Fall 1997
by Robert Tannenwald

Americans have debated the proper division of fiscal and regulatory responsibilities among levels of government since the founding of the Republic. The controversy has often involved the concomitant question of the size of government as a whole. The most recent chapter of this long-standing dispute -- the "devolution" debate -- is no exception. Devolution refers to a variety of proposals to reduce sharply federal aid to the states and to give the states more leeway in deciding how to spend it.

Devolution's proponents maintain that federal spending has bloated government beyond what citizens in many areas of the country want. If states are given more fiscal independence and responsibility, argue supporters, they will be freer to respond to the preferences of their citizens. Furthermore, interjurisdictional competition will induce efficient, innovative, and self-reliant government. Federal aid, no matter how well designed, would weaken these desirable incentives. Other analysts and policy makers doubt the ability and will of state and local governments to assume devolved responsibilities. Those who believe that states and municipalities should pick up much of what the federal government curtails are especially troubled. They fear that many states will lack the resources to assume the devolved responsibilities. If these states attempt to raise taxes, they may only erode their long-run competitive position and exacerbate their fiscal dilemma.

Suppose that devolution were to proceed as extensively as its most avid supporters would like, and federal assistance to the states fell by half. How disparate would be the capacity of states to respond? Which states would have the most difficulty expanding their fiscal domain? And how would the New England states fare?

Every state, along with its municipal governments, must provide vital public services to those who reside, work, travel, and vacation within its borders. Some states must work relatively hard to meet these responsibilities. They may have a high proportion of low-income residents who need cash assistance, special education, and extensive health care. Or a large percentage of their population may be between the ages of five and eighteen, requiring high per-capita spending on primary and secondary education. Such services -- welfare, health and hospitals, and education -- accounted for almost half of state and local direct spending in 1994. Some states traverse a large area or contain a dispersed population, increasing the need for road construction and maintenance. All these conditions intensify fiscal need; they increase the cost of providing services or augment the scope of programs for even the most efficient state and local government.

States also differ on the revenue side. Some are endowed with especially rich potential tax bases. They may be able to collect large income and property tax revenues because of the high income and wealth of their residents. They may enjoy a large sales tax base because their physical beauty and man-made attractions are effective tourist draws. Or they may have a rich severance tax base because of a local concentration of extractable minerals or timber. All these conditions augment fiscal capacity.

Fiscal comfort combines fiscal capacity and fiscal need. States with high fiscal capacity and low fiscal need are likely to be most fiscally comfortable. States with low capacity and high need are likely to suffer the most fiscal stress.

NEW ENGLAND IS COMFORTABLE

To arrive at a gauge of fiscal comfort, I estimated the relative fiscal capacity (measured by the revenue that would be generated by a uniform state tax code) and fiscal need (measured by the amount needed to provide a bundle of public services, adjusting for prices) for each of the fifty states. What I found is heartening for New England.

On the revenue side, New England as a whole has more tax capacity than any other region. It enjoys the top spot primarily by virtue of its high per-capita income and wealth, especially in Connecticut and Massachusetts. Still, there is considerable dispersion within the region. Three New England states rank in the bottom half in terms of tax capacity, with Maine lowest at forty-third. Moreover, the relative capacity of all six states dropped between 1987 and 1994, with Massachusetts suffering the largest percentage decline. Nonetheless, New England has greater fiscal capacity than any other region.

On the spending side, New England also looks good, enjoying the lowest fiscal need of any region. Only Connecticut has above-average need, the result, in part, of a relatively sharp increase in its ratio of school-aged to total population and a 3 percentage-point rise in its poverty rate between 1987 and 1994.

By dividing tax capacity by fiscal need, I am able to arrive at an index of fiscal comfort. According to the map, we New Englanders are in an enviable position. New England is by far the most fiscally comfortable region, 24 percent more comfortable than the nation as a whole. All six states enjoy a relatively high degree of comfort, although most have slipped relative to the nation since 1987. Even states with low tax capacity, such as Maine and Vermont, are fiscally comfortable because they enjoy a mild degree of fiscal need.

By contrast, states in the southern and western regions of the country have the least comfort. They tend to have low potential tax revenue for all three major state and local broad-based taxes: property, personal income, and general sales. They also face a relatively large demand for public services due to high poverty rates and large number of school-aged children. Even California and our neighbors, the mid-Atlantic states, are more stressed than New England. New York, for example, has seen its tax capacity drop and its poverty rate rise over the past seven years. It also must cope with a high crime rate, which is an important determinant of need for police and correctional facilities.

EVERY TUB ON ITS OWN BOTTOM?

Perhaps we New Englanders should welcome devolution. Compared to other regions, we're best positioned to provide for ourselves. As our clout in Congress has waned since the days of Tip O'Neill and George Mitchell, so has our share of federal largess relative to the federal taxes we pay. Analysis of recent appropriations bills suggest that, New England's share of federal spending may fall even more down the road.

Thus, we might well ask whether we really want to subsidize other states. Perhaps the disadvantaged residing within our borders deserve our attention more than those in Mississippi. For all their fiscal stress, the southern and western states seem to be effective competitors, luring our companies with cheap land, cheap labor, and a warm climate. Moreover, people in those regions, however fiscally stressed they may be, tend to like small government at all levels. They may lack fiscal resources and have to contend with difficult problems. But they do not seem to believe that it is the business of government -- even state and local government -- to resolve them.

Still, we may prefer to ensure that all Americans have access to some minimum level of public services, even if their states and municipal governments choose not to provide them. And it may be desirable for state and local governments to play a role in supplying these services, because they know best how to deliver them. In that case, it would make sense for the federal government to step in and provide state aid. The devolution movement is evidence that Americans are questioning whether national standards exist. The limited success of the movement to date suggests that many citizens believe they do.

Robert Tannenwald is an economist at the Federal Reserve Bank of Boston.