Questions of federalism-in ordinary times, an eye-glazing subject-are currently headline news on both sides of the Atlantic. In Europe, the debt crisis that began and continues in Greece now poses an existential threat to the union. No such specter, of course, haunts the United States. Still, the political debate across the pond has taken on a tone of great urgency; and as so often in American history, federalism has taken center stage. Much of the tea party's energy, as well as the rhetoric of the leading candidates for the Republican nomination, is directed towards "more federalism"-to the proposition that we must "take the country back from Washington" and restore state and local governments to their rightful place.
This agitation occurs in a context of acute political and economic distress. Large majorities of Americans-larger than ever since the advent of modern opinion polling-think that the country is headed in the wrong direction. The causes are hardly a secret. The 2008-2009 financial crisis brought the country, and the world, to the brink of a Great Depression. Then, the Obama administration's health care initiative prompted widespread dismay over a fateful step toward a cradle-to-grave welfare state. This past summer, public attention shifted to the nation's perilous financial condition, unsustainable entitlement programs, mounting debts at all levels of government, and Washington's evident inability to stem these alarming trends. All this has been playing out against a backdrop of stagnant wages, a desolate housing market, escalating health care costs, and persistent high unemployment. Naturally, the politicians argue and fiddle. Democrats attribute the country's distress to an unusual confluence of external shocks; Republicans say that it's the result of rotten leadership and socialist policies. But the voters seem to think that Rome is burning-that our institutions have ceased to function, almost regardless of who occupies them. This is why public fears run so deep, why election results are so volatile, and why the political debate has assumed such a prominent constitutional dimension. The clamor for "More Federalism" is part of this picture. If Washington fails, the thinking goes, don't have it do so doggone much. Bring government closer to the people.
Up to a point, the anti-Washington sentiment strikes me as a good thing. For example, it serves as a salutary check on some of government's more grandiose ambitions, like a carbon-free world. But the debate has taken overtones of a kind of European Union-ism in reverse. European constitutionalism rests on the unshakable premise that there has never been, there is not now, and there never must be a question to which "ever-closer union" is not the answer. The American debate is not quite so dogmatic. Still, it often seems as if conservatives in particular have yet to discover a problem (regulatory, fiscal, or social) to which an "ever looser union"-decentralization, or "devolution"-is not the answer. The notion that "more federalism" will automatically mean better, smaller, more responsible and accountable government is a standard trope of American conservative politics.
I believe that it is wrong. In some forms and settings, federalism can indeed discipline government and render it more transparent and more accountable. In its current form, however, federalism is a pathology. It is an institutional arrangement that empowers government at all levels and, in the process, erodes political transparency and accountability. Many of the problems of American politics-fiscal profligacy, regulatory excess, political alienation-are caused or at least amplified by the federalism we have.
My central point is that federalism is a "they," not an "it." Let's call the good, constitutional federalism competitive federalism. Its central virtue is to allow productive citizens and firms to exit oppressive, exploitative states and to sort themselves into states more to their liking. States that want to keep productive citizens will have to give them their tax money's worth. In other words, they will have to compete, and that will discipline the politicians. Let's call the bad federalism cartel federalism. Its point and effect is to suppress policy competition; to block the exits from poorly governed states; and to empower politicians, rather than citizens.
"America doesn't have too little federalism. It has way too much federalism of the wrong, cartelizing, government-empowering kind"
- Michael S. Greve
Armed with this simple distinction, let me re-state my contention: The central federalism question is not how much federalism-that is, the degree of decentralization. The central question, rather, is the kind of federalism one would like. America doesn't have too little federalism. It has way too much federalism of the wrong, cartelizing, government-empowering kind. It has way too little of the right, competitive federalism-the federalism that the Constitution envisions, and which the country enjoyed for much of its history.
My self-imposed task today is to explain why this question-what federalism, not how much-is a central dilemma of American politics; why it's important to get the answer right; and why the country has very little room for error. But to see what is wrong with America's federalism today, it is best to start with what was once right with it-with the United States Constitution.
Like all constitutions, the United States Constitution serves a two-fold objective: to make politics possible, and to limit it. However, the United States Constitution differs from virtually all modern constitutions in crucial respects.
First, the U.S. Constitution places constitutional structure over rights. Unlike modern, rights-laden constitutions, America's original Constitution contained no Bill of Rights at all. A Bill of Rights was added shortly after ratification-but only after, and because, the authors had reassured themselves that the rights guarantees would leave the constitutional structure unaffected.
The Constitution's second distinctive feature is the way in which it seeks to make the structure work to limit politics and, in particular, to prevent a ruthless majority from trampling on minorities. Many modern constitutions pursue this end by means that political scientists call "consociational." The basic idea is to ensure minority representation in all government institutions. Strategies to that end include proportional representation, coalition government, fiscal and other distributional guarantees for less-prosperous groups or regions, the deliberate promotion of a "culture of consensus," and powerful constitutional courts, armed with expansive rights guarantees. In sharp contrast, the United States Constitution does not envision or provide for any of this. (America's rights-driven Supreme Court is not a design feature but a relatively recent bug.). The Constitution is better understood as a system of incentives: it establishes competing institutions with rival, empire-building motives, and it endows them with the means to act on those motives and to protect their institutional turf. As James Madison, "the Father of the Constitution," put it, "Ambition must be made to counteract ambition." Competition, not consensus and consociation, is the name of the institutional game.
These structural features carry forward into the Constitution's federalism: it is a distinctly competitive federalism.
The Constitution treats states on the basis of strict formal equality and then compels them to compete with one another for productive citizens and firms. It accomplishes this, first, by prohibiting state interferences with the free flow of commerce. No state may discriminate against outsiders with respect to citizens' "privileges and immunities," and none may impose tariffs or their regulatory equivalent. The Constitution ensures competitive conditions, second, by barring states from exploiting each other's citizens. For example, states may not create paper money, or impair the obligation of contract. (The point is to prevent the exploitation of out-of-state creditors by means of debtor relief laws.) The Constitution ensures competitive conditions, third, by what it does not say and contain. As Kenneth Dam put it in a now-ancient but still wonderfully illuminating article, the U.S. Constitution, unlike that of Germany and virtually all other federal countries, has no "fiscal constitution." It prohibits Congress from legislating taxes that overtly discriminate against particular states (a pro-competitive feature, come to think of it). However, with only one important but limited exception (a federal monopoly over import tariffs), the Constitution does not assign any tax to any level of government. Nor does it have anything to say about the distribution of federal revenues to state and local governments. What that distribution looks like is left to politics. Throughout the nineteenth century, this usually meant that there would be no distribution at all. Even vocal demands for federal transfer payments and bailouts-notably, after a financial panic in 1837 had sent several states into default-foundered on deep disagreements over how and in accordance with what those payments should be distributed among the states.
Fourth, and finally, the Constitution entrusts the protection of its competitive federal order not to the United States Congress but rather, at least in the first instance, to the United States Supreme Court. The constitutional prohibitions against state protectionism and exploitation are in a sense redundant: Congress could enact them under its authority to regulate commerce among the states and several other clauses. If the Founders nonetheless wrote the prohibitions directly into the Constitution, it was to render them judicially enforceable and to dispense, to this extent, with a fickle, easily distracted legislature. The Supreme Court's jurisdiction-especially its so-called "diversity" jurisdiction, meaning the authority to adjudicate disputes among parties from different states-is the institutional backbone of the Constitution's competitive federal order.
Political economists have often looked to the U.S. Constitution as a model of "competitive federalism," and for good reasons. If you had to write a charter for competitive federalism, it would in fact be hard to improve on the U.S. Constitution. Moreover, throughout the nineteenth century and for several decades thereafter, American federalism conformed admirably to the constitutional template. The Supreme Court gave wide berth to its jurisdiction and enforced the Constitution's pro-competitive provisions with a very firm hand against the recalcitrant states. It even inferred from the structure of the document pro-competitive doctrines that are not explicitly stated in the text. Prominent among them is the so-called "dormant" Commerce Clause-that is, the judicially enforced prohibition against the states to regulate interstate commerce even when Congress has failed to exercise its powers in this domain. (This is the U.S. equivalent of the European Court of Justice's Cassis de Dijon doctrine.) Similarly, and especially in light of the Euro crisis, it is worth noting that the United States had no common currency until after the Civil War. Rather, private commercial paper served as the crucial source of liquidity throughout the country. Those instruments were negotiable in the various states-not under some federal statute but because the Supreme Court made it so, as a principle of general common law and in the exercise of its diversity jurisdiction.
The force of this internal free-trade regime is difficult to overestimate. It facilitated the astounding mobility of capital and labor. It accounts for the ascent of the United States from agrarian backwater to economic powerhouse. It explains the rise of large, vertically integrated corporations in the United States: the Supreme Court's superintendence over the domestic economy gave those corporations access to a gigantic market (unrivaled, in those mercantilist days, elsewhere in the world), thus producing new forms of organization and economies of scale. And competitive federalism played a very large role in sparing the United States the class warfare, socialism, and authoritarian politics that afflicted every other industrializing nation in one constellation or another. It is sometimes said that the United States Constitution is pre-modern; and in some respects, this is so. But it is pre-modern in a very funny way: over well over a century of operation, it facilitated social and economic modernization on a fantastic scale, at a fantastic pace.
Europe provides within living memory a very similar example of a court-led push for a competitive federal order. That example is the European Court of Justice's energetic effort, beginning in the 1960s, to promote European integration by means of breaking down trade barriers, especially in periods when political efforts seemed to be flagging. Granted, the transatlantic differences loom large. For starters, the U.S. Supreme Court operated under a Constitution that had firmly established the supremacy and direct effect of federal law. The ECJ had to create those doctrines, rather boldly, from the European Treaties. But the similarities are sufficiently striking to have produced a large, intriguing comparative literature on the ECJ and John Marshall's Supreme Court (spanning the first three-plus decades of the nineteenth century). Neither court ever adopted an explicitly pro-competitive agenda. For both, the watchword was integration-economic, legal, and political. However, competition and closer union turned out to be the same things. As European scholars say, courts cannot produce "positive" integration. The ECJ cannot harmonize cucumber standards or mandate transfer payments among governments. Neither can the Supreme Court. The only integration courts can produce is "negative" integration: they can break down trade barriers, prohibit discrimination, and crush local monopolies. Thus, if integration is to proceed at all, it will have to proceed on competitive terms. That is what the ECJ supplied, and what the nineteenth-century Supreme Court supplied-in both cases, to splendid effect.
Can You Keep It?
As you can probably tell, I am quite taken with competitive, court-led federalism. Economists are not just taken; they are mesmerized. They have examined formal competitive federalism models and their efficiency characteristics in thousands of specifications. Not one of those models, however, explains why competitive federalism is so rarely observed in practice. It was America's initial constitutional choice; but with a few exceptions, it hasn't been anyone else's. (The drafters of Germany's Constitution, for example, deliberately rejected it.) Moreover, in the United States and more quickly elsewhere, competitive arrangements are routinely overwhelmed by profoundly anti-competitive practices: regulatory and tax cartelization (or "harmonization"), and expansive intergovernmental transfer payments. If competitive federalism is so attractive, why is it so hard to stabilize?
The most potent reason, in my judgment, is competitive federalism's corrosive effect on governments, political elites, and their interest group clientele. The ECJ's pro-competitive jurisprudence provides an example. It re-invigorated political integration not because it embodied an ideal but because it posed a threat. Europe, it was said, is a political project. It should not become a mere economic union or trade pact, and so the politicians should redouble their efforts. Now at one level, court-led economic integration on competitive terms is perfectly consistent with ever-closer union on Schengen issues, military cooperation, or cultural exchange, or even a constitution. After all, the United States, an actual country with an actual Constitution, acquired all these sorts of things over the nineteenth century, while retaining a fiercely competitive federal order. What ECJ-led integration actually endangered was integration on terms that the political class could accept. The only government that liked it was Margaret Thatcher's, which deemed it helpful in crushing the trade unions and in allowing the City of London to play on a continental field. For France, Germany, and other countries, in contrast, the point of the European project was to save the welfare state, not to expose it to yet-more ruinous competition. Their vision of European federalism was and is an intergovernmental cartel to protect the acquis communautaire.
Let me quickly assure you that this is not a diatribe against Europe. My point is just the opposite. In any open, competitive system, states-their governments, political elites, and interest group clients-behave like private producers in economic markets. They may make polite noises about competition, but their general orientation is to stamp it out, for the obvious reason that it constrains profits-that is, by analogy, governments' ability to tax and regulate for purposes of redistribution. This impulse is endemic to all federal systems, and virtually all succumb. Even America is not exceptional enough to have escaped the drift: beginning in the 1920s, and decisively under the New Deal, competitive federalism became cartelized. Responding to state and interest group demands, the national government began to harmonize workplace conditions, labor relations, agriculture, and much else. The first systematic fiscal transfer programs date to the same period. After the New Deal, those patterns became firmly entrenched. Especially during the Great Society in the 1960s and early 1970s, the programs grew exponentially and came to engulf an ever-growing share of the business of government.
Our Federalism Problems
The New Deal is of constitutional significance because it managed to overcome competitive federalism's constitutional protections. As I mentioned, the Constitution contains many explicit constitutional safeguards of competitive federalism; they all became effectively unenforceable after 1932, and certainly after 1936. The doctrinal shift, moreover, reflects a more fundamental political dynamic. State politicians and their clientele loathe competitive federalism; so does a national government bent on doing big things. The natural solution is to bargain around the constitutional entitlements that protect the competitive order. The U.S. Constitution, I mentioned, makes that very hard. It contains specific, textual obstacles to the enterprise, and it contains no fiscal baseline against which the states and the feds could bargain. However, institutional players who get to play often enough will eventually find the cooperative, cartelizing solution. And under conditions of extreme economic stress and very high partisan-political consensus, the New Deal found that solution and offered states the ability to lock themselves into federally sponsored regulatory and fiscal cartels.
The crucial point is to recognize-as many American conservatives do not-that the New Deal did not simply centralize American politics. Its point was not to expand the federal government; it was to enlarge government at all levels. And to that end, the New Deal substituted for the old, constitutional, competitive federalism a new, vehemently anti-competitive federalism. Let me briefly emphasize two central features of this federalism: bilateral regulatory overreach, and fiscal entanglements.
Start at the regulatory front: It is hard to deny that America suffers from pervasive federal overreach. The national government regulates local storm drains, grade school curricula, and conflicts between a citizen's plan to build a home on his own property and a frog's desire to procreate in the same location. (Under U.S. law, the general rule is that the frog wins.). Parking spots at the mall, office jokes, children's playground conduct-these and countless other local matters close to home have become of national concern. The national government's constant meddling sustains a lot of anti-Washington agitation; and yes: it is a federalism problem.
However, it is not our only federalism problem. Productive national enterprises that want to sell stuff on the internet, produce life-saving drugs, or provide flood insurance find themselves beleaguered by state legislatures, courts, attorneys general, regulators, and trial lawyers from fifty fiefdoms-all with their own conflicting, cascading demands, but united in a desire to have a piece of the action. California, among other states, has contrived to regulate the internet, to tax corporations on profits earned in foreign jurisdictions, and to impose sales tax collection obligations on internet sellers domiciled elsewhere. States have enacted global warming policies that reach far beyond their boundaries, and some have signed greenhouse treaties with foreign nations. State attorneys general have reorganized entire industries through settle-or-else prosecutions and multistate settlements. Each state has an incentive to exploit out-of-state producers for the benefits of in-state plaintiffs; thus, products and profits routinely disappear in the states' hellhole jurisdictions. In short, federal regulatory overreach has gone hand-in-hand with state overreach.
These tendencies, moreover, do not somehow cancel each other out; they compound. The central government stands ever-ready to wipe out state competition on any dimension. At the same time, it authorizes states to regulate firms or individuals inside or outside their own borders, on a global basis. Thus, interstate commerce becomes subject to 51 regimes, and the rules of the strictest regulator will dominate everyone's calculus. The world marvels at the excesses of America's state-based tort system. Less noted is the fact that it is the intended result of our so-called federalism. The Congress could preempt state tort law, especially in its reach over interstate commerce, any day of the week, but it rarely does. Nor does the Supreme Court. Thus, states race towards ever-higher levels of liability.
Having bemoaned cartel federalism's regulatory dysfunctions, let me turn to its equally potent fiscal dimension-that is, its reliance on transfer programs that encourage states to "experiment" with federal dollars. Much of American government-education, environmental policy, welfare-operates on this principle. The most menacing program is Medicaid, which pays states between 50 and 80 cents on the dollar to provide medical services to the poor. Thanks to the exceptionally generous match, Medicaid now consumes almost a quarter of state budgets (much more in some states). For the most part, this is not a result of federal coercion or mandates. It is a result of the states' voluntary decisions to expand Medicaid so as to attract federal matching funds. The states' perverse incentive to expand their domestic welfare state on our collective nickel-trillions of nickels-is, again, a federalism problem. So is the attendant moral hazard-that is, the risk that states will overspend in the expectation that the federal government will bail them out. If you think Greece is a problem, come visit the failed state of Illinois.
The political theme behind these dysfunctions is the erosion of political accountability and transparency. Under a federalism of bilateral overreach and fiscal cooperation, everything government puts on offer is a joint product. The projects will consistently fail-even if all the institutions and their occupants are competent and well-intentioned. Failure, in turn, consistently produces an orgy of bureaucratic blame-shifting: state officials complain about "unfunded mandates"; the feds, over state irresponsibility and incompetence. Citizens are left confused and frustrated.
You may remember Hurricane Katrina. To be fair, our federalism did not cause the hurricane. But it created the infrastructure that rendered New Orleans defenseless. It engineered an emergency response that would have embarrassed Bangladesh. And it spent upwards of $140 billion on a "reconstruction" that, to the best of anyone's knowledge, has had no major effect except to enrich state and local politicians and their contractor-friends. None of this, however, has caused any great consternation or scandal. It's the way we expect the system to work, or not work.
How serious are our federalism's dysfunctions? In my estimation, very.
The most obvious problems arise at the fiscal front. The national government is effectively bankrupt and is racking up debt at an alarming rate; but this is also true of state and local governments. Because states cannot print money, and because they operate under balanced budget requirements, they overspend on things that are subsidized by the federal government and then hide the shortfall in future obligations. There are about $4 trillion dollars in unfunded pension obligations alone.
The regulatory problems are equally serious. In 2002, in response to the dot.com bubble and collapse, the U.S. Congress enacted a law to restructure American corporate governance (called, after its sponsors, Sarbanes-Oxley). As a result, IPOs fled from New York. Officials in the City of London proposed to erect statues in honor of Senator Sarbanes and Congressman Oxley, in recognition of their achievements in driving American capital into Albion's hands. One financial crisis later, Congress enacted the Dodd-Frank act. In addition to creating several new federal regulatory agencies, the act empowered state regulators and litigators to sue banks for a ton of money over allegedly fraudulent foreclosure practices-the same money, mind you, that the federal government, under a different policy, has pumped into the banks. This policy is hard to explain to Europeans; but then, we haven't explained it to ourselves, either.
The political costs of our federalism are hard to measure. Still, it probably has a lot to do with rising levels of public disaffection, and anecdotal evidence is suggestive. Last year, President Obama's Secretary of Education had the bad taste of noting that Katrina actually had an upside: it physically wiped out the entire school district. So the district has a chance, not shared by any other urban school district, to create schools that actually teach, as opposed to feeding the teachers' unions-until the intergovernmental machinery reestablishes itself.
"In short: American federalism encourages state and local financial commitments that cannot possibly be sustained"
In short: American federalism encourages state and local financial commitments that cannot possibly be sustained. It surrenders the rule of law, the only comparative and competitive advantage that America can hope to retain, to parochial states and trial lawyers. And it has brought us to the point of celebrating the physical destruction of our federally funded, locally run institutions. So yes, this is serious.
Can Anything Be Done?
One might think that sheer necessity will compel America to re-negotiate its unaffordable, dysfunctional federalism. But I am not sure that this is right.
For starters, experience from around the world-from Argentina to Germany, from India to Brazil-strongly suggests that cartel federalism, unlike competitive federalism, is enormously resilient. Relative to a competitive order, it makes every government better off. In this or that dimension, the central government may fail to cartelize the system. (The still-remarkable level of state tax competition in the United States is an example.) And here and there, one or a few states may defect and decide to compete. But the system as a whole never will. Barring a truly catastrophic event, it will lurch from one level of dysfunction to the next, higher level. The German political scientists who first introduced me to federalism three decades and two miles from here called this institutional debility Politikverflechtung. A mouthful, but not a bad term.
It is possible that the 2008-2009 financial crisis was a sufficiently serious event to force a renegotiation of our federalism. For an obvious example, the state and local pension obligations I mentioned will fall victim to what AEI's Alex Pollock calls Pollock's first law: debts that cannot be paid will not be paid. What, though, is the most likely response? Other countries (such as Argentina), afflicted by the same problem, responded by lumping local pensions into the federal system. The Obama administration's health care law-Obamacare, as we call it-envisions a very similar bailout solution: it encourages states to dump their employees and retirees, whose health care costs currently fall on state and local governments, into federally subsidized programs, called "exchanges." The states are counting on this. (It is why they were for Obamacare before some of them were against it.) This de facto bailout may or may not happen, inasmuch as Obamacare is unraveling as we speak. Still, the law illustrates the larger point at issue. While things that cannot go on will come to an end, the question is on what terms they will end. I am not at all certain that federalism's impending renegotiation will translate into a reversion to the constitutional, competitive norm.
One might think that such a reversion, in a time of fiscal distress and political discontent, ought to command broad political appeal. After all, cartel federalism frustrates any project, including any progressive project, that requires a modicum of policy coherence and implementation capacity. You cannot build solar power plants or high-speed train links if you simultaneously empower state-based constituencies to block these things. Similarly, if progressives want to provide health care or other benefits, they can ill afford to let state and local hacks and hangers-on siphon off half the money before it reaches the intended beneficiaries; we ought to give the money directly to people, not to places or politicians. To raise the prospect, however, is to see the futility. Cartel federalism's beneficiaries-state regulators and attorneys general, plaintiffs' lawyers, public sector unions-are the backbone of the Democratic Party. One cannot talk a political party out of an existential commitment. Thus, a campaign against the bad federalism and for the good, competitive federalism would have to be an ideological, conservative project.
"The central question, I have argued, is not 'how much federalism' but what kind of federalism"
This is a depressing prospect, because conservatism-at a political, intellectual, or legal level-is almost certainly not up to the task. The central question, I have argued, is not "how much federalism" but what kind of federalism. However, American conservatism is firmly wedded to the notion that "more federalism" automatically means a smaller, more responsible government; and this commitment seems to be immune against any evidence. Consider: three-plus decades ago, no serious businessman or corporate lawyer in the United States worried about state law, state regulators, or trial lawyers. Now, companies operate amid a horde of regulators, any one of whom can unleash a firestorm any day of the week. Never in American history have states exercised more power over the commerce of the United States than they do now. Likewise, from the end of the Korean War to 2008, federal taxes in relation to GDP hovered between 18 and 20 percent. Over that same time frame, federal transfer payments spurred local tax efforts to the extent of tripling state and local taxes, from about five to fifteen percent. In fiscal terms, the entire growth of government in the United States is attributable to the growth of state and local government. As suggested earlier, the Obama administration's initiatives-state bailout, Obamacare, Dodd-Frank-have not changed these trends. Rather, they double down on the most dysfunctional practices of our federalism. And yet: there is no conservative or Republican plan, not even in broad contours, to protect commerce against parochial state interference. And there is no plan or even an idea to come to grips with the fiscal transfer system that is our ruinous federalism's warp and woof. No idea, that is, beyond the shopworn proposal to "block-grant" those payments and let states decide, more freely than ever, how to spend federal tax dollars. God help us.
Nor do things look very promising in the arena of legal and constitutional thought. There has been a great deal of excitement over the Supreme Court's supposedly "pro-business" agenda. It is certainly true that the Court's docket teems with cases at the intersection of commerce and federalism. However, the Court is very far from reconstructing any kind of constitutional order, and its conservative members in particular see no need to do so: if commerce is in trouble, the thinking goes, let it turn to Congress. That line of thinking, I have tried to explain, is antithetical to our competitive constitutional order, which depends on the confident exercise of judicial power. Alas, the justices are not about to correct the error.
There is in the United States a pervasive sense that the country is in very deep trouble. And there is, on the conservative side, a certain triumphalism: this is our moment. The country will reject President Obama and his wayward, European policies. We will win this battle because we're Americans. Distracted and confused in ordinary times, we rise to great challenges. We will recover our constitutional heritage. I don't necessarily disagree. But the recovery will require more than constitutional happy-talk. It will require a much clearer recognition of the insidious nature of our federalism, much more rigorous thought about institutional reform, and a much keener awareness of the Constitution's genius.