The Efficiency of Equity in Local Government Finance

Zachary D. Liscow

For generations, debates over what level of government should pay for local government services—most notably school funding—have largely boiled down to a simple pair of assumptions. Having the state or federal government pay for services promotes equality across rich and poor areas, but hampers local tailoring and thereby reduces citizens’ choice sets. Economists call this an equity-efficiency trade-off—centralized funding promotes equity but undermines efficiency.

This Article argues that this presumed trade-off is not as stark as generally thought, as it ignores important and underappreciated reasons that centralization promotes choice and thus efficiency. Specifically, more centralized funding helps people live where they prefer to live, unburdened by artificially needing to pay more for services in poor jurisdictions with large numbers of impoverished households who can pay little for services themselves. This insight should not only shift the scholarly debate on the equity-efficiency trade-off, but also supply important, real-world payoffs for debates over school funding and similar programs. Put simply, centralized funding promotes equality and, by promoting choice, efficiency.

The Article does not merely make a theoretical argument; it also empirically tests the claim using natural experiments across the country in centralizing state funding for schools. The Article finds large efficiency benefits. The results also show that more centralized financing has encouraged people to move back to central cities, suggesting a second, hidden efficiency benefit to more centralized financing: It promotes the positive externalities associated with central city living. The Article could thus broaden support for more centralized funding of local services, something that could fundamentally reshape not just academic debates over fiscal federalism, but also state and local fiscal policy and urban living.

Federalism as a Safeguard of Progressive Taxation

Daniel J. Hemel

This Article considers the distributional consequences of the Supreme Court’s federalism jurisprudence over the past quarter century, focusing specifically on the anti-commandeering, anti-coercion, and state sovereign immunity doctrines. The first of these doctrines prevents Congress from compelling the states to administer federal programs; the second prevents Congress from achieving the same result through offers that for practical purposes the states cannot refuse; the third prohibits Congress from abrogating state sovereign immunity outside a limited class of cases. These doctrines vest the states with valuable entitlements and allow the states to sell those entitlements back to Congress for a price. In this respect, the doctrines have an intergovernmental distributional effect, shifting wealth from the federal government to the states.

The distributional consequences of the anti-commandeering, anti-coercion, and state sovereign immunity doctrines are not purely intergovernmental, however. The doctrines also have potential implications for the distribution of wealth across individuals and households. By forcing Congress to bear a larger share of the costs of federal programs, and by shifting some of the costs of liability-imposing statutes from the states to Congress, these doctrines allow the states to raise less revenue and compel Congress to raise more. For a number of historical as well as structural reasons, the federal tax system is dramatically more progressive than even the most progressive state tax systems, and so the reallocation of fiscal responsibility resulting from these federalism doctrines causes more revenue raising to occur via the more progressive system. The likely net effect is a shift in wealth from higher-income households (who bear a larger share of the federal tax burden) to lower- and middle-income households (who would have borne a larger share of the burden of state taxes).

This conclusion comes with a number of caveats. The distributional consequences of the Supreme Court’s federalism doctrines may be moderated—or magnified—by differences in federal and state spending priorities. Moreover, the doctrines may affect the size of government as well as the allocation of fiscal responsibility across levels of government (though the net effect on government size is ambiguous). And the doctrines may have distributional consequences that are not only interpersonal, but also intergenerational. What seems clear from the analysis in this Article is that federalism doctrines affect the distribution of income and wealth in subtle and sometimes unexpected ways, and that a comprehensive understanding of wealth inequality in the United States requires careful attention to key features of our fiscal constitution.