Viewpoint: Deficit Sharing

A fairly simple solution to many of the problems of older industrial cities would be to eliminate all Federal revenue sharing and grants-in-aid to state and local governments. That would chop about $72 billion of ugly fat out of the Federal budget, permitting an equivalent reduction in Federal taxes.

Any form of revenue sharing is, of course an outrageous fraud. The Federal government has no source of revenue that doesn't ultimately come out of the hides of people who live within cities and states. Federal taxes leave people poorer; Federal borrowing competes with other borrowing and requires higher taxes in the future to service the added debts; increasing the money supply just imposes a tax on money by diluting its value.

There is no such thing as free money. Yet state and local officials still scramble for Federal dollars without bothering to ask where the money comes from. It is logically impossible for all communities to benefit from Federal aid, since some places must obviously be paying more in Federal taxes than they get back in Federal largess. But the flow of money to Washington and back again (minus brokerage fees) is sufficiently confusing to foster the popular illusion the Federal aid is spontaneously generated, like manna from heaven.

Several studies have tried to follow this shell game. The Tax Foundation, Brookings Institution and National Journal use different methods to arrive at broadly similar conclusions—namely, that most Northeastern and Midwestern states are substantial net losers. States like New Jersey and Illinois (but not New York) apparently pay something close to two dollars in Federal taxes for every dollar they get back in Federal "aid". The point is explicitly acknowledged in the growing controversy over Federal aid to the Sunbelt. Yet the conclusion is never the obvious one of scrapping the whole idea of regional redistribution. Instead, the call is for even more Federal grants, with more wrangling over who gets which end of the stick.

Short of civil war, it won't work. The political forces that gave rise to the existing allocation of Federal burdens and benefits will not simply be wished away. There can't really be any objective criteria for allocating Federal funds and the related taxes, so the actual distribution is instead determined by political clout. States with Congressmen in key positions on the appropriate committees, for example, are sure to jiggle the complex formulas in a way that helps their home states.

A Wall Street Journal editorial (December 27) challenged the "economic foolishness" of the idea that Federal monies are flowing from the Snowbelt to the Sunbelt. Taxes on workers in Detroit may indeed flow to retired bureaucrats in Miami, said the Journal, but the pensioners will then "make a payment on a Chevrolet, made in Detroit, and a payment on their mobile home, made in Pine Grove, Pa." The curious implication that it makes no difference who gets the rewards from productive activity clashes violently with other Journal editorials, which have stressed the disincentives inherent in our system of taxing work and investment in order to subsidize leisure and consumption. It is hardly a matter of indifference if pensioners in Miami are buying cars and mobile homes with taxes extracted from the labor and capital involved in producing those cars and mobile homes.

Many regional economies have become strangled in the tangled web of strings tied to Federal aid. Matching grants are particularly perverse. The feds offer money for this or that foolish program, on the condition that state and local governments cough up part of the cost. State and local officials buy votes with programs that would never have been undertaken if the link between spending and taxes had not been disguised by Federal grants. The resulting combination of Federal, state and local taxes to finance such programs soon drives productive individuals and enterprises into other regions, or into varying degree of retirement (e.g., the civil service).

The formula for general revenue sharing is equally weird. Communities actually get extra money for having a high "fiscal effort"—i.e. for taxing the stuffing out of their citizens. Naturally, the most productive individuals in any community do not just stand there like lambs to be shorn. They leave—taking their capital and skills with them. Voting with the feet is a rare and valuable element of wholesome competition in the provision of government-monopolized services. Yet revenue sharing is rigged to draw Federal tax dollars out of places where local taxes bear some remote relationship to the quality of government services, and send the proceeds to places where local taxes just seem to disappear.

Finally, there is the Carter Plan for giving a much larger share of Federal aid to those states and cities that are most successful in maintaining high unemployment rates. People in areas of high unemployment are said to have a "right" to public employment, which can only mean that other taxpayers have an obligation to pay their salaries.

Now, there is no question that state and local governments can and do promote poverty and unemployment through such devices as punitive taxation, building codes, rent control, environmental policies, minimum wage laws, lavish welfare and unemployment benefits, and so on. The question is why anyone would want to subsidize such idiotic policies at the expense of states and localities which are relatively sane. More aid to areas with chronic high unemployment, as President Carter has proposed, necessarily requires higher taxes on those areas which have provided favorable incentives for workers to work, for employers to employ, and for investors to invest. Taxing success and subsidizing failure is hardly the best way to reduce unemployment.

The message is not apt to be missed by mayors and governors, who can be expected to compete for the Federal "free money" by perpetuating or extending destructive policies.

Contributing editor Alan Reynolds is a vice president of the First National Bank of Chicago, where he supervises business and economic research. His Viewpoint alternates in this space with those of Murray Rothbard and Tibor Machan.