Budget Crises Have Made States Dependent on Federal Funds, and the Flow of Money from Washington Has Given the Feds More Control over Local Spending

Seventy-nine percent of household income growth since 2007 has come from government transfer payments. People earn less real money. They have less real money to spend. Their major assets — their houses — are going down in value. And now they depend on the feds for more than half their income growth. Who’s going to vote for less government spending now? - Dependent on Fed Spending and the New Money System, The Daily Reckoning, April 27, 2011

As the following chart shows, federal aid to state and local governments has almost doubled in real terms over the past decade:

It’s not a coincidence that the states find themselves in a fiscal bind. [Source]

Bonjour! America on Verge of European-style Government - Feds Becoming Biggest Part of State Budgets

April 2, 2011

WorldNetDaily - This will be the first year that federal aid will become the largest individual component of state budgets, expanding Washington control over more of the decisions at that level, according to a report by an educational and research organization.

Already 27 states rely on federal aid as their primary source of funding, but the report by the Wyoming Liberty Group describes this year's level as a critical breaking point.

"It sends a profound message," says Wyoming Liberty Group research fellow Sven Larson, the author of the report. "There is a growing consensus among the states that dependency on the federal government is tolerable, even desirable."

While state revenues have declined during the current economic downturn, debt-financed federal aid has risen. Nationwide it now stands at more than one third of total state revenues, with greater state conformity over the level of federal aid dependence.

Last year, Oklahoma and Louisiana were the most dependent, with federal aid comprising 50 percent or more of their revenue. Ten other states were more than 40-percent dependent, compared to only one state in 2005, Louisiana, at 45 percent.

The rankings also reveal that another 16 states have dependency levels above one-third of their budget.

The Wyoming Liberty Group has documented the trend in sources for state revenue, which includes general funds for the ordinary expenses of the executive, legislative and judicial departments, for debt servicing, and for capital outlay. Other funds include program-specific taxes and fee revenues that are not available for discretionary spending:

Larson, author of "Remaking America: Welcome to the Dark Side of the Wefare State" and an immigrant from Sweden, said the federal funding trend is part of a broader decline of federalism toward a European-style unitary United States. And he believes the nation is at a critical threshold in that direction.

"Evidence from Sweden primarily, but also from other European welfare states, indicates that once government passes 40 percent of GDP (precisely where the United States hovers) the productive sector can no longer keep up with the tax obligations that government puts on it."

Larson explains that his research confirms that for states with the highest dependence, it has grown from 36.4 cents per dollar in the state budget to 45 cents. He also notes for those states with the lowest dependency, the level of federal funds has grown from 14.5 cents per dollar to 21.4 cents.

"Every state has increased its dependency on federal funds, and low-dependency states have increased their dependency the most," he said.

Chris Edwards, editor of DownsizingGovernment.org, in his February Tax and Budget Bulletin, also documented and denounced the large and growing federal presence in state policy.

He attributes state entanglement and dependency to the 1,122 federal aid programs in 2010, up 29 percent from 2005 and more than triple the 1985 level.

According to the Cato Institute, the Agriculture Department has 118 programs alone, spending nearly $37 billion. Health and Human Services runs 297 programs dispensing nearly $357 billion, and Housing and Urban Development runs 43 programs spending more than $42 billion. The Education Department runs 109 programs spending $86.5 billion.

The organization illustrates the massive growth in federal programs over the last 25 years:

"[These programs] combine federal subsidies with top-down regulations to micromanage state and local affairs... Furthermore, aid ties up the states in bureaucratic knots and reduces state policy innovation," said Edwards.

Robert Higgs, a senior fellow with the Independent Institute and a Louisiana resident, is a specialist on the growth of American government, most notably with his book, "Crisis and Leviathan." Like Larson, Higgs warns that federal funding makes a mockery of genuine federalism, since states then have less independence to act in the interests of local people.

"Fearing the loss of such a large part of their funding, state authorities become nothing more than puppets of the federal authorities," he said.

Alarm over the ever-increasing federal debt — it's about $14.3 trillion at the moment — has prompted the creation of a "No More Red Ink" campaign that has delivered nearly 1 million red letters to House Republicans urging them to vote not to raise further the debt ceiling.

The move would create an immediate cut in federal spending. Already, some 125 House Republicans, who control the issue and by themselves could stop more borrowing, have expressed their desire to cut off the credit.

Feds to States: "Drop Dead" - State Bank Movement Picks Up Steam

May 19, 2011

Ellen Hodgson Brown, Web of Debt - "Ford to New York: Drop Dead," said a famous headline in 1975. President Ford had declared flatly that he would veto any bill calling for "a federal bail-out of New York City." What he proposed instead was legislation that would make it easier for the city to go bankrupt.

Now the Federal Treasury and Federal Reserve seem to be saying this to the states, which are slated to be the first ritual victims in the battle over the budget ceiling. On May 2, Treasury Secretary Timothy Geithner said that the Treasury would stop issuing special securities that help state and local governments pay for their debt. This was to be the first in a series of "extraordinary measures" taken by the Treasury to avoid default in the event that Congress failed to raise the debt ceiling on May 16. On May 13, the Secretary said these extraordinary measures had been set in motion.

The Federal Reserve, too, has declared that it cannot help the states with their budget problems -- although those problems were created by the profligate banks under the Fed's purview. The Fed advanced $12.3 trillion in liquidity and short-term loans to bail out the financial sector from the 2008 banking collapse, 64 times the $191 billion required to balance the budgets of all 50 states. But Fed Chairman Ben Bernanke declared in January that the Fed could not make the same cheap credit lines available to state and local governments -- not because the Fed couldn't find the money, but because it was not in the Fed's legislative mandate.

The federal government can fix its own budget problems by raising its debt ceiling, and the too-big-to-fail banks have the federal government and Federal Reserve to fall back on. But these options are not available to state governments. Like New York City in 1975, many states are teetering on bankruptcy.

A Beacon in the Storm

Many states are in trouble, but not all. North Dakota has consistently boasted large surpluses, aided by a state-owned bank that is showing landmark profits. On April 20, the Bank of North Dakota (BND) reported profits for 2010 of $62 million, setting a record for the seventh straight year. The BND's profits belong to the citizens and are produced without taxation.

Inspired by North Dakota's example, twelve states have now introduced bills to form state-owned banks or to study their feasibility. Eight of these bills have been introduced just since January, including in Oregon, Washington State, Massachusetts, Arizona, Maryland, New Mexico, Maine and California. Illinois, Virginia, Hawaii and Louisiana introduced similar bills in 2010. For links, dates and text, see here.

The Center for State Innovation, based in Madison, Wisconsin, was commissioned to do detailed analyses for Washington and Oregon. Their conclusion was that a state-owned bank on the model of the Bank of North Dakota would have a substantial positive impact on employment, new lending, and government revenue in those states.

The BND partners with local banks in providing much-needed credit for local businesses and homeowners. It also helps with local government funding needs. When North Dakota went over-budget a few years ago, according to the bank's president Eric Hardmeyer, the BND acted as a rainy day fund for the state; and when a North Dakota town suffered a massive flood, the BND provided emergency credit lines to the city. Having a cheap and readily available credit line with the state's own bank reduces the need for massive rainy-day funds that are a waste of capital and are largely invested in out-of-state banks at very modest interest.

What States Can Do with Their Own Banks

North Dakota has a population that is less than 1/10th the size of Los Angeles. The BND produced $62 million in revenue last year and $2.2 billion in loans. Larger states could generate much more.

Banks create "bank credit" from capital and deposits, as explained here. The Bank of North Dakota has $2.7 billion in deposits, or $4000 per capita. The majority of these deposits are drawn from the state's own revenues. The bank has nearly the same sum ($2.6 billion) in outstanding loans.

You can get a rough idea of what a state bank could do for your state, then, by multiplying the population by $4,000. California, for example, has 37 million people. If it had a state-owned bank that performed like the BND, it might amass $148 billion in deposits. This $148 billion could then generate $142 billion in credit for the state, assuming the bank could come up with $12 billion in capital to satisfy the 8% capital requirement imposed on banks.

Note that this capital would not be an expenditure; it would just be an investment. And like any capital investment, it would actually make money for the state. The Bank of North Dakota has had a return on equity in recent years of 25-26%, and a major portion of this has been returned to the state treasury. All states have massive rainy day funds of various sorts. Some of this money could simply be shifted into equity in the state's own bank.

There are many options for using the state's credit power, but here is one easy alternative that illustrates the cost-effectiveness of the approach. Assume California's state-owned bank invested $142 billion in municipal bonds at 5% interest. This would give the state $7 billion annually in interest income. California has outstanding general obligation bonds and revenue bonds of $158 billion, and $70 billion goes for interest. If California had been funding its debt through its own bank for the last decade or two, it would have saved $70 billion on its bonded debt and would be that much richer today.

Read more here and here.