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Governor Cuomo Gets It, Sort Of. So Does The Donald.

New York Governor Andrew Cuomo is mad as hell, and he is not going down without a fight. The object of his ire is the recent federal tax reform, which sharply limits the deduction for state and local taxes (“SALT”) to $10,000. As the Governor notes, the reform hits hardest in states with disproportionate numbers of high-income earners, high tax rates, and high property values. They’re all blue: New York, New Jersey, Massachusetts, Connecticut, Illinois, California. The tax reform is an “economic civil war,” the Governor says, and he has filed a lawsuit to the effect that it is unconstitutional. That will go nowhere. It’s a distraction from the Governor’s main point. And in fact, he has one.

The Power to Tax, and Spend

Why should red states effectively subsidize the blue spendthrifts’ high-tax experiments, by way of the SALT deduction? That excellent question, Cuomo & Co respond, has it backwards: blue states are subsidizing red states by way of transfer payments. Their federal “balance of payments” (tax dollars to Washington, where they spend an expensive night on the town; remaining federal dollars back) is consistently negative; that of red states (Texas and a few smaller states excepted) is positive, and some red-state moochers make out like bandits. The end of the SALT deduction makes an unfair situation worse.

The reply is correct, as far as it goes. While there are various ways to run the calculation, the list of payor states is always the same, as it has been for many decades. One well-executed study by the Rockefeller Institute concluded that in 2015, New York had a net payment of $48 billion—a whopping $2,425 for every wretched soul in the Empire State.

What to do about it? Not make things worse: got that, Governor. But the blue-state balance of payment was consistently negative even with the SALT deduction. It’s driven primarily by above-normal tax payments, not below-normal transfer payments. (New York receives, and spends, federal Medicaid dollars like nobody’s business).  The imbalance has worsened as the federal income tax has become a lot more progressive. The only real fix is a rip-roaring tax cut for the hedgies, an option that isn’t high on the Dems’ agenda. (They yapped even about the modest cut in the recent reform.) Although, come to think of it, that’s the real-world constituency on whose behalf Governor Cuomo has filed his preposterous lawsuit.

From here to eternity, then, wealthy blue-staters will continue to do what they’ve done all along: pay to support social services and other stuff in other states. You wonder how that could ever be a stable arrangement. Part of the answer is that states don’t pay taxes. Taxpayers do, and they don’t think in balance-of-payment terms. (Nor do the recipients of federal largesse.) In many ways that’s a much more natural perspective. But you’d think that some blue-state politician would propose to terminate the intergovernmental transfer system and to run, say, Medicaid or education with domestic dollars, for the home folks only. With the interstate cross-subsidy gone, it’ll be much cheaper—no?

No. There is no way that New York or California or any other state would tax itself to support social services at remotely the current price level: rich people would exit at an even faster clip. You can’t have socialism in one country. If you’re a blue-state politico you desperately need a federal transfer system even if it plays your own citizens for suckers—not because you want to be nice to Alabama but because you need (a) a source of funds that taxpayers can’t escape by moving and (b) a fiscal illusion.

The transfer system creates that illusion by lowering the perceived tax price both at the federal level (“we’re getting a lot for our money because the states pay for most of the program”) and at the state and local level (“look at all the federal funds we’d lose if we did not expand Medicaid”). The SALT deduction helps, or rather helped, to further obscure the transactions, to jack up state tax capacity, to ramp up the demand for government everywhere, and to dampen state tax competition.

It’s easy to see, then, why Cuomo & Co denounce the reform as an assault on the blue-state model. But there’s more to this.

Energy and the Executive

If you’re a blue state politico and you don’t want wealthy and productive people to head for the hills, you need the feds to create fiscal illusions and to supply implicit subsidies. But you need them for something else: impose burdens on red states that makes their business model less attractive. Economists call this strategy “raising rivals’ cost.” Policy dorks call it the Clean Power Plan. And the Methane Rule. And the Waters of the United States Rule (WOTUS). And 500 other impositions that make it way more difficult for red and especially energy-producing states to exploit their comparative and competitive advantages.

Lo and behold: with the change in administration, much of that is gone. The Clean Power Plan is dead, or will soon be. The Dakota and Keystone pipelines have been or will be built. A new WOTUS will bring relief to farm states. Included in the tax reform was a telling piece of real estate management: we will drill, baby, in Alaska. Anti-fracking rules are being relaxed or yanked back. Vast tracts of Utah desert have been declared safe for bipeds. And so on, for so long as Mrs. Rao, Mr. Pruitt, and Mr. Zinke remain in their respective offices.

To be sure: you can (and I would) defend America’s splendid Energiewende on independent grounds that have nothing to do with political calculations or the red-state/blue-state divide—just as you can (and I would) proffer such arguments for ending the SALT deduction. Still, it is striking that in both cases, the costs and benefits of the recent policy changes fall along totally predictable state lines. Pure coincidence? I think not.

Economic Civil War?

We’re not going to re-fight or re-argue Grant v. Lee. But the Governor’s larger point is correct: as I observed in these pages eons ago (2012), American federalism has again become sectional, and the divide now runs along parallel economic, ideological, and partisan lines. The federal government has enormous control over the distribution of costs and benefits across the country; and in a sharply polarized environment, partisan calculations will come to dominate. For the most part, moreover, what matters is control of the presidency. The SALT deduction repeal required congressional action; not much else does. Herewith, then, some safe predictions:

The major free-trade deals will survive.  The President may or may not be a stable genius, but he is not sufficiently dumb to hammer the farm states. On a less happy note, ethanol subsidies will continue to gush. An infrastructure package, should it materialize, will be structured so as to allow the Executive to steer the benefits to friendly or crucial “swing” states (as was done under President Obama’s “Stimulus” bill). Major benefit programs will be restructured. The GOP’s American Health Care Act would have revamped Medicaid in a way that was plainly calculated to benefit states that had declined to expand the program under Obamacare—all of them (except Virginia) deep-red. That bill failed, but the same result or something close to it can be achieved by executive order or connivance. That shoe will drop.

In short, the SALT assault is but one piece of a broad-scale policy agenda that puts enormous pressure on the blue-state model and in particular on its principal beneficiary: public sector unions. They are taking it on the chin in several ways. The net payor, now-SALT-less states are by and large also the ones with the most under-funded pension plans, and that fiscal dilemma will be fun to watch. Further, the major federal benefit programs (Medicaid, education) don’t really fund the poor and the sick: they fund their unionized providers, and federal retrenchment can’t be good for those groups. All that, mind you, before we learn what Secretary DeVos might come up with.

I confess that I am of two minds about this. I remain persuaded, as I was even before the creation of this splendid site, that sectionalism—a deep divide among state blocs, on a vital issue of politics—is just about the only hope for limited government in a federal system; and we should count ourselves blessed that it’s economics, not race, that now defines the divide. Surely, too, it’s past time to wring the union and provider rents out of the system. Then again, it is mildly alarming that the Executive so dominates the system. The grim prospect is profound corruption—not Mickey-Mouse emoluments, but the sort of “corruption” the Founders feared: the executive use and abuse of the governmental apparatus for purposes of systematic favoritism and oppression.

That’s what you fear, Governor—right? Let’s think about who and what brought us to this point.

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