Two Men Holding Bag with Money, Studio Shot --- Image by © Mike Kemp/Rubberball/Corbis

But What Kind of Federalism?

FEDERALISM, WE (CONSERVATIVES) are inclined to believe, requires a healthy “balance” between Washington and the states. The New Deal threw the balance out of whack, and we have been on a relentless march toward centralization ever since. An overbearing, out-of-touch, out-of-control government in Washington, D.C., has aggrandized itself and trampled state and local governments underfoot. To restore fiscal sanity and democratic government, the thinking goes, we should restore federalism’s balance. We should respect the Tenth Amendment, return power to the states, and bring government closer to the people.

The conventional view of federalism is seriously deficient in several crucial respects. It misses the pathologies of our federalism, and it cannot be the basis for or even part of a plausible conservative agenda for a smaller, more disciplined government.

This conventional view has much to commend it. But it is seriously deficient in several crucial respects. It misses the pathologies of our federalism, and it cannot be the basis for or even part of a plausible conservative agenda for a smaller, more disciplined government. I will suggest what the federalism piece of such an agenda might look like, but I start with four common and fateful misperceptions.

Four Federalism Misconceptions

Our Bilateral Federalism Problem. The conventional federalism prescription, as just noted, is to “return power to the states.” At some level, it’s hard to disagree. The national government regulates local storm drains, grade schools, and conflicts between your plan to build a home on your property and a toad’s desire to procreate in the same location. (As a rule, the toad wins.) Parking spots at the mall, office jokes, and children’s playground conduct have become matters of national policy. This is a federalism problem.

It is, however, not our only federalism problem. Excessive centralization is a concern; but so is excessive de-centralization. The problem has a regulatory dimension and a fiscal dimension.

To see the regulatory problem, put yourself in the shoes of someone who is trying to run a productive national enterprise that wants to sell stuff on the Internet, produce life-saving drugs, or provide flood insurance: You will find yourself beleaguered by legislatures, courts, attorneys general, regulators, and trial lawyers from 50 fiefdoms—all with their own conflicting, cascading demands, but united in a desire to have a piece of you and your business. The failed state of California, among others, 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 vigorously asserted a right to conduct their own global warming policy; some have signed greenhouse treaties with foreign nations. State attorneys general have reorganized entire industries through settle-or-else prosecutions. Day in, day out, products and profits disappear in state hellhole jurisdictions. In short, federal regulatory overreach has gone hand-in-hand with state overreach.

At the fiscal front, the central problem is the flood of transfer programs that encourage states to “experiment” with federal dollars. The most menacing example is Medicaid, which now consumes almost a quarter of state budgets. 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 moral hazard that attends these arrangements—that is, the risk that states will spend themselves to the brink of bankruptcy in hopes of a federal bailout. Greece exemplifies that problem; but then, so does Illinois.

The False Notion of the Decline of States. Excessive centralization and de-centralization have escalated in tandem. Quite clearly, though, the centrifugal tendency is more than a mere footnote. Consider: From the end of the Korean War to 2008, federal taxes in relation to gross domestic product hovered between 18 percent and 20 percent. Over that same time frame, state and local own-source revenues tripled, from about 5 percent to 15 percent. In fiscal terms, the entire growth of government in the United States is attributable to the growth of state and local government.

There has never been a time in our history when states exercised more power over the commerce of the United States than they do now. The conventional story of a relentless march toward centralization has a certain charm. But as an empirical matter, it is mostly false.

And consider: A few decades ago, no serious businessman or corporate lawyer worried about state law, state regulators, or trial lawyers. Now, companies operate amid a horde of regulatory trolls, any one of whom can unleash a regulatory firestorm. There has never been a time in our history when states exercised more power over the commerce of the United States than they do now. The conventional story of a relentless march toward centralization has a certain charm. But as an empirical matter, it is mostly false.

Perhaps (you might say or think) the Obama administration has changed the game. But that, too, is false. For example, the first Obama administration bailed out states by means of the “Stimulus” bill (formally, the American Reconstruction and Recovery Act). Nor do ObamaCare and Dodd–Frank herald a lurch into socialist centralization. Rather, those signature accomplishments build on the most dysfunctional practices of our federalism, and double down. To expand the already unaffordable Medicaid system, the Affordable Care Act increases the states’ Medicaid match. Moreover, come 2014, the law will enable states to dump many of their employees and retirees—whose health care costs currently fall on state and local governments—into federally subsidized exchanges (This fact explains why the states were for ObamaCare before some of them were against it.) Similarly, Dodd–Frank gives state regulators and attorneys general a power they have lacked since McCulloch v. Maryland (1819) and the creation of the national banking system in 1864—the power to sue and supervise nationally chartered banks. Unleashing hordes of state regulators and courts on national financial institutions has undoubtedly enhanced state power. It may be a “federalism” of sorts; but it’s not John Marshall’s federalism, or a federalism conservatives should embrace.

The Not-So-Noble States. The conservative demand for “more federalism” reflects an intuition that states will manfully defend their citizens’ rights against federal usurpation (unless the federal government corrupts or oppresses them). For well over a century, however, the general pattern has not been state resistance to federal ambition but state demand for federal intervention. Look at the famous Supreme Court cases that first blocked and then routinely sustained the nationalist innovations of the New Deal—U.S. v. Butler, Schechter Poultry, Steward Machine Company, U.S. v. Darby, Wickard v. Filburn: As the captions suggest, each and every one of those cases was brought by (mostly small) business owners, not by states. In each case, states supported the federal laws. Likewise, when states protest federal regulation, they rarely do so in defense of free commerce. As often as not, states demand federal regulation—so long as they (the states) get to regulate on top of those standards.

It is not hard to see why this is so. The principal reason is a Constitution that in unmistakable terms requires open borders and free commerce across the country. Constitutional federalism means competitive federalism, on account of highly mobile capital and labor: Overtax or over-regulate your citizens or firms, and they move to a more hospitable state. This competition makes it hard to do favors for constituents. Thus, state politicians do what private producers do when they face competition: They call on the federal government to stamp out competition and to create cartels. Every federal minimum standard—for wages, safety, air quality—-dampens state competition on those margins. Hence, states lobby for those standards. Likewise, every federal food stamp or housing subsidy is a benefit that state officials do not have to finance from their own tax revenues, and so they lobby for a bigger federal welfare state, so long as they get to hand out the money. Virtually every federal regulatory and transfer program can be understood as a cartel among states. When states complain about the programs, they don’t want to get rid of them; they simply want a bigger share of the excess profits, meaning our taxes. In short, trusting states on federalism is like trusting the Fortune 500 to defend free markets. You can always trust states to defend their own privileges, just as you can always trust corporations to defend tax exemptions for the CEO’s private jet. But you can never trust them in the defense of a competitive federal order.

The False Idea That More Federalism Means Smaller, Better Government. The notion that “more federalism” or “devolution” means smaller, more responsible government has been a refrain of modern conservative politics from Nixon to Reagan to Gingrich to, most recently, Romney/Ryan. However, it is demonstrably wrong.

Consider two federalism arrangements: (A) The feds take over the entire field of regulation (say, airlines) and prohibit state interferences; or (B) the feds establish minimum standards, and states get to regulate on top of them. Which is the more “state-friendly,” de-centralized solution? B. Which will mean bigger government? Again, B. You can have smaller government or you can have concurrent state power; you cannot have both.

Consider another, slightly more complicated choice: (A) States provide some benefit or service (say, health care) without federal financial assistance; (B) the federal government provide the benefit exclusively; no states involved; or (C) the federal government provides financial assistance to the states, and both provide the service jointly. Which is the small-government solution? Plainly A: States would have to tax themselves for the service; and often they won’t, for fear of inducing capital and labor flight. For that reason, the national government has become extensively involved in providing social services. Here, the choice is between B and C—exclusive federal provision or joint production.

Suppose you want a really big welfare state: Would you opt for exclusive federal provision or for federal aid to states? Lo and behold, the big government solution is the state-friendly federalism solution. At one end, federal aid drives up local taxing and spending. No state would devote 20-plus percent of its budget to Medicaid if it had to tax its own citizens for the cost. But states are evidently willing to tax themselves for half the cost—because if they don’t, they leave federal dollars on the table. Due to federal “assistance,” every state ends up with a level of spending that no state would adopt on its own. At the other end, the fact that the feds are paying only part of the program makes it look much cheaper than it actually is. If the federal government had to provide all those services by itself, government at all levels would be much, much smaller. Fiscal federalism is the engine that drives the transfer state. It is the American version of social democracy. Less of that federalism would be better.

Two Madisonian Lessons

To be sure, the “federalism” I have just described is not the federalism conservatives had in mind. And that is the central point: Federalism is a “they,” not an “it.” Depending on its form, it can be a blessing or a curse. Thus, the question is not: How much federalism? The question is: What federalism should we aspire to? We cannot simply be “for federalism” and yelp about the Tenth Amendment; we have to articulate a coherent agenda for a particular kind of federalism.

The question is not: How much federalism? The question is: What federalism should we aspire to? We cannot simply be “for federalism” and yelp about the Tenth Amendment; we have to articulate a coherent agenda for a particular kind of federalism.

In thinking about that question, it is best to go straight back to the Constitution and its most illustrious exponent, James Madison. Two of his insights are essential.

Federalism Is for Citizens, Not States. Our high-minded, “principled” federalism talk is about how much federalism—about the federal balance, about the states’ “dignity” and supposed constitutional prerogatives, and (to quote Justice Anthony Kennedy) about federalism’s “etiquette”—as if better table manners would improve our diet. That is the wrong “how much” question in a different version. The right question is crass and utilitarian: What’s in it for us citizens and taxpayers? And sure enough, that is the question the Constitution wants you to ask. The balance question isn’t just beside the point; it is an assault on the foundations of the republic. To quote Madison’s impassioned language in Federalist 45:

Was … the American Revolution effected, was the American Confederacy formed, was the precious blood of thousands spilt, and the hard-earned substance of millions lavished, not that the people of America should enjoy peace, liberty, and safety, but that the government of the individual States, that particular municipal establishments, might enjoy a certain extent of power, and be arrayed with certain dignities and attributes of sovereignty?

The answer he is trying to evoke is: Hell, no. We did not fight and bleed for the dignity of states and their politicians. Rather, quoting Madison again:

[T]he public good, the real welfare of the great body of the people, is the supreme object to be pursued; and [that] no form of government whatever has any other value than as it may be fitted for the attainment of this object.

States Are Purely Instrumental. If they can advance the “real welfare of the great body of the people,” good for them. If they stand as a hindrance, ignore them or get rid of them. That is the fundamental calculus and the irreducible premise of the United States Constitution. The cartel federalism we have is profoundly state-friendly: It serves the interests of the political class. The constitutional, competitive federalism we need is citizen-friendly: It would discipline government, not help it grow.

The Federalism of the Compound Republic. The Founders never used the word “federalism” in our modern sense. Madison called the constitutional system a “compound republic.” State and federal powers are organized in a particular way. (Organize the powers differently, and you end up with a very different federalism.) The general government’s powers, Madison said, are federal in extent. What he meant was that the powers are limited and enumerated. But the compound republic has a second feature: Federal powers, according to Madison, are national in operation. What he meant was that the powers are supreme over state law; that they operate directly on citizens, without the assistance of the states; and that they operate exclusively unless the Constitution says otherwise. Conservatives have rightly emphasized the first, limited-and-enumerated part of the equation. They have wrongly slighted the second, national-in-operation part.

State powers, conservatives (especially those on the Supreme Court) say, are concurrent unless the Constitution or Congress says otherwise. So: Just about every commercial transaction is subject to one federal rule and, at the same time, 50 state rules. Private conduct becomes subject to multiple, often conflicting impositions: The states and the federal government “compete” by heaping regulatory burdens on the commerce of the United States. There is no stopping point, and the toughest regulator or hellhole jury sets the rules of the game. Frankly, that is nuts. We should heed Madison’s crucial insight: Problems should be regulated by one or the other level of government but not by both. One problem, one sovereign.

As with exclusivity, so with the Madisonian principle that federal powers operate directly on citizens: Overwhelmingly, it is observed in the breach. Under the conditional funding programs mentioned earlier, the federal government regulates education, the environment, health care, welfare, and much else besides. But it does not regulate us directly; it has subcontracted that task to state and local governments, in the name of “federalism.” Within broad parameters, the Constitution permits this strategy. But that doesn’t mean that it is a good idea. As Publius understood very well, “cooperative” government programs are very hard to monitor; they destroy political accountability and transparency. The programs will fail even if all the institutions and their occupants are competent and well-intentioned. Failure, in turn, produces an orgy of bureaucratic blame-shifting: State officials complain about “unfunded mandates”; the feds, over state irresponsibility and incompetence. None of us can figure out which is true and who is responsible. Meanwhile, all government actors agree that yet more money and another 100,000 teachers will solve the problem. It won’t. We have acceded to that demand time and again, and failed each time. The only thing that will solve the problem is to burn the intergovernmental jungle to the ground and to have services provided directly by one or the other level of government—not jointly by both. We would end up with less government, and better government.

Pieces of an Agenda

Suppose we were to champion the right kind of federalism—Madisonian federalism. What would that look like? A full agenda is above my pay grade, but I have a few pointers.

First, and above all, prevent the next junkyard dog from biting. In important niches, competitive federalism is still operating, and we should keep it that way. The technologies that have allowed the development of new energy resources, for example, are largely unregulated at the federal level, and this is a game changer. Attempts to shut it down are under way; much depends on stopping them.

At the same time, the coming years will produce numerous proposals to assist the poor, pitiful, financially distressed states: make ObamaCare more state-friendly, meaning lucrative; have the Federal Reserve buy distressed state and local bonds or (more likely) make nominally private banks buy the bonds; have the federal government assume teacher pension obligations under No Child Left Behind. The correct answer in each case is “no.” That answer will come more easily if we recall that federalism is about competition, not balance.

Our federalism of cartels, concurrent powers, and fiscal transfers is deeply dysfunctional—and it is big and resilient enough to swallow mere policy reforms. Conservatives should forget the “how much?” question and put the “What federalism?” question front and center.

Second, in terms of reform, think big. Think institutions, not policies. Our federalism of cartels, concurrent powers, and fiscal transfers is deeply dysfunctional—and it is big and resilient enough to swallow mere policy reforms without a burp. And in thinking big, conservatives should forget the “how much?” question. They should put the “What federalism?” question front and center and remember both parts of the Madisonian federalism equation: limited federal powers, national in operation.

In some contexts, that means emphasis on the “limited” part. For example, remember the controversy over the National Labor Relations Board’s attempt to stop Boeing from building a production facility in right-to-work South Carolina rather than unionized Washington. Clearly, that was a case of national overreach. What is not clear is what a grown-up country is doing with a national labor relations board in the first place. Labor law is precisely the sort of issue where states should experiment; where voters should make their own decisions, state by state; and where everyone—employers and employees, liberals and libertarians—can sort themselves into a state they like. Get rid of the NLRB, and let competition reign.

In other contexts, the “national” part—supremacy, directness, exclusivity—deserves emphasis. If you want to build the Keystone XL pipeline, you have to preempt the states. And if you want to deregulate anything in interstate commerce, you have to prohibit states from re-regulating. The Airline Deregulation Act categorically prohibits states from going anywhere near the carriers’ rates, routes, and services. That is a federalism dilemma for those who obsess over “balance.” From a Madisonian perspective, it is a model.

That same prescription—think big, think Madisonian—also applies to federal transfer programs, except more so and probably more urgently. The agenda cannot be to make “cooperative” fiscal programs more state-friendly. The key problem with those statutes is the misalignment of tax and spending authority: The federal government taxes and the states spend. That way lies moral hazard and fiscal ruin: One cannot enhance political responsibility by giving states more freedom to spend federal dollars. “Devolution” is simply another word for yet more irresponsibility and profligacy. We will have to disentangle these programs.

The true, Madisonian federalism solution is to separate Washington from the states. Senator Lamar Alexander has proposed a grand “swap”: nationalize Medicaid, and, in return, wipe out all federal education funding and attached strings. That is the right approach.

In plaintext: I believe that block-granting Medicaid would be a bad mistake. Sensible states—Indiana, Utah, South Carolina—may indeed be able to run the program in accordance with their local needs and at much lower cost. But a national policy that allows good states to do good things also allows bad states to do bad things. California and New York will hand the block-granted money to their unions and providers, toss destitute Medicaid recipients into the street, and then complain about the “emergency” and—volubly echoed by all states—demand more money. Short of heeding that call, the only option is to re-categorize the program. This is what happened under the Reagan administration; it would happen again. The true, Madisonian federalism solution is to separate Washington from the states. Senator Lamar Alexander (R–Tenn.) has proposed a grand “swap”: nationalize Medicaid, and, in return, wipe out all federal education funding and attached strings. That is the right approach, at least conceptually.

Is Reform Possible?

Those who served in the Reagan administration will recognize the agenda I have just sketched in very broad terms. Especially the first Reagan administration pursued a broadly Madisonian program. Its deregulation programs were brutally preemptive, meaning national in operation. At the same time, the administration advocated greater and often exclusive state authority over other matters such as natural resource management. And the administration emphatically advocated disentanglement: A version of Senator Alexander’s “swap” was part of the President’s 1982 State of the Union address. (Reagan proposed to nationalize Medicaid, while giving all of Aid to Families with Dependent Children (aka, welfare)—including full funding responsibility—to the states.)

In retrospect, it is dismaying how little of this succeeded. The regulatory state escaped largely unscathed; the swap was gunned down by its supposed beneficiaries (state and local governments); and the intergovernmental blob has become ever-more entrenched. What is there to give us hope now? Two things.

First, our bad cartel federalism is in crisis. It was a product of affluence: So long as the country felt rich, no one really cared that most federal transfer payments disappeared in intergovernmental bureaucracies and public sector unions. And no one cared that those programs drove up state and local taxes and spending, because that was the intended result. Now that affluence has come to an end, maybe we do care. Maybe a more sensible, constitutional federalism may get a hearing.

Second, our bad, dysfunctional federalism hangs on roping all states underneath federally sponsored regulatory and fiscal cartels. Increasingly, however, some states have begun to comprehend that there is nothing in such a federalism for them and that it may in fact prove ruinous. As that recognition sets in, major disagreements no longer run along “states versus Washington” lines; they run among and between states. The brawl over the Boeing facility wasn’t between the virtuous states and the big, bad Obama administration; it was between competitive right-to-work states and cartels-and-unions states. The EPA’s extravagant global warming program we owe to lawsuits and legislation instigated by some states; other states are fighting back. Most conspicuously, the ObamaCare litigation pitted coalitions of states against each other. And upon inspection, it turns out that it’s always the same state coalitions—a cartel coalition, anchored by New York, California, and Illinois; and a competitive coalition, anchored by Texas and, most of the time, Virginia. Both are “for federalism,” but of a very different kind.

It should be possible to cement and institutionalize the ad hoc “good state” coalitions that have sprouted from labor, environmental, and health care controversies. That coalition would be sufficiently powerful to block new “bad federalism” initiatives. It might even be able to support meaningful institutional reform programs. That hopeful scenario, though, requires a coherent federalism agenda—not for more Tenth Amendment, states’ rights federalism, but for the right federalism: constitutional, Madisonian, competitive federalism.

Dr. Greve is Professor of Law at George Mason Law School and a visiting scholar at the American Enterprise Institute. He is a frequent contributor to Liberty Law Blog, and the author of numerous books, most recently, The Upside Down Constitution (2012). This article is adapted from a lecture given October 13, 2012, at a meeting of the Philadelphia Society.