Category Archives: Constitutionalism

An interesting development in state regulation of wine shipment

Can one state enforce another state’s laws that prohibit direct-to-consumer wine shipment from out-of-state retailers while allowing it by in-state retailers?  That’s the question posed in a recent New York case.

The New York State Liquor Authority has a rule that prohibits licensees from engaging in “improper conduct.”  The liquor regulator argues that direct shipments by retailers that violate other states’ laws constitute improper conduct.  It has fined, revoked licenses, and filed charges against New York retailers that it believes have shipped wine illegally to customers in other states. One retailer, Empire Wine, refused to settle and has sued the liquor authority in state court, claiming that the “improper conduct” rule is unconstitutionally vague and that the liquor authority cannot enforce other states’ laws that discriminate against interstate commerce.

Many states continue to prohibit direct shipment from out-of-state retailers. For example, 40 states do not allow New York retailers to ship directly to consumers.  This harms consumers, because it is usually out-of state-retailers, rather than wineries, that offer significant savings compared to in-state retailers. In a 2013 article published in the Journal of Empirical Legal Studies, Alan Wiseman and I identified two different anti-consumer effects of laws that allow out-of-state wineries to ship direct to consumer but prohibit out-of-state retailers from doing so. First, these laws deprive consumers of price savings from buying many bottles online: “Online retailers consistently offered price savings on much higher percentages of the bottles in each year—between 57 and 81 percent of the bottles when shipped via ground and between 32 and 48 percent when shipped via air. Excluding retailers from direct shipment thus substantially reduces—but does not completely eliminate—the price savings available from purchasing wine online.” Second, these laws reduce competitive pressure on bricks-and-mortar wine stores, since they exclude lower-priced out-of-state retailers from the local market. Thus, the laws likely harm consumers who buy from their local wine shops, not just consumers who want to buy online. (The published version of the paper is behind a paywall, but you can read the working paper version at SSRN.)

(Photo credit: http://srxawordonhealth.com/2011/07/11/exercise-in-a-bottle/)

 

Is American Federalism conducive to liberty?

In new Mercatus research, Dr. Richard E. Wagner, Harris professor of Economics at George Mason University tackles a fascinating question: Is the American form of federalism supportive of liberty?

His answer is a qualified ‘yes.’ Under certain conditions, American federalism does support liberty, but that very same system can also be modified resulting in the expansion of political power relative to the liberty of citizens. The question of what results from the gradual constitutional transformation of the American federalist system is a salient one for not only students of government but also policymakers.

The important conditions that determine which form of federalism prevails (liberty-supporting or liberty-eroding) are rooted in competition among governments. Today we are experiencing a very different kind of federalism than the one instituted by the Founders. For the better part of a century, the US constitution has often been amended in a way to encourage collusion among the states thus undermining a key feature of a liberty-supporting federalism.

Restoring a liberty-supporting federalism first requires a deeper diagnosis of the American federalist system. Dr. Wagner develops that possibility through a very engaging synthesis of public choice theory, Austrian and new institutional economics.  Student of Dr. Wagner may be familiar with many of these concepts, developed in his public finance books including Deficits, Debt and Democracy (2012, Elgar). Rather than summarize the paper in today’s blog post, for now I encourage you to read the piece in full.

The “pension tapeworm” and Fiscal Federalism

In his annual report to shareholders, Warren Buffett cites the role that pension underfunding is playing in governments and markets:

“Citizens and public officials typically under-appreciated the gigantic financial tapeworm that was born when promises were made. During the next decade, you will read a lot of news –- bad news -– about public pension plans.”

He zones in on pension mathematics – “a mystery to most Americans” – as a possible reason for accelerating liabilities facing state and local governments including Puerto Rico, Detroit, New Jersey and Illinois. I might go further and state that pension mathematics remains a mystery to those with responsibility for, or interest in, these systems. It’s the number one reason why reforms have been halting and inadequate to meet the magnitude of the problem. But as has been mentioned on this blog before: the accounting will eventually catch up with the economics.

What that means is unrelenting pressure building in municipal budgets including major cities. MSN Money suggests the possibility of bankruptcy for Los Angeles, Chicago and New York City based on their growing health care and pension liabilities.

In the context of this recent news and open talk of big municipal bankruptcy, I found an interesting analysis by Paul E. Peterson and Daniel J. Nadler in “The Global Debt Crisis Haunting U.S. and European Federalism.”(Brookings Institution Press, 2014).

In their article, “Competitive Federalism Under Pressure,” they find a positive correlation between investors’ perception of default risk on state bonds and the unionization rate of the public sector workforce. While cautioning that there is much more at work influencing investors’ views, I think their findings are worth mentioning since one of the biggest obstacles to pension reform has been the reluctance of interested parties to confront the (actual) numbers.

More precisely, it leads to a situation like the one now being sorted out in federal bankruptcy court in Detroit. Pensioners have been told by Emergency Manager Kevyn Orr that if they are willing to enter into a “timely settlement” with the city and state, they may see their pensions reduced by less than the 10 to 30 percent now suggested. Meanwhile bondholders are looking at a haircut of up to 80 percent.

If this outcome holds for Detroit, then Peterson and Nadler’s findings help to illuminate the importance of collective bargaining rules on the structure of American federalism by changing the “rules of the game” in state and local finances. The big question for other cities and creditors: How will Detroit’s treatment of pensions versus bonds affect investors’ perception of credit risk in the municipal debt market?

But there are even bigger implications. It is the scenario of multiple (and major) municipal bankruptcies that might lead to federalism-altering policy interventions, Peterson and Nadler conclude their analysis with this observation:

[public sector] Collective bargaining has, “magnified the risk of state sovereign defaults, complicated the resolution of deficit problems that provoke such crises, heightened the likelihood of a federal intervention if such crises materializes, and set the conditions for a transformation of the country’s federal system.”

Does statehood trigger Leviathan? A case study of New Mexico and Arizona

I was recently asked to review, “The Fiscal Case Against Statehood: Accounting for Statehood in New Mexico and Arizona, by Dr. Stephanie Moussalli for EH.net (the Economic History Association).

I highly recommend the book for scholars of public choice, economic history and accounting/public finance.

As one who spends lots of time reading  state and local financial reports in the context of public choice, I was very impressed with Moussalli’s insights and tenacity. In her research she dives into the historical accounts of territorial New Mexico and Arizona to answer two questions.  Firstly, did statehood (which arrived in 1912) lead to a “Leviathan effect” causing government spending to grow. And secondly, as a result of statehood, did accounting improve?

The answer to these questions is yes. Statehood did trigger a Leviathan effect for these Southwestern states –  findings that have implications for current policy – in particular the sovereignty debates surrounding Puerto Rico and Quebec. And the accounts did improve as a result of statehood, an outcome that controls for the fact that this occurred during the height of the Progressive era and its drive for public accountability.

A provocative implication of her findings that cuts against the received wisdom:  Are the improved accounting techniques that come with statehood a necessary tool for more ambitious spending programs? Does accounting transparency come with a price?

What makes this an engaging study is Moussalli’s persistence and creativity in bringing light to a literature void. She stakes out new research territory, and brings a public choice-infused approach to what might otherwise be bland accounting records. She rightly sees in the historical ledgers the traces of the political and social choices of individuals; and the inescapable record of their decisions. In her words, “people say one thing and do another.” The accounts speak in a way that historical narrative does not.

For more read the review.

 

Giving Illinois local governments control over their workers’ pensions

The Chicago Tribune makes a “modest proposal” this week. Discouraged by the inaction of the Illinois General Assembly on state-wide pension reform, the editorial board supports the idea that costs for teacher pensions should be shifted and shared with local governments. Republicans, fearful of property tax hikes, don’t like the notion. But the Tribune makes a good point: the cost shift should be accompanied with the ability of local governments to directly negotiate with their employees minus the influence of Springfield. It’s an interesting idea.

Ultimately, pension reform must proceed according to certain principles that clarify the following:

a) What is the true and full value of the benefit? The market valuation principle.

b) How do you incentivize such a system to properly value, steward, and fund benefits? The principal-agent problem.

c) How do you connect the full employee wage/benefit bill with taxpayers who enjoy the services? The fiscal illusion problem.

Right now, it’s a mess. Government accounting is a still a jumble. (But the real value is always knowable via market valuation.) No entity currently has the incentive to properly value and fund these systems. And in fact, we continue to see risk-taking and the shifting of assets into alternative investments, the issuance of Pension Obligation Bonds, and the deferral of reforms. Politicians have a short-term horizon.

And then there is the problem of “disjointed finance.”

Take the case of New Jersey. Local governments negotiate with their employees over wages. But pension policy is set by the state. New Jersey municipalities get an annual bill to fund their employee pensions based on the state actuary’s calculations. Local officials don’t have any sense of what those obligations look like going forward. The state’s annual funding calculations low-ball what is needed to fund the benefits. Could it be that such opacity leads local governments to offer wage enhancements, or hiring increases, that translate into total compensation packages that they can’t afford?

The Chicago Tribune’s idea only works if Illinois local governments accurately calculate what is needed on an annual basis to fund the pensions they negotiate with their workers and to have a full assessment of the value of compensation packages over time. How is market valuation incentivized? Perhaps Moody’s move to calculate pensions based on a corporate bond yield will have an effect. Or perhaps plans need to be managed by a third-party, as Roman Hardgrave and I suggest in our 2011 paper. 

Tying local costs to local taxpayers is a good idea. Another phenomenon the pension problem has revealed is gradual separation of taxing and spending in American public finance over the course of the past half century. That has produced a growing fiscal illusion in finance – where things seem less expensive than they actually are since the costs are spread over larger groups of taxpayers. Local costs are spread among state taxpayers, and now the worry is that state pension costs and debts will be spread across national taxpayers. At least, it’s been suggested.

In his 2012 budget, Governor Quinn alluded to a federal government guarantee  of Illinois’ pension debt. It’s not a popular idea with Congress at the moment. But it appears to have been part of the political calculations of those who are responsible designing and enforcing the rules that guide Illinois’ budget and determine pension policy.

 

 

 

 

The Problem with States’ Rights

This week, Eileen Norcross hosted a fiscal federalism symposium, bringing together scholars of various disciplines to discuss some of the challenges that our system of federalism faces today. Part of the discussion centered around Michael Greve’s new book The Upside-Down Constitution.

One of his key points is a reminder of the reason federalists believed that states’ rights are important. We shouldn’t care about states’ rights for the sake of states’ rights — states are merely groups of residents. Rather, we should care about people’s rights, and how these can be better protected in a federalist system than under a centralized government. This distinction sometimes gets lost when people advocate states’ rights rather than states’ enumerated powers. The problem with advocating states’ rights is that this nuance paves the way for states to collude rather than to compete.

A clear example of this collusion happened in 1984 when Congress passed the National Minimum Drinking Age Act. Because setting a drinking age does not fall under the federal government’s enumerated powers, when Congress wanted to change the rules in this area, it had to bargain using tax dollars. States that kept a drinking age in place below 21 would have lost 10-percent of their federal highway funding dollars.

While this may sound like the federal government is coercing the states, it’s key to remember that the goal of federalism is individuals’ rights. With the National Minimum Drinking Age Act, the states and federal government colluded to bring an end to competition in policy. This Act made state policy in this area the same, taking away Americans’ opportunity to choose to live in states with lower drinking ages.

When multiple levels of government pay for a given service, such as roads, many opportunities arise for this type of collusion, leading to the growth of government and the erosion of competition between governments. A competitive federalism means both that governments have incentives to provide the policy environments that their residents want and that people will have greater variety of policy climates to choose from. If the drinking age is an important issue to a family, competitive federalism could provide them with the option of living in a city or state with a higher or lower minimum age.

In the coming year, we hope to pursue research exploring what institutions limit competition within American federalism and what institutions prevent collusion between the federal, state, and local jurisdictions.

 

Monday morning links

Demographic shifts in American metropolitan areas since 1950 via Demographia

Public Sector Inc post: The consequences of investment risk in public sector plans

Woonsocket, Rhode Island and talks of bankruptcy 

New federal school lunch rules: students must buy fruit and vegetables (even if they throw it in the trash)

Don’t Bailout the States

Last week the Illinois House adopted HR 0720 which was part of a growing effort to remove the possibility of a federal bailout for the states. The synopsis of the House Resolution reads:

Urges the federal government to take no action to redeem, assume, or guarantee State debt; and the Secretary of the Treasury should report to Congress negotiations to engage in actions that would result in an outlay of Federal funds on behalf of creditors to a State.

Senior Director of Government Affairs at the Illinois Policy Institute, Collin Hitt, offered committee testimony on the resolution. While writing about his testimony, Collin correctly argues that

Illinois’ problems are its own. Illinois has the tools to fix its finances. The state is seeing record reviews. Pension reform and Medicaid reform are possible, and there are concrete ideas to fix these debt-ridden programs. The prospect of a federal bailout only forestalls those solutions. If a federal bailout is considered imminent – or even possible – then the urgency to actually solve our problems ourselves is diminished. This resolution sends a message throughout state government that a bailout is not a solution that the State of Illinois can plan on.

That last part is absolutely essential, as it gets at a serious issue currently taking place in Illinois and other troubled states across the U.S. When politicians and law makers are dealing with a state that is on the brink of fiscal collapse they have two options: 1) make lasting intuitional and structural reform or 2) avoid significant reform and hope that most of the issues fix themselves. As a federal bailout becomes more likely, however, avoiding reform becomes politically easier. This, therefore, becomes a race to the bottom scenario where the states that end up in the worst fiscal shape are “rewarded” with a federal bailout… A very bad incentive structure and a scary road to head down.

Hopefully HR 0720 gains more traction and Illinois and begins to change the growing federal bailout expectations. If it is successful, other states should surely follow.

Hamilton’s Paradox

I recently finished reading Jonathan Rodden’s 2006 book Hamilton’s Paradox: The Promise and Peril of Fiscal Federalism. The book provides a fascinating analysis of fiscal federalism that combines theory, qualitative and quantitative analysis, and contemporary case studies.

Rodden begins by detailing the potential promises and perils of fiscal federalism. He states that the promise of federalism is straightforward: “decentralized, multitiered systems of government are likely to give citizens more of what they want from government at lower cost than more centralized alternatives.” The perils of federalism, although less examined in the literature, are rooted in the idea that “In decentralized federations, politically fragmented central governments may find it difficult to solve coordination problems and provide federation-wide collective goods. As in the private sector, public institutions only produce desirable outcomes when incentives are properly structured” (p. 5).

In Chapter 3 Rodden provides a very interesting history of federalism and federal bailouts in the U.S. Specifically, he discusses the federal assumption of state debt that took place in 1790, the rapid growth in state borrowing in the early 1800s, the nine states that defaulted in 1841 and 1842 (Maryland, Pennsylvania, Arkansas, Florida, Illinois, Indiana, Louisiana, Michigan, and Mississippi), and the constitutional debt limitations that many states adopted in the 1840s and 1850s.

Most interesting is the game theory model Rodden develops in the second half of Chapter 3. Specifically, it’s a dynamic game of incomplete information that takes place between the central government and a single subnational government. Information is incomplete because subnational governments don’t know exactly how the central government will behave in the event of fiscal crisis. That is, the central government will either allow the subnational government to default (resolute type) or will provide a bailout (irresolute type).

The fist move of the game occurs when a subnational government experiences a fiscal shock with lasting effects (i.e. recession). In response to the fiscal shock it can either adjust immediately or refuse to deal with the shock by borrowing, with the long term hope of receiving a bailout. The path that the subnational government takes is a function of, among other things, the expected probability of the central government being resolute or irresolute (the complete game is much more detailed than the brief description provided here).

Rodden utilizes this game as he develops each of the case studies provided later in the book. The case studies involve comparing and contrasting the events that have taken place in Germany and Brazil. In the 1990’s two states in Germany received formal bailouts by the federal government (the Bund). During the same time, however, bailouts were distributed to virtually every state in Brazil. In Chapters 7 and 8 Rodden carefully details the structures of government in these two countries and outlines the reasons their outcomes were so different.

Two of the many important conclusions that Rodden makes in this book are (1)

when free to borrow, growing transfer dependence is associated with increasing deficits, both among federated units and local governments (p. 116)

and (2)

The central government must not only allow subnational governments significant tax autonomy and disentangle its books from those of the subnational governments, but it must demonstrate through costly action that it will not assume subnational liabilities when times get tough (p. 267)

This brief review of Hamilton’s Paradox only covered a few of the many important topics that the Rodden details in the book. I strongly recommend this book for anyone interested in fiscal federalism.

Happy Bill of Rights Day

Image is in the public domain

A few observations:

Common conceptions to the contrary, the first ten amendments to the Constitution do not grant people their rights.

The First Amendment does not say that, henceforth, people shall have a right to establish a religion or to speak freely. Instead, it says that “Congress shall make no law respecting an establishment of religion…or abridging the freedom of speech.” The second Amendment does not say that the people now have a right to bear arms. It says that “the right of the people to keep and bear Arms, shall not be infringed.”

This is not a matter of semantics. The framers knew that they could not possibly name all of the legitimate rights of the people. Indeed, as Hamilton expressed in Federalist 84, there was a danger in trying to do so, for if the list left anything out (as it surely would), then there would be a presumption that people lacked the omitted rights and this might be used as a “pretext to claim” that the federal government possessed more than the strictly enumerated powers laid out in Constitution.

So instead of enumerating the rights of the people, the Bill of Rights talks about the things that the Federal government may not do: “Congress shall make no law…”,  “the right…shall not be infringed”, “the right of the people to be secure in their persons…shall not be violated”, “In Suits at common law…the right of trial by jury shall be preserved”, “excessive bail shall not be required.”

Each of these is a limitation on the powers of the government, not a positive grant of a right to the people (I’ll concede that the Sixth Amendment, which says that in criminal prosecutions the accused “shall enjoy the right to a speedy trial…” comes close to a positive grant; but even there, the idea is that the government cannot lock you up without a trial).

The handy thing about this wording is that it sets up the presumption that we don’t have to go to the government to ask for our rights. Our rights existed before government was established. And if the federal government were to one day fall, then our rights would still exist. This was a central tenet of the Enlightenment philosophy and it can be found in the writings of Locke, Mason, and Jefferson, among many others.

The framers thought of these rights as God-given. But if you prefer a secular spin on it, you can imagine that they are reason-given. The point is that they are not government-given.