How Congress Can Help the States

As the United States confronts the challenge of the coronavirus pandemic, it has mostly been well served by its system of federalism. Many governors have stepped up to lead: because leadership has sometimes been lacking in Washington, because public-health is ultimately a state purview, and because the virus has hit different parts of the country in different ways. Their efforts have led to some disputes over just who has the power to shut down and reopen economic activity, but on the whole, we have had reason to be glad that our system of government has multiple layers.

In the coming months, however, we can expect some serious trouble for American federalism. It will be caused not by competition over power, but by discord over money. And to keep it from poisoning the cooperative tenor of the national response to the pandemic, Congress will need to divide the aid it offers into several distinct categories, each with its own set of rules.

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The coronavirus is crushing state budgets, as the public-health response has required enormous amounts of new spending while the economic slowdown is wiping out tax revenue. The federal government has faced similar pressures and responded with massive deficit spending. States, however, are generally subject to constitutional balanced-budget requirements, and also have far fewer options for borrowing. They will soon face the prospect of sharp budget cuts in the middle of a severe recession, and to avert that, they will plead with Congress for bailouts.

This is a familiar challenge. American federalism has been about money and not just power from the very beginning—when, under the Funding Act of 1790, the new federal government assumed all the debt the states had incurred to help finance the American Revolution. Federal borrowing has since frequently served as a backstop for state budgets in hard times. And by now, large portions of our welfare, social-insurance, health-care, and public-education systems are run by the states but funded at least in part by the federal government.

That has often led to tensions. The states have sometimes gamed the rules to squeeze Washington for more money, and the federal government has sometimes treated states as subsidiaries rather than sovereign members of a complex federation. Wealthier states often resent sending money to poorer ones, while states with less leverage over Congress have felt put upon by those with more.

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But the breadth and depth of the disaster we are now living through mean such stresses will grow especially intense. The pandemic has hit some states harder than others, and the economic ruin unleashed by necessary economic shutdowns will fall unevenly too. Moreover, some states were better prepared for hard times, while others have long been fiscally reckless (especially regarding state-employee pension and health-care obligations) and might now see an opportunity to pass long-standing problems off as costs of the emergency.

Interstate disputes will translate into disagreements within Congress, because representation follows geography. It is already clear that such discord will complicate the next pandemic-relief bill, which is now being formulated. State governments are calling for aid, and most members of Congress are eager to provide it. But some are wary of giving their constituents’ tax dollars to states that will divert a portion of them to fill fiscal holes dug over years of irresponsible spending.

They’re not wrong to worry. In late April, for instance, Illinois officials asked Congress for billions to bail out the state’s perennially underfunded pension system, presenting the request as a response to the pandemic. If such cynical opportunism succeeds, other states with pension troubles will surely follow suit. Yet concerns about such ploys shouldn’t blind Congress to its crucial role in assisting the states through the genuine pain of this national catastrophe.

To prevent disputes on this front from derailing the Phase IV bill, Congress needs to clarify some key distinctions. Members should establish three separate categories of problems to be addressed by three distinct forms of aid to the states.

First, Congress should use federal grants to cover state costs for direct pandemic response—things such as testing and tracing, hospital and health-system needs, and public-health infrastructure. This is a national emergency, and the federal government’s far greater capacity to borrow means it should assume the direct costs involved. For the same reason, Congress should also consider providing some help to reinforce state unemployment trust funds, as the American Enterprise Institute’s Matt Weidinger has argued.

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Second, Congress should offer to make up lost state-government revenue resulting from the economic shutdown through guaranteed loans on favorable terms. Lost revenue can be quantified against some measure of expected tax receipts—for instance, the average of the past five years of each state’s revenue. And Congress could have the Treasury build on the Municipal Liquidity Facility it established with the Federal Reserve in April to buy state bonds and quickly provide financing. Or it could otherwise guarantee loans that could help states replace lost income. Swift support could allow the states to get through the coming economic hardship without needing to cut back education, welfare, or other core services. And providing such help not as grants but as generous loans that can be slowly repaid to the Treasury, as state revenues recover over time, can both protect federal finances and avoid favoring higher-tax states.

Finally, for states whose long-standing fiscal negligence is now becoming untenable because of the suddenly weaker economy, Congress should offer some options for help strictly conditioned on essential reforms. Bankruptcy, which is not available to state governments under current law, should be made an option, as the University of Pennsylvania’s David Skeel has argued. Or as AEI’s Andrew Biggs has suggested, in return for federal financial support, Congress could require states either to accept the stricter accounting rules that federal law imposes on private pensions or to freeze existing pension programs and shift employees to defined-contribution plans. Such options would limit the exposure of federal taxpayers while still helping states and encouraging them to behave more responsibly. This sort of conditional assistance could be offered to states but not forced upon them, maintaining their sovereignty.

The boundaries between these three categories of need might be murky sometimes, and the exact nature of the aid offered to each would need to be hammered out in Congress. But the core strategy of dividing any assistance offered to states into three general tiers of this sort could help avert squabbles over federalism that might otherwise cripple the larger effort to enact another needed pandemic-response bill.

We are approaching a dangerous moment for American federalism. But if Congress can prioritize the states’ most urgent needs and adapt help to the nature of the problems they are facing, federalism could again prove itself a great advantage of our system of government, and the states could emerge from this crisis both sovereign and strong.