417 March 13, 1985 FOR REVENUE SHARING TIME HAS RUN OUT INTRODUCTION The federal government has a huge deficit. The states in the aggregate have a healthy bu dget surplus. Yet Washington could be sending local governments 4.6 billion this year under a program which, despite the federal deficits, is still named Revenue Sharing Declared Ronald Reagan to the nation's gover nors.at their annual Washington meeting l ast month There is simply no justification for the federal government, which is running a deficit, to be borrowing money to be spent by state and local governments As such, Reagan's proposed FY 1986 budget slashes Revenue Sharing by 80 percent and eventua lly will eliminate it altogether.

Revenue Sharing gives federal funds to local governments for their unrestricted use. The program was adopted during the Nixon Administration on the rationale that the federal government had preempted the strongest and most effective tax revenue sources and had a far more secure financial base than state and local governments. Giving local governments unrestricted federal funds, it was argued, would enhance what was viewed as the de creasing power of states and localities r elative to Washington.

The original rationale for the program has evaporated com pletely because of chan ged financial circumstances. The federal government now faces record deficits, while state and local governments enjoy surpluses--with even brighter prospects for the future. State and local tax structures, moreover, have been reformed to remedy in large m easure the perceived inadequacies at the time Revenue Sharing was launched. And concerns over the relative power of state and local governments are today being addressed more effectively through the Reagan Administration's policies to strengthen federalis m 2 Every local jurisdiction in America receives Revenue Sharing including the bedroom communities and vacation retreats of me wealthy. The distribution of Revenue Sharing, indeed, is often perverse, with many richer communities receiving more per capita a i d than poorer communities. Even without a federal deficit such poorly targeted subsidies would be unjustifiable of local government revenues; by FY 1986 this share will be smaller. The loss of this relatively tiny contribution to local revenues would be e s pecially easy to absorb now, thanks to the firm financial condition of state and local governments. State governments could aid local communities in the adjustment through their own revenue sharing programs, which already exist in 49 states. Moreover, eve n after eliminating Revenue Sharing, the federal government would still be funneling $100.7 billion to states and localities, amounting to 10.7 percent of total federal In FY 1983, Revenue Sharing funds comprised only 1.4 percent spending Revenue Sharing h a s represented unwise federalism policy from its inception. At last, time has run out for the program, and it should be eliminated THE REVENUE SHARING PROGRAM Revenue Sharing provides federal grants to local governments to be spent without restriction, apa r t from certain procedural requ1rernents.l All U.S. local governments are eligible and virtually all-more than 39,00O--receive them. Recipients include counties, cities, towns, townships, villages, and other governmental jurisdictions.2 The size of the gra n t is determined by a statutorily set formula which divides the total Revenue Sharing funds appropriated I by Congress among the eligible recipients. Basically, the formula provides funds to recipient governments according to their popula tion It also awar ds extra funds if a locality's per capita income is low and if its tax revenues are high relative to local income (a relation known as tax effort).

Revenue Sharing was first adopted in 1972, as part of Richard Nixon's federalism initiative. The grants init ially were provided to state governments as well as local governments It was argued Discrimination in the use of Revenue Sharing funds is prohibited, public hearings regarding proposed uses of the funds must be held, and recipient governments are subject t o audit requirements Local government" for the purpose of the Revenue Sharing program is defined as a general-purpose government under the definition prescribed by the Census Bureau, which generally means a government that provides a minimum of three diff e rent types of services to its residents 2 3 that the federal government possessed the strongest tax revenue sources and had a far more stable financial base than most state and local governments. Though the federal government.was giving substantial funds to state and local governments for specified purposes, Revenue Sharing advocates maintained that this gave Washington too.much power over state and local spending priorities.

To. avoid this it was urged that the federal government share its surplus revenue s without restrictions on how the funds could be spent. This would return some power and flexibility to state and local governments, enabling them to set their own spending priori ties. And legislators at lower levels of government, they argued could best determine what was most needed in their communities So far, Revenue Sharing has transferred $78.6 billion to state and local government Current law would provide for another $4.6 billion in FY 1986--the level of Revenue Sharing each year since FY 1981.4 T h e program's annual funding peaked at 6.9 billion annually in fiscal years 1978 to 1980.5 Grants to state governments ended in EY 1981, accounting for the drop in spending in that year. Congress took this action because of the improving fiscal conditions o f state governments, and because of congressional anger over the call by many states for a Constitu tional Convention to pass a federal balanced budget amendment.

The Reagan Administration's EY. 1986 budget proposes eliminat ing Revenue Sharing for local g overnments as well THE LOST RATIONALE Changing circumstances have nullified the original Revenue Sharing rationale. It is now the federal government which is in deep financial trouble, while state and local governments general ly are far more robust. The f ederal budget deficit for FY 1984 was $185 billion, and the deficit for FY 1985, which ends this September, is currently estimated by the Administration at $222 billion If no changes are made in current law, the federal deficit will likely remain over $20 0 billion at least through FY 1990.7 This compares with federal deficits of less than $10 billion in each year from 1960 to 1970 (except for 1968).8 ly in surplus and are improving. Many states; including California I State and local government budgets, by contrast, are general Office of Revenue Sharing, Eleventh Annual Report (U.S. Treasury Depart ment, June 1984).

Ibid.

Ibid. Office of Management and Budget, Budget of the United States Government Fiscal Year 1986 (Washington, D.C U.S. Government Printing Office 1985).

Ibid 8Ibid. are now planning to build up reserves for the future, and several governors, such as Anthony Earl of Wisconsin, are calling for tax cuts. State general fund expenditures increased 8 percent in FY 1984, while general revenues inc reased 13 percent.g State govern ments ended FY 1984 with an operating surplus (not including pension fund accumulation) of $6.3 billion, plus another $1.0 billion set aside in reserve Itrainy dayt1 funds.1 This total 7.3 billion surplus amounted to 4.4 p e rcent of FY 1984 state expenditures,ll compared with a EY 1984 federal deficit equal to 21.8 percent of expenditures.12 For cities, the latest available data show that in FY 1983 total expenditures increased by 6.5 percent, while total revenues increased b y 8.4 percent.13 Total revenues exceeded total expend itures for cities in FY 1983 by $4.7 billion, equal to 3.9 percent of expenditures.14 The latest survey of the fiscal conditions of cities by the Joint Economic Committee of Congress estimated that the cities examined would have carry-over contingency funds equal to 7.5 percent of expenditures in FY 1983.15 For local governments as a whole, total revenues exceeded total expenditures in FY 1983 by $6.0 billion, equal to 1.8 percent of expenditures.ls Sin c e 1972, local governments combined have run a modest surplus each year except for the 1975 recession year, while the federal government has incurred increasingly larger deficits.17 This contrasts sharply with the 1960s, when local governments ran signific a ntly larger deficits each year relative to their own revenues) than did the federal government.18 Preliminary results of a thorough study of state and local government finances by the U.S. Treasury Department indicate that even brighter days are ahead.19 Using mid-range economic growth 9 10 11 12 13 14 15 16 17 18 19 National Association of State Budget Offices and National Governors Association, Fiscal Survey of the States (February 1985 update).

Ibid.

Ibid OMB, Budget of the United States Government, Fiscal Year 1986.

U.S. Bureau of the Census, City Government Finances in 1983-83 (Washington D.C U.S. Government Printing Office, November 1984).

Ibid.

Joint Economic Committee and Municipal Finance Officers Association Trends in the Fiscal Condition of C ities U.S. Government Printing Office, November 1983 1981-1983 (Washington, D. C U.S. Bureau of the Census, Governmental Finances in 1982-83 (Washington D.C U.S. Government Printing Office, October 1984).

Office of Management and Budget, Background on Major Spending Reforms and Reductions in the N 86 Budget (Washington, D.C U.S. Government Printing Office, 1985), p. 72.

Ibid.

Office of State and Local Finance, U.S. Treasury Department, Recent Trends in State-Local Finances and the Long-Term Outlook for the Sector November 28, 1984 5 assumptions, along with current tax and spending policies, the combined annual state and local s ector surplus (not counting social insurance funds) would grow to $86.5 billion by 1989 equivalent to 14.1 percent of expenditures in that year. Under high economic growth assumptions, the 1989 surplus reaches $129.8 billion, or 21.2 percent of expenditur e s. Even under low growth assumptions, the 1989 surplus would still reach $29.9 billion, or 4.5 percent of expenditures. The low growth 1989 surplus would be a record for state and local governments in both absolute and percentage terms with states in fina n cial surplus is like bankrupt Argentina providing assistance to oil-rich Saudi Arabia. State and local governments easily could absorb the loss of federal Revenue Sharing grants, since all but Delaware have their own revenue sharing programs for local gov ernments20 and thus could assist these governments if the loss of federal funds posed a particular problem For the debt-ridden federal government to be "sharing revenue"

The tax structure of state and local governments also has changed substantially since the early 1970s. Local governments have reduced their reliance on property taxes, drawing an increas ing proportion of their revenues from sales taxes, income taxes and user fees.21 State governments, too, have shifted toward income taxes and user fees.22 States, moreover, have granted local governments more authority to tax and develop entirely new revenue sources.23 And-boundaries between local governments together with service responsibilities distributed among them have been adjusted to match responsib i lities more closely with taxing authority over service beneficiaries.24 In short, the perceived inadequacies of the state and local tax structure used to justify Revenue Sharing largely have been remedied. The federal government no longer monopolizes the most effective methods of raising revenue.

The Reagan Administration's federalism policies have consoli dated many federal categorical grant programs into block grants and eliminated many federal regulations and mandates on state and local authority. This enables state and local governments to exercise more authority and control over priorities than in decades. The Administration's continuing efforts along these lines will further enhance state and local power U. S Department of Housing and Urban Developme nt, The President' s National Urban Policy Report 1984 (Washington, D.C U.S. Government Printing Office, 1984 p. 18.

Major Spending Reform and Budget Reductions, p. 72 The President's National Urban Policy Report, pp. 13-21 21 Advisory Commission on Interg overnmental Relations; OMB, Background on 22 Ibid. 23 24 Ibid 6 THE RICH GET RICHER WITH &VEMTE SHARING A particularly troubling aspect of Revenue Sharing is its extremely poor targeting It is not limited to poor communities.

Every local jurisdiction in America receives grants, including posh vacation retreats.

Last fiscal year, for instance, Palm Springs, California obtained $617,000 in federal Revenue Sharing funds; Greenwich Connecticut, received $782,000; and Scottsdale, Arizona, $806,000.

Together, Palm Beach and West Palm Beach, Florida, received $1.3 million from Washington, while another $4.6 million went to the Palm Beach county government. The various local governments in Palm Beach county received a total of $9.1 million. The local jurisdictio n s in New York's affluent Westchester County were awarded 12.2 million in Revenue Sharing, and Orange County California, governments received $28.8 million. Other Revenue Sharing recipients included such well-to-do communities as Vail and Aspen, Colorado, Scarsdale, New York, and Wellesley, Massa chusetts.

Booming sunbelt cities do nicely under 'the program. Phoenix Arizona, received $10.6 million in FY 1984, with another $7.8 million awarded to its county government. San Diego, California received $11.3 mi llion, with another $12.4 million to its county Dallas, Texas,.received $14.3 millon, with another $8.0 million for Dallas County. Tampa, Florida, received $5.9 million, with 7.8 million for its county, and Orlando, Florida, received $2.5 million, with an o ther $5.6 million to the county.25 These are not isolated cases. They merely indicate how perverse is the formula for distributing Revenue Sharing grants In FY 1983, for instance, local communities in Alaska, which has the nation's highest per capita inco m e, received per capita Revenue Sharing grants about 4.5 times the national average.26 Virtually every local government in Alaska received a higher per capita Revenue Sharing grant than local governments in Mississippi which has the lowest per capita incom e in the nation.27 Local communities in the ten wealthiest states received 25 percent of all Revenue Sharing funds in FY 1983, while communities in the ten poorest states received less than 12 percent.

28. The 3,300 poorest local governments received only 2 percent of Revenue Sharing funds in FY 1984.29 25 26 27 28 Ibid All grant totals are from Office of Revenue Sharing, Fifteenth Period Entitlements U.S. Treasury Department, January 1984).

Office of Revenue Sharing, Eleventh Annual Report, Table 2 OMB, B ackground on Major Spending Reforms and Budget Reductions, p. 73 29 Ibid p. 74 7 Even without record federal deficits, there should not be a federal program allowing the richest states to avoid their rraspon sibilities to assist their own communities by s e nding the tab to Washington and pushing the federal budget further into the red A PAINLESS CUT Revenue Sharing funds could be eliminated entirely without causing hardship. The program's grants constitute only a tiny portion of total local government reven u es and expenditures. FY 1983 Revenue Sharing funds, for instance, amounted to only 1.4 percent of total local government revenues and of total local government expenditures, excluding pension income and expendi ture frozen since then, they would constitut e an even smaller propor tion of local government finances in FY 1986 Because total Revenue Sharing funds have remained Since the program's funds must be divided among all local governments in the U.S., moreover, they are spread thinly among individual loc a l jurisdictions and consequently are rarely criti cal for any particular jurisdiction. Revenue Sharing funds in FY 1983 accounted for more man 5 percent of total expenditures excluding pensions) in only one city over 300,000 in population and in only five counties over 500,000 in population, with the highest proportion still just 6.9 percent.31 Only 4.6 percent of Revenue Sharing funds go to local governments where such funds represent 10 percent or more of local revenues, and only 1.2 percent go to govern m ents where they represent 15 percent or more.32 The loss of this relatively small contribution to local revenue would be especially easy to absorb now, given the bright prospects for further improvement in state and local revenue collections. State govern m ents could aid local jurisdictions in the adjustment through their own state revenue sharing programs particularly in those few minor instances where federal Revenue Sharing funds now constitute a comparatively high proportion of an individual local gover n ment's revenues. Federal Revenue Sharing funds under current law would amount to only 8 to 16 percent of the state and local government total combined surplus now projected by the U.S. Treasury for 1986, so the burden would not be great.33 In recent weeks , defenders of Revenue Sharing have claimed that specific essential services have been funded by the program.

If the program is ended, they claim, these basic services must be 30 Calculated from U.S. Bureau of the Census, Governmental Finances in 1982-83. 31 32 Ibid., Table 4. 33 Office of Revenue Sharing, Expenditures of General Revenue Sharing Funds 1982-83, Table 11 Calculated from Office of State and Local Finance, 'Recent Trends in State-Local Finances and the Long-Term Outlook for the Sector, Table 8 8 drastically cut or even eliminated. But this argument is totally spurious. When local governments claim that the federal assistance is used to fund critical services, such as fire and police depart ments, they mislead the public. The unrestricted federa l money simply goes into the general pot--it is not earmarked for any particular activity. So cancellation of the progr.am means simply that jurisdictions would have to examine their spending priorities leading to cutbacks in the least important services, n ot the essential ones Even after eliminating Revenue Sharing, the federal government would still be providing an enormous amount of aid to state and local governments. The Administration proposes spending $100.7 billion on aid to state and local governmen t s in the Fy 1986 budget.34 This amounts to 10.3 percent of the entire proposed FY 1986 federal budget, and would account for close to 20 percent of total state and local revenues.35 The Administration projects this state and local aid growing to $105.4 bi l lion by FY 1990.36 In no sense, therefore, would the federal government be Ifabandon ingl! America's state and local governments by ending Revenue Sharing PHONY FEDERALISM Revenue Sharing has been bad federalism policy from the beginning. State and local g overnment services, such as local roadways and fire protection, should be financed primarily by funds raised at the state and local levels-just as national programs, such as defense, should be financed at the federal level. If the benefits of a particular local service or project are worth the cost, then the local citizens who benefit will be willing to tax themselves to pay for it. If they are not willing to do so, this is strong indication that the costs are not worth the benefits, and the service or pro ject should not be undertaken activities, however, this decision-making process is distorted.

Local taxpayers no longer have to pay full costs for their govern ment activities, since part of the funds in effect are provided Ilfree'I by the federal governme nt. Consequently, local residents will not take full costs into account, and tend to support services or projects where the costs are not worth the benefits, resulting in substantial waste and inefficiency. Moreover, federal financ ing for local projects i s unfair,to federal taxpayers across the When the federal government offers funds for state and local 34 Office of Management and Budget Federal Aid to State and Local Govern ments Special Analyses of the Budget of the United States Government Fiscal Year 1986 (Washington, D.C U.S. Government Printing Office February 1985 Table H-7 35 Ibid 36 Ibid. 9 country, who will not benefit from it, but are nevertheless forced to pay for it.

Federal aid to state and local governments may, of course be justified when a national benefit or priority is involved.

For example, the construction of the interstate system, and various waterway projects, helped to secure legitimate security and nationa l development goals. But even in these cases, state and local governments should be given maximum discretion in how to achieve the benefit or priority in the context of local condi tions. Revenue Sharing does not serve such a role, precisely because it ha s no targeted spending restrictions, and does not serve a nationwide need or priority.

Federal Revenue Sharing fails to conform to the principles of federalism. It does not seek to promote a clear national purpose with national funds. The activities suppor ted with federal money are state and local concerns, and so should be funded by those levels of government. Revenue Sharing adopts the rhetoric and facade of federalism without really attempting to accomplish the difficult tasks necessary to restore the h istoric balance among different levels of government. The program is itself part of the federalism problem.

CONCLUSION The original rationale for Revenue Sharing is no longer valid. The program, moreover, often perversely grants more to the rich than to th e poor. Given present and projected state and local surpluses, the loss of the tiny proportion of local revenues represented by the program could be absorbed especially easily today. The program, meanwhile, is unwise federalism policy. For these reasons a lone, Revenue Sharing should be eliminated.

Making its elimination urgent is the prospect of record federal deficits well into the future I The Reagan Administration has proposed eliminating almost 80 percent of Revenue Sharing outlays for FY 1986 and endi ng the I program entirely thereafter. Given the depth of the federal deficit crisis and the ability of state and local governments to absorb the proposed cut, the Administration's proposal makes good sense and is good policy. The time to eliminate Revenue Sharing is now.

Prepared for The Heritage Foundation by Peter J. Ferrara a Washington Attorney Formerly a senior staff member in the White House Office of Policy Development.