The UK and EU have achieved their shared ambition to remove tariffs and quotas on all goods, but the deal will have larger consequences.
There’s been a lot of talk that our federalism might come to look like the EU, with Illinois starring in the role of Greece or Italy. However, the institutional differences are far too great for meaningful comparison. For example, Chancellor Merkel can depose the Italian Prime Minister with a phone call; our Constitution does not give the President, the Congress, or for that matter the National Governors Association any such agency in the affairs of a member-state. For another example, the EU (outside the egregious but fairly small Common Agricultural Policy and a few other slush funds) isn’t a transfer union. Our federalism is or rather has become that sort of union. That doesn’t mean we have a smaller problem than the EU; it just means that we have a different problem. For purposes of comparison and instruction, you want to look at a federal system that shares our problem. Come visit Argentina: you’ll see the future, and it doesn’t work.
It Can Happen Here
Like the United States, Argentina is a presidential, federal, and bicameral system. It features a large number of states (provinces) and a powerful, poorly apportioned upper house (the Senate). Its nineteenth-century constitution is modeled on the U.S. Constitution and, prior to 1994 amendments that in atonement for the country’s authoritarian sins domesticated the international NGO agenda (e.g., the protection of women during lactation, art. 23 § 75 ch. IV), resembled ours in striking detail. And, Argentina’s federalism was profoundly “dual” until the mid-twentieth century when it succumbed, as did our federalism, to a “cooperative” model and massive federal transfer payments.
Argentina has since become a poster child for fiscal federalism’s dysfunctions. Provinces overspend and gamble on federal bailouts; go bust; are taken over by federal officials; and, following a brief interregnum, promptly revert to their exploitative form. This dynamic, political economists have argued, has contributed greatly to Argentina’s lamentable fate: its century-long economic decline, broken by intermittent, often hectic and inflationary growth spurts; periodic defaults on the nation’s debts; and political instability and lurches into authoritarian government. Rebuilding democracy in the wake of those events requires, in practice, the purchase of local political elites. But you can’t really buy local politicians; you can only rent them. When the game gets out of hand yet again, you need another caudillo.
Occasional suggestions to the effect that America, too, confronts an authoritarian threat are probably due to the peculiar air in New Haven. However, American federalism has begun to develop other pathologies that are on full display in Argentina. Two parallels are particularly suggestive: “executive federalism,” and federal bailouts in the form of pension reform.
Argentina suffers an extreme vertical fiscal imbalance—that is, a highly centralized system of tax collection, coupled with highly decentralized spending (and borrowing) authority and an extravagantly large system of federal transfers. Over 60 percent of provincial budgets consist of federal transfers. The distribuition is supposed to follow a prescribed formula. In practice, however, transfer amounts and conditions are often haggled out in “fiscal pacts” between provincial governments and the national executive. Naturally, those pacts are driven not so much by substantive economic rationality but by political needs and forces, such as the executive’s protection of a political power base and the provinces’ bargaining strength. A general reform of this system, though promised in a 1994 constitutional revision, has never materialized.
It’s tempting to think that that can’t happen here. The Congress is far more assertive vis-à-vis the executive than the Argentinian legislature. It seems unlikely that it would consent to executive-led fiscal pacts or that individual states would voluntarily lock themselves into global fiscals bargain with the federal government. In fact, however, it’s already happened: behold Medicaid.
Medicaid represents well over 40 percent of all federal transfer payments. The vertical fiscal imbalance has reached Argentinian proportions: the feds pay 60, 70, or 80 percent of state expenditures. Moreover, the Congress has deliberately put itself into the position of the Argentinian legislature and agreed to write a blank check for whatever the federal expenditures the states’ fabulous experiments may entail. The contours of state programs, in turn, are haggled out between a federal bureaucracy with ample discretionary and waiver authority and individual states that vary widely with respect to both the local spending demand and their propensity and ability to game the system.
Obamacare massively expands Medicaid and further increases the vertical imbalance. Moreover, it couples this expansion with a system of state-run but federally subsidized and superintended health care exchanges. These arrangements, too, are largely a matter of poorly constrained, individualized federal-state bargains. In short, the health care and insurance sector—a very large swath of the U.S. economy and of the business of government—has been effectively Argentinianized.
Unfunded, unsustainable state and local pension obligations have been a central issue in Argentina as well as the United States, for substantially identical reasons: those obligations are the hangover that follows a federally co-financed spending binge. A few states (led by Rogue Island, of all places) have sought to address the problem. Most, however, have failed to take appropriate measures, and the steps taken so far—for example, a move from defined-benefit plans to 401(k)-style plans for new state and local employees—can delay but not avert the day of reckoning. Someday, somebody will have to cut the entitlements and abrogate the contractual (and in many states constitutional) obligations: how? Argentina provides a model.
In 1994, the central government rolled the pension programs of eleven provinces—outstanding obligations, contributions, and all—into a recently reformed (but soon-to-be troubled) federal pension system. The cost of this bailout was initially estimated at $500 billion; the actual cost proved three times that amount. Then, the government declared that the obligations would be payable not (as originally promised) in U.S. dollars but in Argentinean pesos. The devaluation amounted to roughly 13 percent of outstanding obligations.
Perhaps, the scheme is needlessly complicated: we could and most likely will peso-ize the U.S. economy and inflate state and local debts away along with everyone else’s. Moreover, a global federalization of state and local pensions seems very unlikely. State and local employees who are firmly entrenched at the local level but lack a federal “go-to” agency that would tend to their demands (for example, police and firefighters) would consent to federalization only as a last resort and as an alternative to an otherwise certain benefit cut. However, one can quite easily imagine an Argentinian solution for other parts of the state and local workforce, such as educational personnel. Teachers have a muscular presence in Washington and a federal agency (the U.S. Department of Education) that sees to their concerns. Existing federal statutes, moreover, already regulate their workplace entitlements. A quality education for all children, the federalization argument runs, presupposes highly skilled and motivated teachers. Such teachers cannot be attracted or retained if their retirement benefits are in perennial doubt. Accordingly, the argument continues, states participating in federal education programs must either guarantee and fully fund those benefits in perpetuity or else, opt into a federal pension system. A “Teacher Retention Act” along these lines could roll millions of state and local employees into an Argentinian system.
More Bright Ideas
There are other ways, with precedents in American (as well as Argentinian) history, of dealing with looming state insolvencies. For example, the Federal Reserve could buy distressed states’ bonds or, more likely, engineer their purchase by means of financial repression (“Dear Wells Fargo: buy state bonds, or close your books and branches by Monday.”): that’s how we disposed of WW II debts. Or, California could divide Orange County into Yellow County and Red County and inform creditors that the debtor entity, alas, has ceased to exist: that’s how states often disposed of counties’ railroad bonds in the late 1800s.
Against these imponderables stand two certainties: the only reform that would work is a drastic curtailment of the transfer state; and that, precisely, is the one reform that isn’t going to happen. The Reagan administration tried it in the 1980s. But it failed; and since then, the political environment has deteriorated to the point of putting another reform effort out of reach. Democrats recognize, more keenly than they did three decades ago, that the transfer state is the party’s backbone: it sustains both the recipients and, more importantly, the (unionized) distributors of federal-state largesse. Republicans, for their part, have gotten much dumber. The GOP’s federalism Plan B, after the failure of the Reagan agenda, was “devolution”—that is, the expansion of transfer programs, on “block grant” terms that are more acceptable to state officials and therefore more ruinous to the nation. This agenda unites Republicans from the Tea Party to Romney moderates, from the caucuses to (most ludicrously) the court cases over Obamacare; and the will to rethink the agenda is nil. Thus, our polarized politics converges on a 1960s-ish consensus: Cooperative federalism hasn’t failed. It has never been tried.
As Thomas Hobbes taught, the fear of death never prompts individual action: death is certain, and fear of it is a constant. People learn to live with it and with the loss of vitality along the way. What sparks constitutional thought and action is their fear of a sudden and violent death. The same may be true of political systems, including our federalism. It faces no imminent collapse; and because it doesn’t, it may be destined for an Argentinian fate.