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America’s Fiscal Plumbing: An Interview with Anthony Levitas

Professor Anthony Levitas is a Senior Fellow at the Watson Institute for International and Public Affairs at Brown University. Since the 1980s, he has helped public officials and civil servants in post-communist Europe decide how to delegate funding and spending responsibilities between levels of government. His work has focused on equitable transfer systems, local taxation and finance, and school finance and governance. He advised government reform programs in Poland, Macedonia, Serbia, Bosnia and Herzegovina, Albania, and Ukraine. At Brown, Levitas teaches courses on intergovernmental fiscal relations, education finance and governance, and the history of the US tax state.

James Hardy: What I want to start with is something that anyone who keeps up with city politics is familiar with, which is the idea of cities going “broke.” Could you describe the origins of some of the funding problems that cities are facing right now?

Anthony Levitas: The fundamental assumption in most thinking about American local government finance is that every jurisdiction should pay for what it does through taxes it raises itself and for which it is accountable to its citizens. The idea here is that if people elect officials who are responsible for both taxing them and providing them with public services, then citizens have strong reasons to hold them accountable for their performance. 

The problem is that with time, the number and types of public services that we expect or want local governments to provide has outrun their tax base, which, at least at the municipal level, consists primarily of the property tax. Even in the best of cases, property tax revenues just cannot yield much more than 2 percent of the GDP, which is substantially less than the wage bill that comes from running schools. In some ways, the fundamental problem is that at the municipal level, we expect municipalities to pay for themselves and a growing number of public services using a tax base that is just too thin to yield the necessary revenue. Indeed, the days when local governments basically paid for themselves are long gone. Today, on average, about 40 percent of local government revenues come from a combination of federal and state grants and transfers. The same is true for state level governments with respect to federal grants and transfers. 

We think our local governments are supporting themselves, but in large measure, much of what they do is now financed from elsewhere. Worse, most of this funding comes to them in narrow categorical grants, making it very hard for local governments to think about either their finances or their services holistically.

JH: Could you describe how this structure came about?

AL: There was never really a golden period in sub­national finance in America. But if there was one, it strangely came with Nixon’s General Revenue Sharing program, a program that was dismantled in the mid-1980s by Reagan. General Revenue Sharing provided freely disposable income to most municipalities and more to poorer ones. Since its elimination, the federal government has not only stopped providing general revenue grants to municipalities, but also stopped providing fiscal equalization grants to poorer subnational governments. America does a bad job of providing cash transfers to the poor and a bad job of providing additional revenues to local governments to support the poor.

Instead, federal funding at both the state and the local level has gone up, mostly due to the expansion of Medicaid. Medicaid, to a large extent, has crowded out other forms of federal government support. At the same time, the system has become incredibly differentiated and fragmented at the state level. Essentially, we have 50 different ways of financing health care for the poor, with each state using different systems to pay insurers, health care providers, and the NGOs and local governments that are supposed to provide wraparound services to at-risk populations. These systems have grown so complicated and fragmented that we have lost the ability to compare what is going on across states and local governments or to make reasonable judgments about how the spending is affecting outcomes.

At the municipal level, a lot of things have come together to make a bad situation worse. Our original sin was tying the financing of schools—local governments’ most important and costly function—to the property tax because this virtually ensured the segregation of public schools by class and race. Add to that the absence of any real mechanism for fiscal equalization, the extreme fragmentation of the grant system, and Medicaid’s crowding out of other federal and state support to municipalities, and we have a real mess at the local level.

JH: What are people proposing to fix these problems?

AL: In lots of ways, what I would say is that since the dismantling of general revenue sharing in the 1980s, nobody is really looking at local government finance issues in a systematic way and as a national problem. Instead, every state is essentially doing its own thing based on individual relations with the federal government. Between the 1950s and the mid-1990s, there was an important body called the Advisory Commission on Intergovernmental Relations, which was tasked with thinking about this stuff. But it lost its mission with the end of General Revenue Sharing and was ultimately dissolved in 1996. Since then, we have really stopped thinking about local government finance as a national issue. 

One of the few systemic ideas that I have seen floated as of late is to increase the coefficients used to calculate how Medicaid transfers flow to states by increasing them sharply for states with poorer populations. This is probably a good idea, at least for as long as we have 50 different Medicaid programs. 

The other thing that needs to be said here is that in the last 10 years, local government finances have been saved by hundreds of billions of dollars in new federal aid that came first with the Great Recession of 2010 and then with Covid-19 relief. For the last couple of years, local governments have had trouble programming and spending the federal Covid-19 monies. Covid-19 also opened the door for unprecedented federal transfers to poorer households, something that one might think would also relieve pressure on local governments for at least some public services. That said, it remains unclear whether any of these essentially emergency measures will be transformed into permanent programs.

JH: Is the recent attempt to make the expansion of the child tax credit permanent an example of this?

AL: Yes, exactly. Unfortunately, Manchin’s objections forced it to be taken out of the last infrastructure bill. But to go back to the original question, the efforts to systemically think through how to support municipal jurisdictions with federal money have almost fallen off the table. It’s not something that is talked about much and needs to be brought back.

To my mind, there are few systemic proposals out there for how the intergovernmental finance system should be reformed or reworked. There is a discussion which Professor [Margaret] Weir is involved in about whether more funds should be allocated on a place-based basis as opposed to a program-based basis. For me, this discussion boils down to whether local governments should be getting more in the way of freely disposable general revenues and less in the way of categorical grants. Cities, in particular, need more freely disposable revenue to make the adjustments that they’re being asked to make and to break down the silos that have grown up around the categorical grant system. From my point of view, this is a big hole in the political discussion of what’s next. And I’m kind of hoping that some of the people who come out of my fiscal plumbing course will carry this kind of thinking forward.

JH: Silo-busting has become a popular policy model in recent years, especially in areas like racial equity and sustainability. Do you think these efforts will significantly impact the grant transfer system?

AL: I think there are two problems here. Years of underfunding have reduced the capacity of local governments both to deliver public services and to carry out analytical tasks. At the same time, it has turbocharged an American tendency to privatize the provision of public goods. Underfunding has both accelerated privatization of services while the proliferation of categorical grants has created a world in which public and private entities—meaning mostly NGOs—are all competing for the same fragmented and insufficient funding. And that’s from education to childcare, to Medicaid services, to housing for the elderly. Now, people are trying to integrate services either under the banner of racial and social justice or under the banner of public health. This is a positive development. But the existing fragmentation combined with the under capacity of local governments is making that transition very difficult. I cannot tell you how many reports I’ve read about the need to unify programs in Rhode Island to prevent juvenile involvement with the criminal justice system or to improve health outcomes in poor neighborhoods or to reduce homelessness that call for this kind of pooling of resources and cooperation between entities. In practice, I am afraid I don’t see much progress in actually either defragmenting the grant system or increasing cooperation between all the various private and public agencies competing for funds to make things better.

JH: Are instances of successful transition away from silos so rare that it isn’t enough to put upward pressure on the categorical grant system to reform?

AL: I think there are probably states and localities that are significantly well-endowed that are able to do interesting things to break down silos and make better use of resources. There are also some interesting large-scale philanthropic efforts that are trying to catalyze the kind of cooperation that is necessary to solve some of our “wicked problems.” But for me, the larger question is, systemically, how do you generalize similar actions at the subnational level across the organizational and institutional chaos of American federalism? And that’s where I don’t think there’s enough thought being given. In short, I think that at both local and state level, people are trying to do things in better ways, but that they are continually being frustrated by the existing grant system and their own organizational under capacities—a product of years of underfunding. For me, the question is how do we increase subnational revenue, ensure that more of it gets to poorer jurisdictions and that local governments have the freedom and capacity to experiment with more creative solutions to our ‘intersectional’ social problems.

And again, I think one of the most important pillars of any sort of reasonable response to these issues is to do more general revenue sharing, particularly at the municipal level. 

JH: I’m interested in your idealized version of a tax structure and what you think that would look like.

AL: You know, it’s easy to think of ideal solutions. It’s less easy to think of solutions that have a snowball’s chance in hell, given our current polarization and the constitutional realities of American federalism. Unfortunately, the American Constitution is one of the most rigid and difficult-to-amend constitutions in the world. It is probably the least-amended constitution in the world. Worse, our current political landscape makes it almost impossible to imagine major changes to it or even what could be done within its current limits. 

But I guess in my ideal vision of America’s tax structure, we would—like every virtually other country in the world at this point—have a national sales tax, a national VAT [Value-Added Tax]. This would at once allow us to fund national redistributive programs from more sources other than corporate and personal income taxes. Historically, our efforts to fund national redistributive programs solely from direct taxes has meant that for most of the postwar period, our personal and corporate tax rates have been among the highest in the world. These high rates have facilitated both the hollowing out of the corporate tax system by lobbying and the Republican backlash against taxation in general. 

So, in my idea of a better American tax system, the national government would have some access to the sales taxes that are currently funding state and local governments. Like elsewhere in the world, we would make greater use of regressive taxes to fund progressive social programs. At the same time, it would be good if the national government encouraged or compelled state and local governments to use more of their power to tax personal income.

If, for example, all states and localities had to tax personal income at some minimum level and according to a unified base, that would do a lot to standardize fiscal conditions across the country as whole, reduce pressure on other taxes, and, perhaps most importantly, create a stronger foundation for fiscal equalization. I also think the federal government should begin to use the intergovernmental finance system to encourage jurisdictional consolidation at the local level and discourage practices like defensive zoning. It’s also nuts that we are trying to make states and local governments finance and organize the provision of health care to the poor. While the expansion of Medicaid has been a good thing in one way, it has really knocked the intergovernmental finance system out of whack. In short, I just don’t think health care should be a subnational function, and creating some sort of national universal health care system is not only obviously the right thing to do for public health, but it would also free up a lot of energy at the subnational level to address other problems. In any case, these are a few of the items that would be at the top of my wish list.

JH: Because so much of your agenda seems so difficult without a constitutional rewrite, what might be happening now that could help improve the situation? What is imminently possible that people might not realize?

AL: As I said earlier, it seems like both Covid-19 and the aftermath of Covid-19 have helped change the thinking about federal cash transfers to the poor. The failure to make the expansion of the earned tax credit permanent is very unfortunate. But it is good that the debate on this has moved, at least because providing more cash transfers to the poor would alleviate some of the pressure on local governments to provide services—like heating and housing support—to the needy.

I also think that in a funny way, the response to Covid-19 by both the Trump and Biden Administrations pumped more money through the intergovernmental grant system than the existing system can really handle. Or, put another away, too much money has been pushed down too many different pipes and, in some cases, has blown out the existing piping entirely. So even though the various programs that are being financed say funds should be used in this way or that, creative local officials can use funds more to their liking than before simply because the existing system doesn’t really work. In a perverse way, large amounts of funding through the existing structures may create possibilities for the more creative use of federal monies simply because there isn’t a possibility to really ensure that they be used for the purposes they were directly intended for.

JH: So the chaos created a bit of a dry run?

AL: Or a space for local actors to do what they think is best. And I’m sure there are people who are doing just that. Whether this is a good way to do business is entirely another question. But my hope is that there will be possibilities for a larger discussion sooner than one might think and even despite the polarization just because the problems will become clear enough to demand to be thought about.

JH: So on one hand, there’s plenty of discussion and research on proper spending and better allocation of funds, but on the other hand, not enough discussion of taxation and reorganizing the transfer system?

AL: There are a lot of demands by the left on the federal government to increase taxation on the rich, much of which is entirely justifiable, but which I also don’t think really will fix the wagon. If taxation is going to be made credible again, all levels of government have to be made more capable of delivering more of the services that people want. The way we deliver government-financed health care services in this country is, to say it again, crazy and extremely costly. We spend 16–17 percent of our GDP on health care, about half of which is private and half of which is public. What we spend publicly is equal to what most Western European governments spend, and we get much less for it. And what they spend privately is equal to about 3 percent of the GDP. So we are spending at least 3–5 percent more of our GDP on health care than comparable countries, and we have worse outcomes and no universal coverage. If we could fix that and then put the savings back into a more sensible system of grants and transfers to local governments, this would go a long way toward fixing many of our problems.

*This interview has been edited for length and clarity.