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Michael Greve on American federalism and pensions

by Eileen Norcross on February 15, 2012

in Economic Policy, Pensions, Public Finance, Stimulus, Tax and Budget

In a recent series of blog posts (h/t Arnold Kling), Michael Greve of AEI discusses the parallels between current American federalism and the trajectory that Argentina followed last century. Essentially, decades of “cooperative federalism” and trillions in transfer payments from the federal government to the states has put us on the course of ruin. This long-running arrangement has set the stage for the $4.5 trillion in unfunded pension liabilities owed to public workers, Obamacare, and ultimately an Argentinian future.

States rely on federal spending to implement the federal government’s policy agenda – most notably in the Medicaid program. Greve makes a provocative comparison: Medicaid is a “fiscal pact” similar to the arrangements between Argentina’s federal and state governments.

Federal transfers come with fiscal illusion. There is the incentive to overspend on the state level. And indeed we have seen the greatest growth in government on the state and local level since the post World War II period.

When states end up in trouble they can reasonably expect a bailout from the feds (ARRA is not the first bailout, nor is it likely to be the last). But what happens when both parties are broke?  Might pension liabilities accruing in the states be filled in with a soft bailout (e.g. an education spending package which can be applied to pay for benefits).  Alternatively, we might see an Argentinian-inspired solution: roll the pension obligations of troubled states into a federal corporation. In Argentina’s experience the federal pension corporation found itself with obligations several times larger than projected leading to a devaluation of the payout to retirees.

This is just one potential scenario. But, Greve’s main point is well taken. For reformers (of all ideological persuasions) who insist block grants will restore federalism‘s balance of power and fiscal discipline, think again. “Devolution” was much talked about in the 1990s as a means of restoring federalism but as implemented, it did nothing of the sort. The transfers keep coming just in different forms. Greve’s (Buchanan-based analysis) concludes it is not that cooperative federalism is broken, it has never been tried. 

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