The Debt Trap, Part (2): The Unaffordable We-Don’t-Care Act

Yesterday’s post, on the seemingly unstoppable growth of federal transfer payments to state and local governments, ended on a question: what happens when both parties to the transaction, the states and the feds confront unsustainable commitments? The brilliant answer our federalism has produced: make yet more unsustainable commitments. Why?

Start with an iron law of federalism: in any federal system, junior governments will undertax, overspend, and gamble on a federal bailout. (Jonathan Rodden’s splendid book on Hamilton’s Paradox is a great introduction. If you have the stomach.) When they do, only two remedies are available to deal with the situation and, prospectively, to deter the conduct:

  • Let wayward states go bust. Historically, that’s been the American way. States defaulted in the early 1840s and again after Reconstruction; in the 1930s, Arkansas earned the singular distinction of defaulting for a third time. The feds didn’t blink.
  • Bail them out, while making the remedy so costly that potential offenders will think twice. That’s the Merkel-Schaeuble EU: drum offenders through a back-breaking austerity program and run their governments from the Reichskanzlei for a few years. That’ll teach the next guy (unless he’s French).

The dilemma of our federalism is that neither of these reponses is available. Option (1) requires a strict segregation of state and federal revenues and spending, as we did in the pre-New Deal era. Once a big federal transfer state incentivizes states to tax and spend themselves to the brink of ruin, “drop dead” ceases to be a viable political response. Option (2) is foreclosed as a constitutional matter.

Now what? For well over a decade, the dominant response has been to enact state bailouts under different names and without admitting that that’s what we are doing.

Unsurprisingly, some bailout measures were temporary responses to the financial crisis that began in 2008. For example, the federal government created Build America Bonds, effectively subsidizing some $115 billion newly issued municipal bonds at a 35 percent rate. For another example, the 2009 “Stimulus” provided hundreds of billions to state and local government for “shovel-ready” infrastructure projects and to prop up the government employment market.

The real action, however, has been under Medicaid—the biggest and most generous transfer program and, consequently, the chief contributor to the states’ fiscal woes. Under the Clinton administration, Congress enacted a childrens’ health insurance program (“CHIP”) that allowed states to re-assign Medicaid-covered children from that overburdened program into the yet-more generously funded CHIP program. Similarly, under the first Bush administration, Congress enacted a prescription drug benefit that allowed states to transfer “dual-covered” elderly’s prescription costs from Medicaid to the wholly federal Medicare program, thus producing (despite a federal “clawback” provision) substantial Medicaid savings for states. The 2009 Stimulus contained a temporary increase of the Medicaid funding formula (“FMAP”). All those de facto bailouts, however, pale in comparison to Obamacare.

  • Obamacare provides for a massive expansion of Medicaid, sweeping in some 16 million currently uninsured individuals. Under Medicaid’s current FMAP, the feds pay between 50 and 83 percent of the states’ costs. In contrast, they will pay 100 percent of the costs for the “newly enrolleds.” The ratio will gradually decline to 90 percent by 2019. Even so, Obamacare will add at most 2 or 3 percent to the Medicaid costs that the states would have incurred in any event. For most states, moreover, Obamacare means a substantial increase of the average FMAP. Texas, for example, will see its match increase from roughly 60 to 70 percent.
  • For uninsured individuals outside Medicaid’s ambit and and for small businesses, the act envisions the establishment of state-run, federally superintended “health benefit exchanges.” (In states that fail to establish such exchanges, the U.S. Department of Health and Human Services [HHS] will do so directly.) The federal government will provide substantial subsidies for insurance obtained through—but not outside—an exchange. And wouldn’t you know: states will be able to tranfer hundreds of thousands of current and former employees and the their health care expenses from state-funded programs into the exchanges (or, for some groups, into the expanded Medicaid). The magnitude of this effect will depend on HHS regulations. State politicians will lobby aggressively for transfer-facilitating rules, and HHS will be hospitable to their entreaties. It needs the states, both to provide political support for a widely unpopular statute and to make the unwieldy exchanges work as well as they will.

Obamacare isn’t a centralist assault on federalism. Rather, it doubles down on our federalism’s debilities: yet more debt-financed spending, yet more warped incentives, yet another bailout. That reckless maneuver, aided and abetted by the states (who were for Obamacare before some of them were against it), will collapse under its own weight of debts and dysfunction. To borrow a phrase: it was never “built to last,” and never meant to last. Our federalism has reached its outer limits.

Next stop, this coming Monday: Argentina.

Reader Discussion

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on March 05, 2012 at 19:57:43 pm

As far as I know, no one's ever challenged the child tax ceirdt. But as a broad matter, do I think the way that Congress has mangled our tax code often ought to be unconstitutional? Umm, yes. Do I also think that these manipulations are a bad idea? Also yes. As a legal matter, not all things done through the tax code are taxes, so no, a refundable tax ceirdt is not a head tax. Are you a tax protester? I've heard that argument from TPs before, and as far as I know, that's been litigated extensively already. On the other hand, actual head taxes per person taxes of a fixed amount that are not triggered by an activity or income are pretty much black letter law; as far as I can tell, there would have to be a pretty novel finding to conclude that a $750 per person tax is not a head tax. Taxing income required an amendment for this reason.As for the question can Congress avoid its enumerated powers by forcing the states to carry out its will , this has also been litigated extensively, and the answer is no. Is what Massachusetts doing constitutional? I'm afraid I know nothing about the Massachusetts state constitution; I don't see anything in the US constitution that forbids it.The interpretation of the tax code that y'all are pushing seems to me to end in the conclusion that congress can raise taxes by $3,000 and then start offering $3,000 rebates to people who attend church once a week, or read the complete works of Marx, or volunteer on political campaigns. Should I really not be bothered by congressional attempts to run around limits on its powers whether those limits are it enumerated powers, or the bill of rights by using the taxing power?

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on March 06, 2012 at 12:26:35 pm

Let's go back to how this would have to be structured. After tkihning about this, I believe I misspoke earlier; there may be no real way to replicate the mandate through the income tax code. A $750 decrease in any given allowance does not result in a $750 decrease in your taxes; it results in a ($750*mtr) decrease in your taxes. You would need some incredibly complicated formula to step up everyone's taxes by $750 (maybe reduce all the allowances by exactly $750?)Let's say we figure that out, though. There are a lot of people whose deductions now more than cover their tax liability, which means that no matter how you slice it, you'd have a lot of people whose additional $750 was eaten by the excess deductions and allowances they currently enjoy. You'd then be giving anyone who bought insurance a bonus tax credit. This would be a problem on a bunch of levels. A lot of that insurance is heavily federally subsidized, so that the people on the exchanges whose behavior we are most trying to effect could very easily be getting a tax credit for more than their cost of buying insurance. It would also be way more expensive than the original plan so expensive that I'm pretty sure that the bill never could have passed under that structure. Essentially, there would be no penalty for a lot of people who didn't buy insurance (the group we're most trying to affect) and a bonus $750 we're giving to people who may not have paid $750 directly for thier insurance, either because their employers provide it for less, or because they bought heavily subsidized insurance on the exchange.Which gets us to your argument: doesn't this make insurance essentially free? Why wouldn't people do this? The first answer is that people are liquidity constrained they can't necessarily invest $100 a month now because they'll get $750 back in twelve months. The second is that people do not, in the tax code, behave like rational value maximizers and the lower-income folks we're most trying to affect behave least like this. Framing seems to have had big effects on how the Bush tax rebates were spent, for instance, even though this shouldn't matter at all. The third is that many people again, the ones whose behavior we are most trying to affect will have no idea that the tax credit even exists; sophistication about the tax code is not evenly distributed through the population. And fourth, of course, it will not be essentially free for many of the people expected. Even in a low cost state, a pretty modest insurance policy will run you at least twice the cost of the mandate.So to sum up, a refundable tax credit would be hugely more costly, probably couldn't be enacted in any structure recognizably the one being described by proponents (we're just raising taxes $750 then rebating them!) and would serve as a much weaker deterrent to behavior.It's kind of like saying, What if we presumptively assumed that the government could jail everyone, BUT we gave everyone a get out of jail free' card that we would only take away if they committed a crime. I mean, I can see how in abstract, you could say that this is really the same thing as we have now. But even though the outcomes might look the same at T0, and you could even claim that the system was animated by the same principals, I (and I think most libertarians) would say that it's actually very different.

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