Chapter Two—
Reforming U.S. Federal Fiscal Arrangements

Edward M. Gramlich

Economists have written any number of articles calling for tax and expenditure reform. There have been briefs for reforming the income tax, integrating it with the corporate tax, switching to a consumption tax, moving away from or toward a more progressive rate structure. There have been just as many normative treatises about expenditures—arguing for constitutional limits on total expenditures, reforming the social insurance trust funds, replacing certain expenditures with negative income taxes or vouchers. In a discipline that is alleged to emphasize the positive over the normative, public finance economists have certainly bucked the trend.

But not in one area. In contrast to many other developed countries, the United States has a very decentralized system of fiscal relationships. Over $180 billion is given as intergovernmental grants from higher to lower levels of government, and many promising revenue sources are left completely to local governments. These arrangements, loosely termed a fiscal federalism system, have not received much normative, reformist attention from economists. Politicians have certainly become aware of the potential of the federalism issue, and presidents Nixon and Reagan have both advanced well-publicized reform proposals.^[1] The quasi-governmental Advisory Commission on Intergovernmental Relations (ACIR) has noticed the system and has its own reform proposals.^[2] Economists have done a multitude of theoretical and empirical studies on various aspects of federalism, trying to determine optimal governmental arrangements, predicting the effects of grants or taxes, estimating the degree to which

fiscal decisions are "capitalized" into property values, and the like. Unlike studies of other aspects of public finance, however, these analyses have not provided very pointed statements of what is wrong with the present federal arrangements and how they might be changed to further various goals.^[3] In this paper I try to come up with such a statement.

There are obvious risks in such an attempt—one person's item to be reformed may be another person's ideal. And the theoretical basis for many of these supposed improvements is, as always, in doubt. However, a number of aspects of the present United States federal system seem unlikely to appeal either to those economists who worry primarily about efficiency or to those who worry primarily about equity. For all the positive papers analyzing the empirical impact of federalism, most of these features have not gotten the criticism they deserve from economists.

Two apologies are necessary at the outset. One is that a complete discussion of all aspects of federalism in need of major or minor reform would require a lengthy treatise. There have been two very extensive reviews of federal theory and present-day arrangements in the past decade—by Oates (1972) and Break (1980). Obviously, in one paper I cannot cover all the ground covered by these books and by countless shorter articles. I am forced to be selective both in choice of topics and in the treatment of arguments bearing on the topics. Readers desiring a more comprehensive, and undoubtedly more balanced, discussion can refer to these earlier sources. I must also mention that none of the items I single out for reform is original. I have made a stronger case for many of these measures than is typically found in the literature, but I am certainly not the first to use the relevant arguments.

The second apology is for the omission of a topic that should be fundamental to any discussion of fiscal federalism—that of reforming the structure of governments themselves. The United States has an extremely eclectic structure, with strong historical roots. Some states are large and diverse, others are small; some states conduct extensive expenditure operations of their own, other states leave these operations to localities or special districts; in some areas cities and counties overlap, in others they do not; in some areas special districts are organized to conduct functions, in others they are not; in some areas there is freedom for cities to annex suburbs, in other areas there is not. In all areas it is quite difficult to change whatever arrangements do exist. Economists such as Buchanan (1965) have developed some theories for understanding these arrangements, but there is as yet a wide gap between these theories and their practical applications. I do not even try to fill the gap here, but—as will

become apparent—the optimality or lack of optimality of a set of budgetary arrangements among existing governments depends very much on the existing structures. The two questions should ideally be studied simultaneously, not separately.

The Theory of Federalism and the United States System:
The Musgrave Trichotomy

Twenty-five years ago Musgrave (1959) advanced his now-famous trichotomy that divided governmental functions into their allocation, distribution, and stabilization components. The Musgrave trichotomy is not always very helpful in making particular decisions—almost every tax has both allocative and distributional implications, and most expenditures do too, but it serves a useful function as an organizing device in the area of federalism.

Allocation

Two separate traditions apply to public spending decisions within a federal system. Tiebout (1956) proposed a consumer choice model, according to which rational consumers would select a jurisdiction, and its menu of public goods, that would maximize consumer utility. Jurisdictions would then be led to provide the optimal menu; if not, residents would move to other jurisdictions until utility was maximized.

The second tradition follows Breton's (1965) notion of "perfect mapping" of jurisdictions. According to this notion, jurisdictional boundaries would be set to include only that set of individuals who obtain benefits from the relevant public good. In principle there could be as many jurisdictions as public goods, though in later work Breton and Scott (1978) rationalized a lesser number of jurisdictions by taking into account the costs of organizing and coordinating jurisdictions, and the costs to consumers of relocating.

These two traditions have been combined in various ways by various authors. Oates (1972) showed how jurisdiction size can be determined by the balance between two competing forces—the welfare loss from taste differences, which would argue for small jurisdictions, and the welfare gain from benefit spillovers, which would argue for large jurisdictions. His "decentralization theorem" called for public goods to be provided by the jurisdiction covering the smallest area over which benefits are distrib-

uted, so that public goods efficiencies are maximized and the effect of taste differences minimized. Breton and Scott worked out a more general theory of public goods benefits and organizational costs, but they did not formulate any general theorems, on the grounds that it might always be possible to reduce total costs by various kinds of intergovernmental transfers. Atkinson and Stiglitz (1980) built a series of models that included mobility, changes in the marginal product of labor as labor crowds into a jurisdiction, and income differences. The "results" they got were again very agnostic. Sometimes large jurisdictions were appropriate, sometimes small; sometimes there was a stable local public-goods equilibrium, sometimes not.

In light of this theoretical indeterminacy, it is no wonder that little progress has been made in attempting to determine which levels of government should provide what public services for allocation reasons. It is first necessary to adopt what seem to be reasonable simplifying assumptions and then derive the implications of the relevant model. A plausible set of such assumptions might be that organizing any new government is expensive, that mobility is costly, that changes in the marginal product of labor are small, and that income differences can be ignored (so as to focus only on considerations of efficiency). In this case one is led to the pragmatic conclusion that allocation responsibility for providing public services should be meted out to jurisdictions in accordance with Oates' decentralization theorem. But one should recognize that this conclusion is rather specialized and pertains at best only to marginal changes in the administrative structure and the pattern of production.

Turning to the actual numbers, the distribution of expenditures by function and level of government (Table 2.1) seems more or less in accord with the decentralization theorem. Those expenditures that appear to provide benefits over a wide area—national defense and energy—are conducted almost exclusively at the national level. Those that appear to provide benefits over a narrow area—elementary and secondary education and civilian safety—are carried out at the local level.^[4]

The one mystery in this type of analysis involves state governments. These governments make 60 percent of all government purchases at the national or the local level, but it is not clear what public services convey benefits over as large an area as that covered by most states. I will argue below that at least some of the types of expenditure made by state governments—purchases and transfers for income support and health and hospitals—are better left to other levels of government.

Of the remaining state purchases, transportation is probably the one

public service that does have natural statewide benefits, through the geographical linking of road networks. Education, specifically purchases for higher education by state university systems, may also give benefits statewide, but these benefits do not seem as "natural," since they are strongly influenced by the tuition and admissions policies followed by the state universities. Most such universities offer a large tuition reduction and perhaps relaxed admissions standards to in-state students and then find, unsurprisingly, that in-state students attend in very high numbers. One could argue that the benefits are statewide, but that begs the deeper question of whether the tuition reduction should have been granted in the first place.

To make one suggestive test of the degree of intrinsic statewide benefits, I examined data on University of Michigan (UM) freshmen accepted for admission. The results of this test, in the form of a logit regression explaining students' acceptance probabilities, are given in Table 2.2. They show that once the tuition differential has been eliminated, the probability that in-state residents who were accepted for admission will attend UM is no higher than for the accepted out-of-state residents. That sounds like an example of an unnatural statewide benefit.

Distribution

For this governmental function, the basic theoretical analysis was done by Pauly (1973). The Pauly model determines income distribution by the interdependent utilities of individuals—higher living standards for poor transfer recipients make richer taxpayers better off. In most of his cases Pauly arrives at conclusions close to those of the decentralization theorem—that distributional policies should generally be determined by lower levels of government. Two very strong assumptions must be made to arrive at the result, however, and those assumptions are open to question.

The first assumption involves the geographical linking of utilities. The Pauly model assumes that the welfare of donors can be improved only by raising living standards in the donors' own jurisdictions, as if donors are affected by the sight of, and externalities attendant on, poor people. Some survey evidence analyzed by Ladd and Doolittle (1982) sheds doubt on this assumption. Ladd and Doolittle find that an overwhelming majority of respondents to two separate ACIR polls (1981)—respondents who are assumed to be like those who would ordinarily pay for redistribution programs—believe that the national government should retain an impor-

tant role in supporting needy people. Ladd and Doolittle interpret these results as implying that poor people throughout the nation ought to be the beneficiaries of income support programs, as if donors' preference functions contain no state-line distinction.

The other assumption involves the potential migration of beneficiaries. Even if particular states wanted to be generous, they would not be able to be if prospective beneficiaries of transfer programs were highly mobile. Mobility would raise the tax price of redistribution in all states and would prevent states from following the basic redistribution choices of their donors, for fear of attracting hordes of welfare recipients. The prevailing view seems to be that migration is not, practically speaking, a problem, because only 1 or 2 percent of transfer recipients make interstate moves in a year (see Holmer 1975). But this view is belied by transition matrix calculations given in Table 2.3 which indicate that when transfer recipients (most of whom are not working) do move, they are much more likely to move to states with more generous income-support systems. In the long run, even the low degree of mobility pointed to in the prevailing view can lead to major population shifts among the beneficiary population, as is shown in Table 2.3. This evidence provides another argument for retaining some national interest in income redistribution policies.

But it is not obvious how the national interest should be retained. Tresch (1981) views the federal aspect of redistribution policy as an either/or choice: either the national government would determine an income distribution, or a lower government would. For various reasons he favors having lower governments make the determination, and this leads him to advance a hierarchical redistribution plan. Under this plan, the national government would redistribute income among states, the states among localities, and the localities among households. Legislators at any level could vote for as much or as little redistribution as they wanted. Migration of beneficiaries and positive taxpayers alike could be stabilizing in such a system, if generous localities were entitled to greater transfers from higher levels of governments when low-income families immigrated and high-income families emigrated. But if migration were costly, this system would represent the national interest no better than a fully decentralized system, because there would be no way for national legislators representing national preferences to insure that low-income people were taken care of in particular states. Moreover, even if migration were not costly, the outcome might be socially undesirable, because it could lead to extreme differences in state and local incomes.

An alternative view is taken by Boadway and Wildasin (1984). They

do not see the national-subnational question as an either/or choice but, rather, analyze the question as a matter of benefit spillovers, where the spillover represents both the fact that donors may care about recipients from all states and the fact that when one state raises support levels and attracts migrants, other states benefit. In this logic, taxpayers outside the jurisdiction are willing to contribute to support levels in the jurisdiction, and the appropriate policy would be to allow subnational units to set support levels, partly financed by open-ended matching grants from the federal government. That, as it happens, it close to the present arrangement used in the United States for two of the main general programs for redistributing income, Aid to Families with Dependent Children (AFDC) and Medicaid. Both programs contain the added stipulation that the matching rates are more favorable for low-income states. The third main general redistribution program, food stamps, is a national program with minimum nationwide support levels.^[5]

While the structure of income support programs receives extensive criticism, the Boadway—Wildasin analysis suggests that it is not so obviously in need of repair. I disagree. In the Appendix I give an analysis that shows, first, that any inefficiencies caused by migration spillovers are small, and, second, that present matching grants greatly over-correct for these inefficiencies. Yet even with these overly generous matching grants, AFDC support levels are extremely low in the states of residence of slightly more than half of AFDC beneficiaries. The basic reason is that voters in these low-benefit states appear to have little taste for redistribution, as is readily inferred from their low benefit levels in spite of generous federal matching and upward pressure from the higher support levels in other states.

That leads me to a somewhat paternalistic position, carefully spelled out in the Appendix. I would like to see a uniform national minimum standard somewhere near the level that now obtains in the states of residence of slightly less than half of the AFDC beneficiaries, roughly the Health and Human Services poverty living standard. Certainly this minimum standard could be supplemented by states, and perhaps there should even be a slight federal match for supplementation. My reason for desiring minimum standards is the simple one that I am bothered by the fact that support levels in states paying low benefits are so low. Given the numbers, there is no reasonable way to raise these support levels substantially with Boadway—Wildasin-type matching grants, and no reasonable way to justify national standards by resorting to migration inefficiencies.

Stabilization

The prevailing view as of a decade ago was that national governments should try to stabilize the economy by manipulating taxes and expenditures; subnational governments should not attempt to do so. Over the past decade the first statement has come under a series of withering attacks: the criticism of Mundell (1963) and Fleming (1964) that with flexible exchange rates, foreign capital flows will automatically crowd out fiscal changes; the criticism of Lucas (1972) and Sargent and Wallace (1975) that flexible prices and rational expectations render ineffective any systematic macro-policy changes; the criticism of Barro (1974) that households with long horizons expect to pay the cost of government at some point in history, and hence that the actual timing of tax liabilities (and the split between debt and taxes) has no impact on consumption. There are still unreconstructed Keynesians around (like me), but the faith in activist fiscal policy is substantially less than in former times.

Even in the fiscal activist's heyday, Oates (1972) was arguing that subnational fiscal policies were pointless. In part, his argument was based on the belief that national stabilizing fiscal policies presented a realistic alternative to subnational fiscal policy—now not so readily accepted. In part, the argument was based on a belief that the debt of subnational governments was external and that of national governments internal—a distinction now viewed as obsolete. To the extent that debt is floated on a national or worldwide capital market at a predetermined interest rate, bondholders are no better off by virtue of getting a particular interest payment, all debt is effectively external, and there is no differential advantage in having the national government float the debt.^[6]

In part, the lack of faith in subnational fiscal policy was also based on a view that either the mobility of labor or goods in a country was very high. If the mobility of goods in response to spending demand was high, movements in aggregate demand throughout a country would be highly positively correlated and demand stimulation in one area would not cause extraordinary income changes there. If the mobility of labor was also high, whatever differential movements in demand might occur would inspire offsetting by changes in labor supply.

The last two rows of the transition matrix (Table 2.3) try to verify the latter of these critical assumptions, the assumed mobility of labor. Here the topic is the movement of unemployed workers, either short or long term, between states of high and low aggregate unemployment. The message is certainly to downgrade the importance of labor mobility for

any but the longest run. As with the transfer recipients discussed earlier, in the short run very few workers, even when unemployed for as long as half a year, move from a high to a low unemployment state.

The upshot of all these considerations is that perhaps the question of subnational fiscal policy should be reopened. If most demand shocks these days are ultimately due to relative price shifts that benefit some areas of the country and hurt others (see Medoff 1983 for some evidence on the importance of these), if these shocks are largely transitory, if labor is immobile across regions of the country in the short run, and if currency value changes weaken national fiscal policies, then use of subnational fiscal policies may present a sensible way to decentralize responsibilities for this function of government. In another paper (Gramlich 1984) I make this argument in more detail. Most states have constitutional provisions that prevent them from running current-account-budget deficits, but they are not prevented from altering taxes and expenditures in response to income changes in their areas, and it appears to me that they should follow such policies.

Tax Assignment

Two basic questions arise in any examination of the federal structure of taxation. The first involves the levels of taxes raised by national and subnational governments; the second, the types of tax used.

National vs. Subnational Taxes

While the presumption on the expenditure side of the budget is that expenditure programs should be conducted by subnational governments whenever possible, there is an opposite presumption on the tax side. Partly because of a belief that the administrative costs of levying taxes are higher for subnational than national governments, partly because of a fear of tax competition, the standard belief is that tax collection should be centralized whenever possible.

As on the expenditure side, this presumption can at least be said to be specialized, perhaps appropriate in some cases but certainly not in general. For one thing, it totally ignores a point brought out by the new "rent-seeking" literature: that inefficiencies due to lobbying for the grants may dwarf conventional economic inefficiencies. When expenditure programs are decentralized and taxes centralized, large-scale general-purpose transfers (which actually exist in other federal countries such as Canada

and Australia) are needed to balance budgets at both governmental levels. These large transfers place a premium on local politicians who can lobby for grants from the federal government and very little premium on those who are effective managers of their governments—a common complaint in countries that rely heavily on tax-sharing grants (Walsh 1983). The rent-seeking literature should then alert us to a competing principle—that, as a rule, those governments that buy government services should impose their own taxes.

Moreover, the administrative cost argument given in favor of tax centralization seems quite weak. Perhaps in less developed countries it may be true that the national government can administer tax laws more effectively than can subnational governments, but there is no research supporting such a proposition in the United States. And it would be strange if such research could be found, since all states have to do to lower their own administrative costs and the compliance costs of their taxpayers is to use the federal tax base and apply their own rate.^[7]

The question of competition among various governments for desirable tax bases is more complicated. In a Tiebout model with costless migration, competing governments at the same level should strive to eliminate what Buchanan (1950) called fiscal residuals : the difference between taxes paid to a local government and expenditure benefits received from it. The threat of tax competition among subnational governments will then limit the extent to which any of these governments can tax either industry or well-off individuals in their own community, for if these groups are asked to pay extra costs, they will simply leave the community. There is then relatively little scope for assessing redistributive taxes at any but the national level.

This innate limitation on redistributive taxes at the subnational level does not require fiscal transfers from higher to lower levels of government for redistributive spending, as long as the redistribution is done mainly by the federal government, as I have previously argued that it should be. But it could justify such transfers for spending done for allocation reasons. Gordon (1983) points out that horizontal tax competition eliminates an opportunity for a decentralized government to assess completely nondistorting taxes, if there are some factors that are in highly elastic supply to subnational jurisdictions and completely inelastic supply to the nation. In principle Gordon's point is important, but I would be more worried about it if I could determine what such productive factors are—in today's open-economy models, a routine assumption is that capital and perhaps even entrepreneurship are in elastic supply to the whole

country (called the "small country" assumption, for obvious reasons). Pending illumination on this point, my tentative position on this issue is that while it is theoretically possible that principles of tax assignment would call for having certain taxes levied by national governments and accompanied by grants to the subnational governments actually doing the spending, there is no clear evidence that such an arrangement is appropriate for the United States.

Another form of tax competition would also call for more centralization of the revenue-raising function than the spending function. This form is not very common in the United States, though it exists in resource-rich countries such as Australia. It involves the vertical tax competition among all levels of government that could lay claim to taxing profitable resource deposits. Cassing and Hillman (1982) tell a story about rail freight for coal in Queensland, the most resources-rich Australian state. The federal government tries to gain its return from Queensland coal by imposing an export duty. The state of Queensland tries to gain its own return by charging exploitive rail freight rates. As the federal government raises its rates to gain revenue, the profitability of coal is reduced, as is the monopolistic freight rate Queensland can charge. Similarly, by raising its freight rates Queensland can reduce revenues available to the federal government. If the two were to compete, they would tax coal excessively and generate suboptimal tax revenues for both governments. This is one case where it would make sense to centralize taxes and have one government distribute a share of the optimal tax revenue to the other.

Whatever the resolution of these typically complex normative issues, the previously reported data on general-purpose grants suggest that there is in fact broad adherence to the levy-your-own-taxes principle in the United States. Table 2.1 shows that only $5 billion of the $88 billion in federal grants to state or local governments in 1981 were for general purposes, and only $11 billion of the $93 billion in state grants for local governments.

Types of Taxes

The two basic principles for organizing a tax system are the ability-to-pay and the benefit principles. In a federal system we would expect that migration among subnational jurisdictions would be an important factor in the long run (as the tax competition argument and the evidence on AFDC benefits, described above, suggested), which in turn implies that subnational jurisdictions ultimately have only one feasible taxing ar-

rangement, the benefit principle. If they try to make well-off individuals or industry pay taxes that will be spent in the form of programs that benefit others in the jurisdiction, these groups will move out of the jurisdiction.

It follows that in a federal system, most ability-to-pay, or redistributive, taxes will be imposed at the national level, while most benefit taxation will be done at the state or local level. An examination of actual tax data for the United States (Table 2.4) shows this to be generally the case. Income and corporate taxes, the most important ability-to-pay taxes, are imposed mainly at the national level. Contributions for social insurance, used to finance trust funds such as social security, Medicare, unemployment insurance, and the like, are also assessed at the national level. Those state or local contributions that are assessed are for pension systems for the employees of these governments, and should be viewed as a component of the wages of these employees. Those taxes that are mainly benefit taxes, fees and charges and property taxes, are assessed at the local level.^[8] As on the expenditure side, the taxes of state government represent a mixed bag, with some ability-to-pay taxes, some benefit taxes, and the state sales tax, which is hard to classify.

Tax Exportation

One important source of inefficiency in this division of taxing responsibility involves the possibility of exporting taxes. A standard claim on the expenditure side of the budget, routinely advanced as a rationale for categorical grants from the federal to lower governments, is that spending can be too low if some benefits from an expenditure program are realized outside the community. There is a similar, though less commonly heard, argument on the tax side (first made by McLure 1967). If taxes can be exported from a jurisdiction to individuals outside the jurisdiction, without a concomitant transfer of expenditure benefits, local citizens are not internalizing all the costs of public services, and they will spend too much on these public services. Just as we have categorical subsidies for those types of expenditures with benefit spillovers, we should in principle also assign public-service excise taxes for whatever spending is financed by exportable taxes.

The difficulties of matching expenditures and the taxes used to pay for them probably make any formal excise-tax scheme impractical, but there may be other arrangements that should be made to deal with tax exporting. One is to have the federal government assume all tax sources that can easily be exported. It is sometimes argued that this is why the federal government should take over responsibility for the corporate tax (as it largely has), but that view does not accord with prevailing views on the incidence of the corporate tax. That tax is now generally considered to be a tax on a mobile factor, capital, which would drive it, and ultimately labor, out of a jurisdiction, leaving the tax to be paid by the locationally fixed factor, land. Hence in general the corporate tax would not be exported. What would be exported are capital taxes on factors within a jurisdiction owned by outsiders (such as on resources) and excise taxes on travelers with a low price elasticity of demand.

As a practical matter, tax exporting inefficiencies do not seem to be of overriding practical importance in the United States. A recent study by Mutti and Morgan (1983) finds the revenue implications of excise-tax exporting to travelers to be very small, even for states, such as Florida, for which tourism is very important. Beyond that, though the decisions have been made on constitutional grounds, a long series of Supreme Court rulings have effectively prevented the taxation of outsiders and have thereby kept down the distortions that could have arisen from exporting (Hellerstein 1977).

Although the Supreme Court is of course concerned with legal tradi-

tions and not economic inefficiencies, there is one way an alleged constitutional restriction does cause tax exportation. As a result of court rulings in the early 1940s, the federal government now does not tax state and local bond interest payments. This treatment lowers state and local bond interest rates to about 80 percent of the rate for comparable-risk corporate securities, and subsidizes state and local investment in all communities affected by cost-of-capital. There seems to be no economic point to such a subsidy—if there are spillover benefits, matching grants can be used—and its elimination would improve the overall allocation of capital in the United States, as well as improving the equity of the federal income tax. If the subsidy really is rooted in constitutional constraints, this distortion will be with us as long as we have an income tax, though it could still be removed by moving to an expenditure tax, which taxes return to capital only when it is consumed. But there is enough confusion about the ultimate origin of the subsidy that one might also argue for another court ruling on the constitutionality of having the federal government tax state and local interest payments.

While the courts have generally tried to limit tax exporting, congressional actions have generally gone the other way. In one significant case, Congress explicitly encourages a form of tax exporting through the income-tax deduction for state and local taxes paid. This federal deduction lowers the marginal tax price for local public goods for those voters who itemize deductions, and represents exactly the sort of tax exporting that should be prevented from the standpoint of efficiency.^[9]

An examination of the impact of this tax deduction within a state suggests that its effects might be considerably more pernicious than are commonly supposed. A first point is that not all state and local revenues are deductible—in general, fees and charges, the revenues that most closely conform to the benefits principle and hence cause least deadweight loss, are not deductible, while the less efficient income and sales taxes are. A second point is that only 30 percent of all tax returns claim itemized deductions. If the median, or decisive, voter in a community does not itemize, then the deduction does not affect state or local spending but merely represents an unwarranted tax break for the high-income taxpayers who do itemize.

But that is not the end of it. Although only 30 percent of all tax returns claim itemized deductions, it may still be that a high percentage of the tax returns filed by voters itemize deductions. Table 2.5 presents data from a survey of Michigan voters. The bottom row of the table shows that of all 2001 survey respondents, 862, or 43 percent, claim itemized deductions.

The difference between the 30 percent share from overall statistics and this 43 percent share is apparently due to tax returns filed on behalf of minors and others not likely to appear in a voter survey sample. The bottom row also indicates that among voters, the share of itemizers rises to 49 percent. And some of the disaggregated numbers in the table show that among voters in high-income areas, such as the Detroit and Lansing suburbs, the share rises to 60 percent.

Assume for the moment that the median voter model gives a reasonably accurate picture of how public-spending decisions are made in local jurisdictions. The numbers in Table 2.5 indicate the maximum number of voters who would be swayed by the state-local tax deduction to switch their vote in favor of higher expenditures. Using the overall statistics as an example, say that 49 percent of the voters itemize, and that voting turnout decisions are unaffected by the deduction provision. Then up to 49 percent of the voters could have their desired size of public spending increased by the tax deduction. If not too many of these voters had previously favored big governments (in which case they would have already voted for high spending), public spending would be likely to rise in the community. Reasoning in this way, we can see that the effective tax price for public spending is more likely to fall, and public spending to rise, the richer the community.

The tax price for public spending on such social investment services as education is already relatively low in these richer areas because of their high tax base. Now this basic advantage is compounded by the federal

tax deduction. Indeed, a firm believer in migration will also argue that the tax deduction sets up incentives for rich people to live together so that they can export their taxes to others. It is hard to imagine a consciously designed public-policy measure having worse impacts on both efficiency and equity, in the short and the long run, than the federal income-tax deduction for state and local taxes.

Intergovernmental Grants

The other important financing mechanism in a federal system involves intergovernmental grants. As the previous numbers made clear, the United States has a very extensive grant system at both the national and the state level. While most existing grants are categorical, there are separate rationales for categorical grants and for general-purpose grants.

The Rationales for Grants

Grants from higher to lower levels of government can be of a form that alters relative prices facing the recipient government, or that does not. With general-purpose grants the price structure is not altered: these grants affect community income only, and stimulate local consumption of public services according to the income effect. With open-ended categorical grants the price structure is altered: these grants lower relative prices for certain types of expenditures, have both income and substitution (price) effects, and stimulate local consumption of public services according to the uncompensated price elasticity of demand. Since the substitution effect expands spending, if anything, it is easy to establish that open-ended price reduction grants stimulate more spending on the public service in question per dollar of the federal grant.

Whether one type of grant or the other is appropriate depends on the type of problem being corrected by the grant. If there are externalities that imply that social benefits from public services exceed those realized within a community, open-ended price subsidies are appropriate—just the reverse of the tax exportation argument. If the mismatch of expenditure and revenue responsibilities described above is present, general-purpose transfers are appropriate. Indeed, Breton and Scott (1978) point out that there may be any conceivable mismatch of administrative responsibilities for taxes or expenditures at any level of government, making any set of transfers, from higher to lower governments (as most now are), or from lower to higher governments, appropriate.

But the most commonly discussed rationale for general-purpose transfers, and the one that is potentially most relevant in the United States, involves income differences across communities. Should these exist, there will be one of two outcomes. If benefit taxation is not complete, rich people will be net contributors to the public budget and poor people will receive some transfers through the public budget (in Buchanan's [1950] terms, the rich have positive fiscal residuals and the poor negative ones). If benefit taxation is complete, poor people will gain from the higher demand by rich people for public goods.^[10] Either way, the tax price for public services in a community will depend on how many rich people there are or, crudely, on community income.

The argument often stops there, but it should not. Differing tax prices do not necessarily constitute a social ill, though they can if they lead poor communities to under-consume (relative to rich communities) merit public services such as education. One of many ways to eliminate these tax price differences across communities is through general-purpose transfers. But the general-purpose transfers must be compensatory, that is, they must be given in greater per-capita amounts to poor than to rich communities. And it is by no means obvious that general-purpose transfers are the best way to deal with these community income differences. Yinger (forthcoming) points out that two separate notions of equity could be applied in problems such as this: (a) fair compensation, under which all communities would have access to the same bundle of all goods; or (b) categorical equity, under which the expected expenditures on designated public services would be equalized. Under the former notion, general-purpose grants would be appropriate and would have to be given in the amount of income differences among communities. Under the latter, general-purpose grants could be given, but it would be possible to achieve the same end with fewer grant dollars by using Feldstein's (1975) variant of the power equalization approach.

Say that expenditures on public services in the i th community were determined by the linear equation

where E_i is real consumption of public services, Y_i is community income (here used as a proxy for community living standards), G_i is general-purpose grants received by the community, P_i is the dollar size of price-reduction (open-ended matching) grants received by the same community, and the residual u_i refers to all other reasons why spending might differ across communities. With normal preference functions, a₃ >a₂ ; that

is, the price-reduction grants would provide an added impetus to spending. If there exist what are known as "flypaper" effects, whereby general-purpose grants stimulate more spending than income, a₂ >a₁ .^[11] To achieve fair compensation through general-purpose grants, ¶ G_i /¶ Y_i must equal - 1, that is, all income deviations must be compensated dollar for dollar by larger general-purpose grants. To achieve categorical equity, it is merely necessary to insure that expected spending is equal across communities. This is done simply by taking the total derivative of (1) with respect to income, arriving at ¶ G_i /¶ Y_i = - a₁ /a ₂ if equalization is accomplished through general-purpose grants, and ¶ P_i /¶ Y_i = - a₁ /a ₃ if through open-ended matching grants. The first derivative is greater than or equal to - 1; the second is clearly greater than - 1. In these latter cases, because the price sensitivity is relied on to stimulate public spending, and because the standard is not to eliminate all spending deficiencies but only the public-services spending deficiency, less grant money is needed to achieve categorical equity.^[12] Another advantage of this form of matching grants, not shown in the analysis, is that the stimulated public spending could be limited to those public services that really are merit goods.

The upshot of all this is that the usual rationales for general-purpose grants are all quite limited. One rationale could be the assignment-of-responsibilities mismatch described above, though it seems that American subnational governments are able to raise enough revenue to pay for their spending programs without resorting to obviously inefficient taxation. One could be the income-differences argument, though if the categorical-equity standard is used, categorical grants can achieve the same objective with fewer grant dollars.^[13]

Actual Grants

Table 2.6 shows real levels of intergovernmental grants at the federal level over the past decade, disaggregated by type of grant. In principle, a similar analysis of state grants to local governments should be done, but I do not show these data because nobody has developed disaggregations based on the type of grant, and those distinctions are crucial in the analysis.

The table shows that a decade ago, in 1972, there were almost no general-purpose grants, fairly large grants for income support, and even larger categorical grants for other, benefit spillover programs. Over the decade, general-purpose grants rose until 1980 because of the introduction of the Nixon administration's general-revenue-sharing program,

then dropped back in real terms when the Carter administration eliminated general-revenue-sharing for state governments. Categorical grants remained stable until 1980, then dropped back when the Reagan administration killed some of them and converted others to what are known as block grants—grants that are nominally categorical (money has to be spent on a designated function), but effectively for general purposes (the designated functions are so broad, and enforcement so limited, that recipient governments can effectively do what they want with the grant money). Income-support grants have grown from 1972 levels due to the exploding costs of Medicaid, offset by a real drop in AFDC grants.

General-Purpose Grants

The present general-revenue-sharing program goes only to local governments, basically on a per-capita formula. There are provisions in the law that have the effect of giving slightly more funds to poorer areas, but the redistribution is minimal and haphazard.^[14] Even if the redistribution were effective and systematic, however, there would seem to be little cause to retain general revenue sharing. The program violates the levy-your-own-taxes principle described above, in a way that has never been defended in terms of administrative cost saving. And even if redistribution were a more important objective of the program than it apparently is, open-ended matching grants with federal matching rates depending neg-

atively on community income or positively on needs could accomplish the goals of categorical equity with fewer grant dollars.

Block Grants

These grants appear to represent a political compromise: conservatives would like to kill many categorical grant programs altogether but, lacking the muscle to do that, they settle for converting the grant to block form. As said above, this effectively makes the grant into a general-purpose grant. But the allocation of funds for the grant program is based on whatever categorical program just got cashed out—miles of highway, numbers of dilapidated houses, or whatever. Since the grants now are for general purposes, the random elements in the grant distribution formula make the funds allocation even more haphazard than for general revenue sharing. There are also excess administrative costs to maintain the fiction of the block grant. Finally, as argued above, there is no very good argument for general-purpose grants anyway. For all these reasons, these grants should either be terminated or converted to categorical-equity-matching grants for poorer communities. Block grants may provide a useful political compromise, but it is hard to see why an economist who worries about efficiency and equity would ever favor such programs.

Income-Support Grants

I argued above in favor of replacing federal grants for income support with a national program paying basic income-support levels. This should consist of a basic national benefit level (say somewhat above the present average level of AFDC and food stamps). States should be allowed to supplement this level, perhaps with slight (say 25 percent) federal matching support.

In 1983, federal matching grants for all income-support programs totalled $45 billion (see Table 2.6). States spent another $13 billion of their own funds on Medicaid and yet another $6 billion on AFDC. Were the federal government simply to assume these expenditures, federal costs would rise by about $19 billion. Then there should be some reallocations, with most of the $6 billion going to raise AFDC benefits in low-benefit states in the South. The total amount of funds devoted to AFDC can be greater than $6 billion because of the fact that Medicaid is a program much in need of cost-saving reform apart from the federal aspects focused

on here, and various cost-sharing measures should be able to reduce expenditures on it.

Other Categorical Grants

Until the recent introduction of general revenue sharing, conversion to block grants, and rapid growth of Medicaid, the main form of federal intergovernmental transfer has been categorical matching grants in areas such as transportation, education, community services, environmental protection, and hospital construction. These grants appear to have as their rationale benefit spillovers across jurisdictional lines,^[15] but in fact the grants are structured so that they are unlikely to achieve any such objectives.

A first fact about these grants is that legal federal matching shares are very high, averaging 80 percent across the present $29 billion of other categorical grants.^[16] While there may be some benefit spillovers, at the margin the ratio of internal to total benefits for these programs seems to be much higher than 20 percent. This gives states an incentive to overspend, and overspend they probably will. To prevent grant levels from becoming very large, the federal government is forced to impose limits on the size of the grant—overall program limits enforced by the Office of Management and Budget, formula limits for individual governments or groups of governments, and agency limits for application grants. Standard indifference-curve analysis next shows that the price reduction is not effective at the margin, and that the grants have effects much like those of general-purpose grants.^[17] Then budget-cutters such as David Stockman come along and argue that the grant should be either terminated or converted to block form.

This political cycle is designed to end in the termination of the categorical-grant program. Perhaps many of these grants should never have been passed—that is a question for the benefit-cost analysts. But if there is a valid spillover rationale for categorical grants, a better way to improve the grant than by simply converting it to block form and effectively killing it can easily be found. That better way is simply to lower federal matching shares until the ratio of internal to total program costs at the margin equals the ratio of internal to total program benefits at the margin.

In making such a cavalier proposal, I realize that it will often be difficult, if not impossible, to estimate the critical marginal ratio very precisely. But it should not be difficult to come closer than the 20 percent that is now the standard. My own preference would be to assume an internal

share of 80 percent unless it could be shown to be significantly lower. If this is the appropriate share, a very simple demand analysis indicates that such a change should reduce federal categorical grants by about $11 billion, increase expenditures on public services with benefit spillovers, and eliminate a dead-weight loss that appears to be about 1 percent of the level of expenditures.^[18]

The Reform Agenda

Rather than summarize the paper, I will try to maintain its spirit by listing what seem to me to be the major problems with present-day United States fiscal federal arrangements. These problems and the proposed remedies are stated very bluntly, without even trying to list the many compromises and intermediate reforms that could work in the right direction.

1. Given the inability of the national government to stabilize demand shocks, or to stabilize them in different regions simultaneously, states should undertake limited use of stabilization policies. They can do this by creating rainy-day funds, building up these funds (running budget surpluses) in boom years, and running down the funds in recession years.

2. The federal deduction for state and local taxes paid should be abolished. This change will raise federal revenue by an estimated $26 billion (see the summary in Table 2.7), it should affect tax prices and public-spending levels relatively little in rural jurisdictions and central cities, but it should raise marginal tax prices and lower public-spending levels in high-income suburbs. I would have made a similar recommendation, for a similar reason, about the income-tax exclusion for state and local interest, but I am assuming that the provision exists for constitutional reasons, and even my reform proposals do not go that far.

3. Federal grants for income-support programs should be replaced by direct federal income-support programs with uniform national benefit levels and optional state supplementation, perhaps with limited matching support. At today's levels, a reasonable package would raise federal budget expenditures by $20 billion.

4. Federal general-purpose grants and block grants should be replaced by categorical-equity matching grants to poorer communities for merit public services such as education, health, and housing. At

today's levels, $17.5 billion of federal grants would be saved, and perhaps $10 billion could be used for the categorical-equity grants.

5. Federal categorical grants should be altered by lowering federal matching shares to a level that better corresponds to the ratio of internal to total benefits and by eliminating limits on the size of the grant. At today's levels, such a change is likely to reduce federal budget expenditures by about $11 billion.

The measures are not advanced as a package—any one of them could be adopted with or without any of the others. If the whole package were passed, Table 2.7 suggests that all changes combined should reduce the federal budget deficit by about $24 billion—a saving equal to about one-seventh of the enormous present level of the deficit. The short-run impact of the package would be to raise income-support levels greatly for low-income people in the South; the long-run impact should be to raise support levels for all low-income people. People in low-income commu-

nities should benefit further through increased consumption of merit public services. But not everybody will be better off. For a change, high-income itemizers will be made worse off.

Appendix:
Decentralization of Income Distribution Responsibilities

In the text I asserted that the twin forces of beneficiary migration and the diverse levels of AFDC benefits desired by different states argue for a more centralized system of income support. In this appendix I give the exact nature of this argument. The appendix uses real numbers and parameters from Gramlich and Laren (1984).

Suppose we had a country consisting of two states, one that preferred to pay relatively generous AFDC support levels (B₁ ) and one that preferred to pay very low support levels (B₂ ). Each state determines benefits by maximizing the utility function for its decisive voter:

subject to the constraint that

where i indicates the state determining benefits, j indicates the other state, U_i the utility value for the state's decisive voter, Y_i this voter's pre-tax income (for which I will use average per-capita income), T_i the proportional state income tax rate to pay for AFDC, M_i the federal matching rate for the state, and R_i for the level of recipients per capita if state i paid the same benefits as state j . If state i benefit levels exceed those in the other state (B_i >B_j ), recipients would rise according to the migration-sensitivity parameter b . There are cross-state transmission effects whenever b >0.

Determination of benefits in this two-state country is shown in the well-known bargaining diagram Figure 2.1. At the Nash point N each state is maximizing utility under the assumption that all federal matching rates are zero and that benefits in the other state are fixed. At this point we have, for state 1,

where u₁ is the partial derivative of U₁ with respect to B₁ , and where the partial derivative of U₁ with respect to after-tax income in state 1 has been normalized at unity. At the Nash point there is no first-order impact of changing benefits on utility, because the state has already maximized by

Figure 2.1
Determination of Benefits by Bargaining

equating the marginal value of benefit increases (u₁ ) to the marginal cost of income losses (the term in brackets). Hence the indifference curve passing through this point, U₁ , is horizontal there.

But we also know that at the Nash point B₂ increases will raise U₁ , because they attract AFDC recipients into state 2 and raise after-tax income in state 1 for every level of B₁ . This can be seen by differentiating the utility function with respect to B₂ :

This result shows why the U₁ curve is concave from the horizontal axis:

as B₁ is, say, raised above its optimal level at N, increasing rises in B₂ are necessary to keep the state on its indifference level.

The same results are true for state 2. The equation analogous to (3) shows that the U₂ curve is vertical at Nash point N. The equation analogous to (4) shows that benefit increases in state 1 raise utility in state 2. And the curve is concave to the vertical axis because increasing rises in B₁ are necessary to compensate for non-maximizing changes in B₂ .

The fact that indifference curves cross at N implies that utility can be raised simultaneously in both states by bargaining, or by having the central government simply set benefits in both states at some level that raises utility in one state without lowering it in the other. Such a contract curve solution could be found by maximizing the joint utility function

for some arbitrarily specified weight w , assumed to lie between zero and one. But for reasons that will become apparent shortly, that is not going to be my argument for greater centralization. Another proposition is that the Boadway and Wildasin (1984) solution of federal matching could in principle be used to arrive at a contract curve solution, by effectively externalizing some of the cross-state gains of higher benefit levels in a state. Shortly we will also see that if this is the justification for federal matching, actual matching rates turn out to be far too generous to achieve this limited goal.

The diagram gives the area of possible gains from greater coordination as the shaded area. The northeastern limit of this area, denoted by X, can be approximated by reasoning that U₁ becomes vertical when rises in B₁ no longer raise utility in the state, that is, when B₁ is so high that u₁ is zero. Similarly, U₂ becomes horizontal when u₂ is zero. These points can be located with the equations

where the solution is just as before except that the derivatives are used to solve for the levels of B₁ and B₂ where the indifference curves become vertical and horizontal respectively. It can be seen from the graph that the exact crossing point is at a B₁ value less than that at which U₁ is vertical and at a B₂ value less than that at which U₂ is horizontal. I could locate this point exactly if I were willing to assume a specific form for the utility functions, but we will shortly see that such a step is not necessary.

This is all the positive theory that is required; I now try to find the various points with real-life values. The values for B₁ and B₂ will be state

monthly AFDC guarantee levels for a family of four in 1981 dollars, assuming food stamps at a standard national level. Given this level, AFDC guarantee levels of about $600 would have been necessary to keep a family out of poverty status in 1981 (labeled P on the diagram).

The first step is to locate actual benefit levels in the presence of federal matching and migration. Data from Gramlich and Laren (1984) show that in typical high-benefit states, covering nearly half of AFDC recipients, B₁ ranged from $540 to $720 with a mean close to $600. In low-benefit states, B₂ ranged from $115 to $510, with a mean close to $200. These values are indicated on the diagram by point A.

Values at the Nash point N are determined from the equations given in Gramlich and Laren. Equation 9 there shows benefits to be determined in the two states by the relationships

where L(x ) denotes the log of a variable, c is the price elasticity of demand for AFDC benefits, and the Z_i terms represent the influence of all other variables. The Nash point is found by using the actual values listed above and reasonable parameter estimates from the paper (b = 0.65, c = 1.8) to evaluate the Z_i . Then these figures replace Z_i , the M_i are set at zero, and the values at point N are computed: B₁ falls from $600 to $105, B₂ from $200 to $23. The sharp drops are caused by three factors.

1. There is a sharp change in matching ratios, from M₁ = 0.5 and M₂ = 0.75 to zero.

2. The estimated price elasticity is high.

3. The estimated migration effect is high, causing the fall in B₁ to lower B₂ , this to lower B₁ , and so forth as in a multiplier.

Whether these estimates are believable is, of course, not as obvious. The paper finds both estimates to be highly significant, and it does confirm the all-important migration parameter with two different bodies of data.

The next step is to locate point X, the approximation for the northeastern crossing point. Because u₂ is already found to be very low (that is why the group 2 states pay so little AFDC, even when most costs are financed by the federal government), U₂ becomes horizontal when B₂ rises to 30; the same type of calculation makes U₁ vertical when B₁ equals 150. These two values are shown as point X on the graph; the true crossing point is

slightly to the southwest. That these AFDC levels are so low explains why I do not use this lack of coordination argument for greater centralization: the rises in benefits due to improved coordination would not be very high.

Two other points are shown on the graph. Point C, for a closed economy, shows the solution to the model given in Equation 7 when there is no matching and when there is no migration effect. What migration does is to bring benefits in the two states together; when b is set at zero, states diverge to what might be thought of as their true preference benefit levels—close to the actual value for B₁ but close to zero for B₂ . In this sense the present matching-grant system is about right for preserving the closed economy solution for the B₁ states but much more generous than is necessary for preserving the closed economy solution for the B₂ states. Finally, the point labeled M goes the other way, showing the equilibrium values for benefits when migration is infinitely sensitive to benefit disparities, as might be assumed in extreme versions of the Tiebout model. In this case benefits must be equal in the two states, by my calculation at about $40.

Hence the results here are dominated by the low intrinsic desire on the part of the group 2 states to pay benefits. These states now pay benefits of only $200 a month for a family of four, roughly one-third of the poverty line. And this in the presence of a price reduction by the federal government that averages 75 percent, a large estimated price elasticity of demand, a large migration sensitivity, and benefits in other states over three times as high. When the federal matching is eliminated to find the Nash point, benefits in these group 2 states fall to very low levels, and in the presence of the migration sensitivity, this pulls down benefits in the other states. With a Nash point anchored at this low a level, none of the normal federal policy measures aimed at improving coordination will have much effect—even at point X, benefits will be less than $30 in the low-benefit states.

To be candid, then, my policy suggestions are not aimed at preserving tastes in these low-benefit states. My goal is that benefits in all states be set at something like the poverty level of $600 per month, which also happens to be the preferred level in the high-benefit states. The much-maligned present system does bring about this result in these high-benefit states; its defects are highly overrated. But it still does fall short of my goal because of the low benefits in the other states. The easiest way to achieve the goal is simply to have the federal government establish uniform national benefit levels, with optional state supplementation.

As a final matter here, one might ask about two types of sensitivity

tests. First, does the low intrinsic "taste" for AFDC benefits among low-benefit states reflect their low income? The answer is no . The Gramlich–Laren paper also estimates income elasticities as part of the model, and even when these are complicated by the fact that low-income states are likely to have more AFDC recipients, other things being equal, the income elasticities are extremely low. Redoing the Figure 2.1 analysis with all incomes standardized would lead to only trivial changes. AFDC benefits are low in low-benefit states for reasons that are not captured in the income term: many of these states have high incomes.

The other type of sensitivity test refers to the migration parameter b . It is already high enough that the Nash point is geometrically closer to M than to C. But it is also true that if b were underestimated for any of a number of reasons (the opposite of the usual criticism of the Gramlich–Laren paper), point X could stretch to cover point A. Unfortunately, it would take a b value close to 10 (15 times the value now estimated) to get X up to A, and close to 26 (40 times the value now estimated) to get X up to P. Theoretically, more sensitive migration could relieve the strain of the paternalistic argument for centralization: realistically, it cannot.

Acknowledgments

I would like to thank the editors of the volume, along with Henry Aaron, Harvey Brazer, Theodore Bergstrom, Paul Courant, Roger Gordon, Wallace Oates, David Wildasin, and John Yinger for helpful comments. Deborah Laren and Marieka Klaiwitter produced some of the numbers, and some of the work was financed by a grant from the Sloan Foundation.

References

Advisory Commission on Intergovernmental Relations. 1981. "Changing Public Attitudes on Governments and Taxes, 1981." S-10. Washington, D.C.

Atkinson, Anthony B., and Joseph E. Stiglitz. 1980. Lectures on Public Economics . New York: McGraw-Hill.

Barfield, Claude E. 1981. Rethinking Federalism: Block Grants and Federal, State, and Local Responsibilities. Washington, D.C.: American Enterprise Institute.

Barro, Robert J. 1974. "Are Government Bonds Net Wealth?" Journal of Political Economy 82: 1095-1117.

Boadway, Robin W., and David E. Wildasin. 1984. Public Sector Economics . Boston: Little, Brown.

Break, George E. 1980. Financing Government in a Federal System . Washington, D.C.: Brookings Institution.

Breton, Albert. 1965. "A Theory of Government Grants." Canadian Journal of Economics and Political Science 31: 175-87.

Breton, Albert, and Anthony Scott. 1978. The Economic Constitution of Federal States. Toronto: University of Toronto Press.

Buchanan, James M. 1950. "Federalism and Fiscal Equity." American Economic Review 40: 583-99.

—––. 1965. "An Economic Theory of Clubs." Economica 32: 1-14.

Cassing, J. H., and A. L. Hillman. 1982. "State-Federal Resource Tax Rivalry: The Queensland Railway and the Federal Export Tax." Economic Record 58: 235-41.

Courant, Paul N., Edward M. Gramlich, and Daniel L. Rubinfeld. 1980. "Why Voters Support Tax Limitation Amendments: The Michigan Case." National Tax Journal 33: 1-20.

Feldstein, Martin S. 1975. "Wealth Neutrality and Local Choice in Public Education." American Economic Review 65: 75-89.

Fleming, Marcus. 1964. Domestic Financial Plans under Fixed and Flexible Exchange Rates. Washington, D.C.: International Monetary Fund Staff Papers.

Gordon, Roger H. 1983. "An Optimal Taxation Approach to Fiscal Federalism." Quarterly Journal of Economics 98: 567-86.

Gramlich, Edward M. 1982. "An Econometric Examination of the New Federalism." Brookings Papers on Economic Activity 2: 327-60.

—––. 1984. "Subnational Fiscal Policy." Mimeo. Ann Arbor: University of Michigan.

Gramlich, Edward M., and Deborah S. Laren. 1984. "Migration and Income Redistribution Responsibilities." Journal of Human Resources 19: 489-511.

Hellerstein, Jerome R. 1977. "State Tax Discrimination against Out-of-Staters." National Tax Journal 30: 113-34.

Holmer, Martin. 1975. "Economic and Political Causes of the Welfare Crisis." Ph.D. dissertation. Cambridge, Mass.: MIT.

Ladd, Helen F. 1982. "Financing Public Services in the Federal System." Pp. 31-44 in Federalism: Making the System Work . Washington, D.C.: Center for National Policy.

Ladd, Helen F., and Fred C. Doolittle. 1982. "Which Level of Government Should Assist the Poor?" National Tax Journal 35: 323-36.

Levin, David J. 1983. "Receipts and Expenditures of State Governments and of Local Governments, 1968-81." Survey of Current Business 63: 25-38.

Lucas, Robert E. 1972. "Expectations and the Neutrality of Money." Journal of Economic Theory 4: 103-124.

McLure, Charles. 1967. "The Interstate Exporting of State and Local Taxes: Estimates for 1962." National Tax Journal 20: 49-77.

Medoff, James L. 1983. "U.S. Labor Markets, Imbalances, Wage Growth, and Productivity in the 1970s." Brookings Papers on Economic Activity 1: 87-120.

Mieszkowski, Peter, and William H. Oakland. 1979. Fiscal Federalism and Grants-in-Aid . COUPE Papers on Public Economics 1. Washington, D.C.: Urban Institute.

Mundell, Robert A. 1963. "Capital Mobility and Stabilization Policy under Fixed and Flexible Exchange Rates." Canadian Journal of Economics and Political Science 29: 475-85.

Musgrave, Richard A. 1959. The Theory of Public Finance: A Study in Public Economy . New York: McGraw-Hill.

Mutti, John H., and William E. Morgan. 1983. "The Exportation of State and Local Taxes in a Multilateral Framework: The Case of Household Type Taxes." National Tax Journal 36: 459-76.

Nathan, Richard P., Allen D. Manvel, and Susannah E. Calkins. 1975. Monitoring Revenue Sharing. Washington, D.C.: Brookings Institution.

Oates, Wallace E. 1972. Fiscal Federalism . New York: Harcourt, Brace, Jovanovich.

Pauly, Mark V. 1973. "Income Redistribution as a Local Public Good." Journal of Public Economics 2: 35-58.

Sargent, Thomas J., and Neil Wallace. 1975. "Rational Expectations, the Optimal Monetary Instrument, and the Optimal Money Supply Rule." Journal of Political Economy 83: 241-54.

Schultze, Charles L. 1974. "Sorting Out the Social Grant Programs: An Economist's Criteria." American Economic Review 64: 181-89.

Tiebout, Charles M. 1956. "A Pure Theory of Local Expenditures." Journal of Political Economy 64: 416-24.

Tresch, Richard W. 1981. Public Finance: A Normative Theory. Plano, Texas: Business Publications.

U.S. Department of Commerce. Survey of Current Business , various issues.

U.S. Office of Management and Budget. Budget of the United States Government , various issues.

Walsh, Cliff. 1983. "Reforming Federal Financial Relations: Some Radical (Or Are They Conservative?) Proposals." Paper presented at the Federal Finances Symposium, Hobart, Australia.

Wilde, James A. 1971. "Grants-in-Aid: The Analytics of Design and Response." National Tax Journal 24: 143-56.

Yinger, John. Forthcoming. "On Fiscal Disparities across Cities." Journal of Urban Economics.