Senators, Please Use Federalism to Address the Debt Crisis:

Cut expenditures and tax credits on matters best left to states and localities

The Senate needs to do serious work on “The One Big Beautiful Bill,” the 10-year reconciliation legislation, which squeaked through the House of Representatives by one vote. Senators must slice more than a trillion dollars from the House bill if it is to unravel a massive increase in the national debt induced by the fiscal response to the Covid pandemic. (The number is less than reported in many legacy media outlets, which misleadingly compare the bill to what would happen if current law expired rather than to current law.)

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Between 2010 and 2025, the national debt increased from 80 percent to 120 percent of the nation’s Gross Domestic Product (GDP). In the absence of a policy change, it will increase to over 150 percent by 2055. Just this past week, Moody’s downgraded the once golden U. S. credit rating.

Arriving in time to help the Senate address the issue is a collection of essays, released by the Hoover Institution at Stanford University, that provides guidance on what, where and how deep expenditure cuts need to be made.

In the concluding essay, Hoover economist John Taylor says “government spending [needs to] grow more slowly than GDP [so that] government spending is . . . reduced as a percentage of GDP.” The cuts need to be permanent, pervasive, and predictable. In other words, tax and expenditure policies should be applied broadly, should not target narrow groups of taxpayers or recipients, and should be long-term, not scheduled to expire in a few years.

Taylor-like policies may be too much to ask of a Congress where party lines are tightly drawn, the minority party is united in opposition, and the majority party needs nearly every vote to enact a “one big,” if less than gorgeous, reconciliation bill. To strike the bargains needed to get nearly every Republican vote, House Speaker Mike Johnson had to make concessions to special interests. The Senate needs to repair the damage and bring the bill closer to what Taylor proposes. It can do so by making good use of the federal system.

Two other essays in the Hoover collection provide guidance as to how this might be done. The first, by economist John Cogan, begins with an account of expenditure policy during the earliest years of the American republic. James Madison and his congressional allies repeatedly rejected proposals to spend money on education, road and canal construction, education, disaster relief, or bounties to fisherman. In Madison’s view, Congress did not have the constitutional authority to spend federal dollars for such purposes.

Only after the Civil War did Congress depart substantially from Madison’s view of the constitution. Beginning with the Lincoln and Grant Administrations, the federal presence in the domestic economy began to increase. Freedom schools were opened for former slaves, federal land was used to promote colleges, an office of education was created, construction of a nationwide web of railroads was initiated, and federal payments to the families of Civil War veterans were authorized.

In the 1930s, growth in federal domestic expenditure took off with the launch of Franklin Delano Roosevelt’s New Deal, then escalated to ever higher levels after World War II and during the Great Society decades. In a 32-year stretch between 1950 and 1982, the percentage climbed from 15 percent to 23 percent of GDP, burgeoning to 30 percent during the Covid pandemic. Tax revenues failed to keep pace, driving the national debt steadily upward.

Cogan does not propose a “return to the good old days,” but he does conclude that national priorities should be focused on defense and international affairs. Domestic programs should be “returned” to the lower tiers of government. Were that done, the deficit problem would be resolved. As compelling as that may sound, Cogan’s plan may be too dramatic a policy reversal.

In another essay,” Carlos Lastra and I suggest that the federal government leave the cost of basic services to states and localities and concentrate its own domestic efforts on programs that serve the needy, the disabled, and elderly. We advocate a continued federal role in the funding of social security, Medicare, Medicaid, disability insurance, and other redistributive programs. Were these programs turned over to states and localities, many of them would eschew their responsibilities, setting off a “race to the bottom,” with every state under pressure to downsize its assistance to dependent populations. But we see no need for a federal role in the delivery of basic services.

In its essence, what we propose does not differ from the basic division of responsibilities across tiers of government that exists at the present time. In 2021, 82 percent of federal domestic expenditure was focused on redistributive programs (social security, Medicare, Medicaid, and the like). Only 18 percent funded transportation, police, fire, education, and other basic services that had little to do with social welfare policy.

Still, that 18 percent spent on non-redistributive services was a vast sum of money in 2021, no less than 4.7 percent of the country’s Gross Domestic Product (GDP), up from 2.4 percent when Bill Clinton took office in 1993. In other words, the federal government has taken on numerous tasks better left to the local tiers.

To take just the most recent example, the $900 billion dollar “green” expenditures and tax credits authorized in 2021 departs dramatically from the usual federal sphere of responsibility. It was justified by a utopian goal that required world-wide co-operation that seems further away today than ever before. The House bill corrects that misdirection in public policy by cutting green programs by more than one half, saving a half a trillion dollars. If the Senate made similar cuts in other federal non-redistributive programs, the Taylor goal could come close to realization.

The Senate should also eliminate from the House bill the new federal tax break given to high income earners who otherwise will be allowed to deduct a healthy share of their state and local taxes from their taxable federal income. This provision of the bill is popular in wealthy, high-expenditure states like California and Massachusetts, but for a federal system to work effectively, each level of government should bear the cost of its own operations. High-income taxpayers should not be sheltered from the consequences of excessively overblown state tax and expenditure policies.

Nor should states be allowed to impose a tax on health providers, which can then be passed on to the federal government. In other words, states can make money by taxing the provider they are assisting, a practice that began as the result of mistaken language in a long forgotten piece of legislation. The billions of dollars the mistake is costing the federal government continues to rise, and the House bill has added language which makes matters worse. Unless the Senate takes action, it will cost the federal government $100 billion dollars over the next ten years. Hopefully, the Senate gets rid of the practice altogether.

Finally, all recipients of health services should be required to make co-payments for health services unless they are truly disadvantaged or destitute. When health services are free, they will be utilized excessively.

By focusing on the appropriate division of responsibilities in a federal system, and by making small, sensible adjustments that eliminate favoritism for special interests, Congress can enact a 10-year reconciliation act that meets the Taylor objective, a government fiscal policy that keeps expenditure growth to a rate less than expected GNP growth.

Paul E. Peterson is a senior fellow at the Hoover Institution and the Henry Lee Shattuck Professor of Government at Harvard University.