Trends    and program innovators in their own right. Because heightened state
Could Adversely      prominence reduces dependence on the federal government and
                     enhances opportunities for domestic policy innovation and problem
Affect State         solving, it was viewed by those we interviewed as a positive develop-
Prominence           ment that should be encouraged. Moreover, in light of federal budgetary
                     pressures, it is in the federal government’s interest for states to play an
                     increasingly active role with respect to achieving national program
                     objectives. Clearly, if states are to progress further, however, maintain-
                     ing this momentum is important.

                     While progress can never be fully assured, the combination of federal
                     budgetary and regulatory trends described in this report appears to
                     pose a special concern to the rise of states as leaders and innovators for

                     Page 49                                    GAO/HRD-99-34FederalStatehcal   Relations
Chapter 6
Trends of the Paat DecadeRaise Important
Issues for Federal Policymakers

 the following reasons. First, the overall decline of federal aid and the
 reduction of grants-in-aid from the federal to local governments in par-
 ticular have put pressure on states to make up lost revenues, both in
 their own programs and in those administered by localities within their
jurisdiction. We expect these pressures to continue, or even accelerate,
 as the federal government pressures the states to help implement new
 federal programs to address domestic problems.

Second, with respect to the proliferation of regulations, state and local
officials and experts we interviewed rejected the adage, “You can’t get
too much of a good thing.” Instead, they cautioned that federal reliance
on unfunded regulation should be used judiciously in the future. It is
important for federal policymakers to consider the costs of such regula-
tions and how regulations promulgated at different points in time and in
different policy areas interact. Inadvertently, mixtures of conflicting
and overlapping regulations may reduce the flexibility of states to
deliver public services and administer federal programs,

Finally, economic circumstances are not uniform across states and local-
ities. Different conditions exist, making some states and regions more
vulnerable to this conflicting combination of federal budget and regula-
tory trends. And all states-by virtue of their vulnerability in times of
recession-face the prospect that an economic downturn may exacer-
bate the problem of meeting state-determined public service needs and
priorities while also responding positively to national grant and regula-
tory program goals and objectives. This, in turn, might slow-or even
reverse-state progress, progress that over the past decade has reduced
the dependence of states on the federal government, increased state sup-
port for local governments, and helped the federal government to
achieve its myriad domestic goals and objectives.

Page SO                                    GAO/HRD-90-34Federal&ate-Local Relations

    Page 61   GAO/HRLMO-34FederalState-M   Relations

A@;lkergovernmentail Events: 1978-88

                            During the 1978-88 period, two sets of events pulled the intergovern-
                            mental system in opposite directions and contributed to important
                            changes in its character. The first set is comprised of measures that
                            decentralized the federal system by narrowing the federal role and
                            broadening that of the states. At the outset, two events-the tax revolt
                            of the late 1970s and the election of Ronald Reagan as president in
                             1980-signified the arrival of a more conservative era in national poli-
                            tics and set in motion the process of federal retrenchment. Thereafter,
                            the passage of the Omnibus Budget Reconciliation Act of 1981, the Eco-
                            nomic Recovery Tax Act of 1981, the Gramm-Rudman-Hollings Act of
                            1986, and the Tax Reform Act of 1986 shifted greater responsibility for
                            financing and delivering public services to state and local governments.

                            During this same period, other factors pulled intergovernmental rela-
                            tions in the opposite direction and broadened federal authority over
                            state and local affairs. In areas of new or heightened public concern,
                            demands for national leadership sometimes led the federal government
                            to increase its role in domestic policy. In particular, new or lesser-used
                            tools of federal action were exploited in lieu of more traditional grants-
                            in-aid, notably preemption, regulation, and direct mandating of state
                            and/or local action. Moreover, two recent Supreme Court rulings deter-
                            mined that the Congress and national political processes, not the judici-
                            ary, should decide the balance of power between federal and state

-                           To begin chronologically, California’s Proposition 13, passed in 1978,
Proposition 13              limited property tax rates, thereby slowing the rate of growth of public
                            spending in that state. The passage of this citizen-based initiative was
                            significant for the intergovernmental system because it indicated public
                            support for more limited government.

                            The inauguration of President Ronald Reagan signaled the arrival at the
Election of President       national level of a chief executive committed to reducing the size and
Rbagan                      scope of government and to an intergovernmental system giving much
                            greater prominence to states and localities. In particular, his objectives

                        l   to shrink the role of all levels of government in comparison with the
                            private sector. To achieve this objective, the administration made strong
                            efforts to cut taxes, eliminate grant programs, deregulate areas of social
                            regulation, and privatize governmental functions.

                            Page 62                                GAO/HRD-90-34Federal-State-LocalRelationa
                          Appendix I
                          Key Intergovernmental Events: 1979-M

                     l   to return to a more “dual” form of federalism by stepping back from the
                         “cooperative” federalism that had evolved over the past 50 years. This
                         effort manifested itself in the elimination of federal intergovernmental
                         communication structures, revisions of federal guidance on regulations
                         and rules for managing federal aid, and the creation of block grants as a
                         substitute for categorical programs.
                     l   to devolve certain federal responsibilities to the subnational level. This
                         included successful efforts to end federal involvement in many regional
                         cooperation programs within and among states, to establish primacy for
                         states in social regulatory programs, and to reduce substantially federal
                         enforcement in these same programs. It also included the ill-fated 1982
                         welfare swap proposal,l which would have removed the federal govern-
                         ment from several significant income security programs.

                         Altogether, the Reagan administration employed four specific strategies
                         to achieve these objectives: budget cuts, tax cuts, block grants, and regu-
                         latory relief initiatives. And the President experienced moderate success
                         in these efforts. As a result, Reagan federalism strategies are evident in
                         other events of the decade identified as important in this report. They
                         are (1) the Omnibus Budget Reconciliation Act of 1981 (onn~); (2) the
                         Economic Recovery Tax Act of 1981 (ERTA); (3) the so-called Gramm-
                         Rudman-Hollings Act of 1985 (GRII); (4) the elimination of the General
                         Revenue Sharing program in 1986 (GRS); (5) the Tax Reform Act of 1986
                         (TRA); and (6) two Supreme Court decisions, Garcia v. San Antonio -.--.Met-
                         ropolitan Transit Authority (1986) and South Carolina v. Baker (1988).

                                                                                       ____l___l_--._                       -_-
                         In fiscal year 1981, there were some 538 separate federal grant pro-
Omnibus Budget           grams, prompting great concern among policymakers about how best to
Reconciliation Act       manage and control the system. One way, which gained support in the
(1981)                   early 1980s was to reduce the grant system’s size and complexity. Thus,
                         in 1981, legislation including the Omnibus Budget and Reconciliation Act
                         cut domestic spending by $35 billion, eliminating 59 grant programs and
                         consolidating nearly 80 narrowly focused categorical grant programs
                         into nine broad-based block grants. Significantly, many of grants elimi-
                         nated by OIW had been federal-local, while all the block grants created
                         by it were state-administered. The objectives of these efforts were (1) to

                         ’ IJndcr this proposal the federal government would have returned to the states full responsibility for
                         funding the Aid to ‘Families with Dependent Children and Food Stamp programs in exchange for the
                         federal assumption of state contributions to Medicaid. See Timothy Co&n, New Federalism: Inter-
                         @vornmontal Reform From Nixon to Reagan. (Washington, D.C.: The Brook= Institution, 1988), p.

                         Page 53                                              GAO/HRD-90-34Federal-State-LocalRelations
                        Appendix I
                        Key Intergovernmental Events: 1978-88

                        focus greater program responsibility at the state level; (2) improve ser-
                        vice delivery by fostering better integration of related federal and state
                        programs; and (3) save 26 percent over the cost of the folded-in pro-
                        grams by emphasizing the use of existing state administrative systems.
                        In retrospect, OBRAreduced the size and complexity of the intergovern-
                        mental grant system only marginally. Yet the passage of this act was
                        significant because it visibly enhanced the position of states in the fed-
                        eral system at the expense of localities, while also reducing federal
                        financial commitments in the programs eliminated or turned into block
                        grants by OBRA.

                        The Economic Recovery and Tax Act (ERTA) of 1981 reduced federal
E&non& Recovery         income tax collections from corporations and slowed the rate of growth
an@Tax Act (1981)       for individual income tax receipts. Without countervailing budget cuts,
                        however, the federal deficit began to grow dramatically in the aftermath
                        of this historic legislation. Tax losses associated with ERTA were esti-
                        mated to have been $294 billion by 1987, and this led directly to passage
                        of the Tax Equity and Fiscal Responsibility Act (TEFRA) in 1982. In retro-
                        spect, the passage of ERTA was a significant event in intergovernmental
                        relations because it reduced federal revenue-raising potential, which, in
                        turn, launched the present quest for cuts in all forms of discretionary
                        spending, including intergovernmental grants, loans, and tax subsidies.

                        The Balanced Budget and Emergency Deficit Control Act of 1985, better
Gramm-Rudman-           known as Gramm-Rudman-Hollings or GRH, established deficit-reduction
Hollings Act (1985)     targets for the federal government that were intended to force policy-
                        makers to balance the budget by 1992. Under GRH, if established targets
                        are not met, sequestration and subsequent across-the-board cuts occur
                        automatically. While there has been only one sequestration and GRH has
                        been weakened by amendment and statutory interpretation, the law is
                        an important event in intergovernmental relations. Gnu gains its signifi-
                        cance because, since its passage in 1985, legislators must, in effect, find
                        comparable budget savings to offset the federal costs of new programs.

                        In Garcia the Supreme Court ruled that state and local employees are
Garcia v. San Antonio      ~
                        covered by the federal Fair Labor Standards Act (FLU). In so doing, the
Metropolitan Transit    Court affirmed that Congress has broad power to regulate the wage and
Authority (1985)        hour laws of state and local employees. Of more general importance, the
                        Court overturned an existing precedent established in National League
                        of Cities v. Usery (1976) that-at least in areas of integral state and

                        Page 54                                 GAO/HRD-90-34Federal-State-LocalRelations
                     Appendix I
                     Key Intergovernmental Events: 1979-88

                     local operations -the Constitution prohibits direct federal regulation of
                     these governments. Perhaps most significantly, the Court officially
                     renounced its historical role of judicial umpire between the federal and
                     state governments with respect to claims of protection under the Tenth
                     Amendment, reserving for the states, or to the people, those powers not
                     delegated to the national government or constitutionally denied to the
                     states. Thus, Garcia is important for the intergovernmental system
                     because it firmly established the judicial principle that state and local
                     government participation in national political processes is the most
                     acceptable means of redress against unwelcome federal intervention.


                     As part of a successful effort to lower individual and corporate tax rates
The!Tax Reform Act   by broadening the tax base, the Tax Reform Act of 1986 eliminated the
of 1086              deduction for state sales taxes previously enjoyed by individuals who
                     itemize on their federal tax returns (TRA-86 left identical preferences for
                     income and property taxes untouched). The decision to eliminate the
                     sales tax deduction was controversial in a number of respects. Because
                     burdens fell disproportionately on states that rely heavily on sales taxes
                     for revenue, selective elimination was criticized as discriminatory. More-
                     over, because it constituted an incentive to alter the structure of state
                     and local taxation, selective elimination was viewed as an undue inter-
                     ference in state and local finance decisions. Finally, some state and local
                     officials feared that eliminating the sales tax deduction was only the
                     first step in a process that ultimately would end such deductions

                     TRA-86   also placed stricter limits on the use of tax-exempt bonds, espe-
                     cially private-activity revenue bonds. Not only did TRA-86 lower existing
                     limits on bond volume dramatically, to $50 dollars per capita issued per
                     year in most states, it also placed more categories of bonds in this
                     capped category. Finally, TRA-86 contained a substantial number of new
                     provisions designed to curb perceived abuses in public-private partner-
                     ships and in cash-management strategies regarded by the Congress and
                     the Treasury Department as schemes explicitly intended to generate
                     arbitrage.2 TRA-~~ changes are important for the intergovernmental sys-
                     tem for several reasons. Altogether, they raise the level of federal intru-
                     siveness in state and local finance significantly. In particular, the
                     restrictions of ~1~436 on the deductibility of state and local taxes are the

                     “Arbitrage is earned when states and localities invest bond proceeds in higher-yielding securities
                     before expending funds. For example, before passage of TRA-86 states and localities commonly
                     invested bond proceeds in higher-yielding securities during often lengthy capital project construction

                     Page 66                                              GAO/HRD99-34 Federal-State-LocalRelations

                         Key IntergovernmentaI Events: 1978-88

                         first since passage of the modern income tax in 1913. Moreover, ~~~-86's
                         bond reforms have restricted a primary source of capital at a time when
                         state and local governments are relied on more heavily to finance infra-
                         structure and other capital projects.

                         At one time, the general revenue sharing (GRS) program (enacted in
Elimination of General    1972) distributed virtually unconditional fiscal assistance to all 50
Revenue Sharing          states and about 39,000 general purpose local governments. The pro-
                         gram was eliminated for states in 1980 and for local governments in
    I                     1986. From an intergovernmental relations perspective, the termination
    ~                    of revenue sharing is significant for reasons related to its philosophy
    I                    and funding. While the program was sometimes criticized for giving
                         state and local governments too much discretion and federal budget def-
                         icits probably made it politically untenable, GRS had a number of com-
                         mendable features. First, the program made maximum use of
                         subnational administrative structures, making it among the most eco-
                         nomical of intergovernmental aid programs to administer. Second, GRS
                         had very few conditions attached to it, making it among the most flexi-
                         ble grants-in-aid. Finally, revenue sharing was moderately targeted at
                         the local level. GRS was one of only 29 programs that used income as part
                         of their allocation formulas.

                         The elimination of the local-government component of GRS in 1986 is
                         especially significant for intergovernmental relations because it further
                         reduced (and in the case of many very small towns and townships it
                         eliminated) federal-local grants. It is also an important event because in
                         some communities revenue sharing constituted a significant share of
                         total revenues-as much as 23 percent in some fiscally distressed
                         places. The loss of GRS forced many such governments to seek replace-
                         ment revenues or to reduce services.

                         In South Carolina, the Supreme Court affirmed its Garcia reasoning that
SoClthCarolina v.        states must seek protection from unwelcome federal regulation through
Balker, Secretary of     national political processes. As t,he majority opinion restated, the Court
the Treasury (1988)      will not restrict the federal government’s reach by searching out doctri-
                         nal limits on it in the Tenth Amendment. In particular, the Court ruled
                         invalid South Carolina’s claims that conditioning federal tax exemption
           J             on a TEFRA requirement that state and local bonds be issued in “regis-
                         tered” rather than “bearer” form violated the Tenth Amendment and
                         the principle of reciprocal tax immunity. And, having dismissed both

                         Page 66                                 GAO/HRD-90-34FederalState-Local Relations
Appendix I
Key Intergovernmental Events; 1979-98

charges, the Court negated a nearly loo-year old Supreme Court prece-
dent (Pollock v. Farmer’s Trust), which heretofore had been deemed to
protect municipal bond interest from federal taxation.

South Carolina is important for the intergovernmental system because it
reinforced the Court’s position that political and administrative, rather
than judicial, actions are to define the relationship between the national
and state governments. With respect to intergovernmental finance
issues, the decision is a watershed event because it explicitly establishes
the superiority of the federal government in matters of tax immunity.
Moreover, by making municipal bond law a matter of statutory prefer-
ence rather than constitutional principle, the Court opened the door to
further federal regulation of state and local finance decisions. After
South Carolina it is clear that the Congress has the right not only to
regulate abuse and control the volume of municipal bonds, but that it
also has the power to render bonds issued for any purpose-including
basic public infrastructure-taxable.

Page 67                                 GAO/HRD-90-34Federal%ate-Local Relations
Appendix II

PersonsInterviewed to Develop Issuesin
This Report

               Name                 Current position and affiliation
               -Wayne F. Anderson    Professor, George Mason University
                Enid Beaumont        Director. Academv of State and Local Governments
                Norman Beckman       Director, Washinaton Office, Council of State Governments
                Jonathan Bruel      Senior Analyst, Office of Management and Budget
               John Chubb           Research Fellow, Brookings Institution
               William G. Colman    Consultant, Advisory Commission on Intergovernmental
               Timothy Conlan       Assistant Professor, George Mason University
               James Frech          Consultant, National Academy of Public Administration
               Harold Hovev         President, State Policv Research, Inc.
               Kirk Jonas           Deputy Director, Virginia Joint Legislative Audit Review
                                    Commission                                            _I_.
               John Kincaid         Executive Director, Advisory Commission on
                                    Intergovernmental Relations
               Ann T. Lichtner      Director, Intergovernmental Relations, Department of
                                    Administration. State of North Carolina
               Jerry Miller         Executive Director, National Association of State Budget
                                    Officers                                                   -
               Richard P. Nathan    Professor, Princeton University
               Nonna A. Noto        ;,p;vtX;ist in Public Finance, Congressional Research

               Sandra Osbourn       Specialist in American National Government, Congressional
                                    Research Service
               Paul Peterson        Professor, Johns Hopkins University
               Robert Raymond       Special Assistant to the Deputy Assistant Secretary for
                                    Planning and Evaluation, Department of Health and Human
               Mavis Mann Reeves    Professor, University of Maryland
               JohnShannon          Consultant, Urban Institute          ____-                    --
               Carl Stenbera        Executive Director. Council of State Governments
               Enda Tarr-Whelan     Executive Director, National Center for Policy   Alternatives
               David B. Walker      Professor, University of Connecticut
               Joan Wills           Former Director, Research and Development, National
                                    Governors’ Association
               Deil S. Wright       Professor, University of North Carolina at Chapel Hill
               Margaret Wrightson   Assistant Professor, Georgetown University
               Dennis Zimmerman     Specialist, Congressional Research Service                -__
               Daniel Soyer         Former Director of Communications, Massachusetts
                                    Municipal Association
               Dr. Lynn Bradbury    Director of Policy and Legislation, Office of the Speaker of
                                    the House of Representatives, Commonwealth of
                                    Massachusetts                 ____
               Paul Mahoney         Administrative Assistant, Office of the Senate President,
                                    Commonwealth of Massachusetts

               Page 58                              GAO/HRD-90-34Federal-State-LocalRelations
Appendix II
PersonaIntervIewed to Develop Issues   in
ThIB Report

Name                             Current position and affiliation
Robert H. McClain, Jr.          Undersecretary, Executive Office of Administration and
                                Finance, Commonwealth of Massachusetts
Michael W. Tierney              Assistant Secretary, Executive Office of Communities and
                                Development, Commonwealth of Massachusetts
Richard T. Howe                 Assistant Secretary, Executive Office of Communities and
                                Development, Commonwealth of Massachusetts
Marilyn Contreas                Senior Policy Analyst, Executive Office of Communities and
                                Development, Commonwealth of Massachusetts
William Hamilton                Assistant Director, Economic Analysis Center, Office of the
                                Comptroller of the Public Accounts, State of Texas
Phyllis Coombes                 Supervisor Federal Issues Group, Office of the Comptroller
                                of the Public Accounts, State of Texas
Jay G. Stanford                 Executive Director, Advisory Commission on
                                Intergovernmental Relations, State of Texas
Ron Lindsay                     Director, Office of Planning and Budgeting, State of Texas
Rich Thomas                     Director of State Affairs, Office of State Develobment. State
                                of Texas
Sheila Beckett                  Deputy Director, Office of Planning and Budgeting, State of
Tom Adams                       Assistant Deputy Director, Office of the Intergovernmental
--.                             Relations Governor, State of Texas
Max Sherman                     Dean, Lyndon Baines Johnson School of Public Affairs,
                                Universitv of Texas
-Frank Sturzel                  Executive Director, Texas Municipal League
-_..--Oliver                    Director, Legislative Budget Board, State of Texas
 Gordon Arnold                  Executive Assistant to the Speaker of the House of           -
                                Representatives, State of Texas
Kurt Spitzer                    Executive Director, Florida Association of Counties
Robert Bradley                  Executive Director, Advisory Council on Intergovernmental
                                Relations, State of Florida
Martin Young                    Policy Coordinator, Office of Planning and Budgeting, State
-.I_-      _l_l_                of Florida                                                    -
Raymond Sittig
--.--                           Executive Director, Florida League of Cities
Hon. Larry Durence              President of Florida Lake City, City of Lakeland, Florida
Jim Zingale                     S$$;irector,    House Appropriations Committee, State of

Maxine McConnell                Budget Analyst, Senate Appropriations Committee, State of
Ed Woodruff                     Budget Analyst, Senate Appropriations Committee, State of
__---                           Florida
Elton Revel1                    Senior Analyst, Senate Appropriations Committee, State of
Dale Hickham                    ;en,i;;Analyst, Senate Appropriations Committee, State of
Charles Brown                   Executive Director, Legislative Council, State of Colorado -
Daniel Stewart                  Associate Commissioner, Department of Education, State of

Page 69                                         GAO/HRD-90-34Federal-!%ate-LocalRelations
-   .-.   .I’“----
                                         Appendix II
                                         PersonsInterviewed to Develop Issues in
                                         This Report

                         -_-. .-.^.---                     -
                                         Name                           Current position
                                                                   _..~----     .        and affiliation                          __-
                                         Robert Moore                    Deputy Director of Finance and Administration, Commission
                                                                    -. ~-on.~~.--
                                                                             Higher Education, State of Colorado
                                         Timothy Holemen                 Policy Analyst, Policy Research, Governors’ Office, State of
                                                                         Colorado                                     ___--.-
                                         The Honorable Robert           Mayor, City of Colorado Springs, lsaacs Colorado
                                         Ann Alter                      Intergovernmental Specialist, Office of the City Manager,
                                                                        Citv of Colorado Sprinos.
                                                                                            * - Colorado                        .___
                                         George Delaney                 Deputy Director, Office of State Planning and Budgeting,
                                                                        State of Colorado
                                         Curt Wiedeman                  Assistant Director, Office of State Planning and Budgeting,
                                                                        State of Colorado
                                         B.J. Thornberry                Deputy Chief of Staff, Office of the Governor, State of
                                         Timothy Schultz                Executive Director of Local Affairs, Department of Local
                                                                        Affairs, State of Colorado
                                         Nanci Kadlecek                 Deputy Director, Department of Administration, State of
                                                                              ~~~---.-                                        -__-
                                         Samuel -Mamet                  Associate Director, Colorado Municipal League

                                         Page 60                                        GAO/HRD-90-34FederalState-Local Relations

Appendix III

l@jor Contributors to This Report

                    John M. Kamensky, Assistant Director, (202) 276-0563
HLI.I$UIResources   Robert W. Gage, Evaluator (employed by GAO under the Intergovern-
Division,             ment Personnel Act, and has since returned to his position as
Washington DC.        Associate Professor, University of Colorado at Denver)
                    Margaret Wrightson, Evaluator
                    Brian Lepore, Evaluator
                    Ann M. Barr, Evaluator

                    Page 61                            GAO/HRD-W-34FederalStateLmal Relations

               Block Grants: Federal-State Cooperation in Developing National Data
               Collection Strategies (GAO/HRD-89-2, Nov. 29, 1988) Washington, D.C.

               GAO  believes the cooperative approach to data collection is a viable way
               to obtain national block grant data although some data may not be com-
               parable. Generally, the data gathered were timely and officials in the six
               states we reviewed perceived the data collection efforts to be less bur-
               densome than reporting under the prior categorical programs. But the
               voluntary approach may not be useful for other federal programs due to
               the incomparability of the data collected.

               Legislative Mandates: State Experiences Offer Insights for Federal
               Action (GAO/HRD-88-76, Sept. 27, 1988) Washington, D.C.

               GAO   found that federal mandate cost estimating had little effect on five
               of the eight bills reviewed because legislators were more concerned with
               program and policy issues than with the costs they imposed on states
               and localities. But cost estimates had a significant impact in the states
               when prepared early in the legislative process. Mandate reimbursement
               worked in the states if the public initiated the requirement through a
               referendum or there existed a constitutional amendment requiring it,
               and the state was experiencing a healthy fiscal climate. GAO believes
               that the federal government could focus attention on the impact of fed-
               eral legislation on state and local costs by providing estimates for key
               bills before full committee reports and biennial reports to increase legis-
               lators’ awareness of mandated costs.

               Block Grants: Federal Set-Asides for Substance Abuse and Mental
               Health Services (GAO/HRD-88-17, Oct. 14, 1987) Washington, D.C.

               We studied eight states and found that: (1) most states allocated their
               funds according to historical trends to maintain existing services, (2)
               states met the requirement to set aside funds either by expanding
               existing services or by passing on the responsibility to local or county
               service providers, (3) most states neither received increased block grant
               funds nor provided additional funding to service providers, (4) most
               state officials stated that they would continue these services even with-
               out the set-aside requirement, and (5) a majority of recipient interest
               groups believe that their states’ commitments to the services would
               decrease if the Congress eliminated the set-aside.

               Page 62                               GAO/HRD90-34 Federal%ate&ocal Relations

Grant Formulas: A Catalog of Federal Aid to States and Localities       (GAO/
HRD-87-28, Mar. 23, 1987) Washington, D.C.

The catalog provides: (1) an in-depth understanding of formula alloca-
tion, (2) information on the agencies and congressional committees that
have jurisdiction over the programs, (3) the amounts of program alloca-
tions, and (4) the sources and timeliness of the statistical data used in
making funding allocations.

Health Care: States Assume Leadership Role in Providing Emergency
Medical Services (GAOIHRD-86-132, Sept. 30, 1986) Washington, D.C.

States have assumed a more active leadership role in financing and reg-
ulating the local delivery of emergency medical services. The six states
GAO visited reversed the trend of reducing funds for emergency medical
services and the emergency medical services community increasingly
looked to the states-and not the federal government-for     leadership.

Local Governments: Targeting General Fiscal Assistance Reduces Fiscal
Disparities (GAO/HRD-86-113, Jul. 24,1986) Washington, D.C.

Retargeting general fiscal assistance would produce double the reduc-
tion in disparities if only those communities with incomes below 125
percent of their states’ average income received assistance. Poorer com-
munities must accept lower levels of public services or tax themselves
more heavily to achieve equalization of services under the present pro-
gram. GRS allocated funds to local governments within each state based
on population, per capita income, and tax effort.

Child Support: States’ Implementation of the 1984 Child Support
Enforcement Amendments (GAO/HRD-86-40BR,    Dec. 24, 1985) Washington,

The Child Support Enforcement Program is a federally administered,
state-run program established to require absent parents to support their
children and, as a result, to reduce Aid to Families with Dependent Chil-
dren (AFDC) program funding. In 1984, the Congress enacted amend-
ments mandating states to adopt and implement 10 practices to improve
the program’s ability to: (1) mandate proven collection techniques (2)
ensure that services will be available to non-AFDC families, and (3)
strengthen interstate child support enforcement.

Page 63                               GAO/HRJS90-34FederalState-Local Relations

Block Grants: Overview of Experiences to Date and Emerging Issues
              Apr. 3, 1986) Washington, D.C.

Block grant implementation proceeded relatively smoothly during the
first 2 years because the states have prior administrative involvement in
many of the programs included under the blocks. Continued availability
of categorical grant funds, supplemental federal assistance, and discre-
tion to transfer between the blocks, helped to offset reduced federal
spending under the block grants. The states tended to seek program con-
tinuity under the blocks. The states favored the block grant approach
while interest groups favored the prior categorical approach.

State Rather Than Federal Policies Provided the Framework for Manag-
ing Block Grants (GAO~HRD-86-36, Mar. 15, 1986) Washington, DC.

GAO  found that block grants provided the states with greater discretion
to plan and manage federal funds using existing state procedures. The
states indicated that the broader discretion enabled them to better inte-
grate related state and federal activities. As states gained experience,
the need for additional federal technical assistance diminished.

States Have Made Few Changes in Implementing the Alcohol, Drug
Abuse, and Mental Health Services Block Grant (GAO/HRD-84-62, Jun. 6,
1984) Washington, D.C.

GAO  found that increased state funding and reallocated categorical
grants were used by states to offset reduced federal appropriations for
Alcohol, Drub Abuse, and Mental Health services. No states changed cli-
ent eligibility policies, among those states we reviewed, and most contin-
ued to fund the existing service provider network. States carried out
their increased responsibilities by establishing program requirements,
monitoring grantees, providing technical assistance, and auditing funds.

Summary of Recent GAO Reports on Managing Intergovernmental            Assis-
tance Programs (GAOIGGD-82-91, Jul. 13, 1982) Washington, D.C.

A major conclusion of GAO reports over the years has been that, since
the federal government relies so heavily on state and local governments
to implement national objectives on a partnership basis, the federal level
needs to design programs that are more sensitive to the fiscal, legal, and
administrative environments of state and local governments.

Page 64                               GAO/HRD-9034FederalState-Local   Relations


               Removing Tiering from the Revenue Sharing Formula Would Eliminate
               Payment Inequities to Local Governments (GAO/GGD-82-46, Apr. 16, 1982)
               Washington, DC.

               GAO   found that revenue-sharing allocations to city and township govern-
               ments results from three sources: (1) the three formula elements of pop-
               ulation, relative income, and tax effort applicable to each unit of local
               government, (2) statutory formula constraints, and (3) the statutory
               tiering process. The effect is to distribute more aid to governments with
               more people having lower incomes and supporting a higher tax effort.
               But the tiering process also causes inequities by penalizing those govern-
               mental types with a higher concentration of low-income residents in
               states characterized by rural poverty. Eliminating tiering and directly
               applying the basic three-element formula to local governments would
               reduce inequities.

(118829)       Page 66                               GAO/HRD90-34FederalState-Local Relations
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