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of this appropriation on the basis of population and tax effort and ten percent to the 17 States with the lowest per capita income on the basis of population and per capita income. The Goodell bill earmarks 45 percent of the State allocation for local government with the exact formula determined by each State. The Laird bill leaves the distribution of the money entirely to the discretion of the States. Both bills call for a cutback in the present grant-in-aid program but only the Laird bill directs and authorizes such a cutback. The Laird bill, in addition, provides a Federal income tax credit for State and local taxes paid by individuals, beginning at 10 percent and increasing 10 percent each year to a maximum of 40 percent.

Foreign Experience With Revenue Sharing

Several foreign countries have used the general support device and the same general considerations (equalization and local responsibility issues) were also relevant issues abroad. The lessons of foreign experience, however, are not clear-cut and therefore may not be of general applicability to the United States either now or in the future. Nonetheless, one of the more general findings that does emerge rather strikingly, is the adoption of the income tax as a revenue source for the central government, thereby shutting off or constraining its use by lower governmental levels. This situation of fiscal imbalance, therefore, generated pressures for devices to channel money from the Federal to the State sector involving the complex political problems of creating a sharing arrangement acceptable to several competing governmental units. In India, however, tax sharing avoids this political confrontation, since this is written into the Constitution, with a statutory body--the Finance Commission--appointed every five years to determine the actual tax shares for each region or State.

Although the tax sharing debate in the United States is most generally linked solely to the sharing on the individual income tax, the general support programs of both Canada and Germany include additional taxes as well. In the latter, for example, the corporate income tax is also shared between the Federal and State governments and the 1966 Commission on Financial Reform recommended including also the turnover tax (a sales levy on successive stages of production) as well as the gasoline tax, provided the State use the receipts only for urban road construction.

By and large, equalization has been the objective of tax sharing arrangements in other countries. Canada goes quite far in this direction, providing grants in the amounts necessary to bring the per capita yield from the various taxes included in the base up to the average level in the two wealthiest Provinces. Germany also has equalization features built in to its system with the interesting feature that States are obliged to grant a part of their receipts to municipalities; this share, however, is determined by State-- rather than--Federal law.

The experience in India is different. Although some attention is given to equalization, the results are rather mixed because some of the taxes that are returned are done so on the basis of origin of collection. Thus, the more efficient tax administration powers of the Federal sector are called into play specifically. Some observers read the past experience in India as a demonstration that under tax sharing, State governments do not seem to make an adequate tax effort or carefully scrutinize their public expenditures, and that tax sharing obligations tend to erode the counter cyclical powers of the central Government.

Chapter 4

SIGNIFICANT FEATURES OF FISCAL FEDERALISM

In assessing the fiscal balance in our federal system, we need to examine (a) the legal system that parcels out political responsibility for revenueraising and expenditure decisions, (b) the social and political diversities and fiscal disparities that flow from the basic decision to decentralize tax and expenditure authority, and (c) the various intergovernmental fiscal arrangements designed to minimize fiscal disparities that result from the uneven distribution of revenue resources and public service requirements.

WIDESPREAD DIFFUSION OF FISCAL AUTHORITY

Decentralized decision-making is an enduring objective of our Federal system, and a substantial measure of it is ensured by the sharing of responsibility for tax and expenditure decisions between officials representing the National Government, 50 States, and over 80,000 local governments.

Judicial decisions and legislative actions have rendered largely obsolete the doctrine of strictly limited national powers. States, however, are still free to exercise those powers that are not specifically delegated to the National Government by the Constitution, nor expressly prohibited to them under the Constitution.*

Multiplicity of Local Government

Local governments derive their powers from the States, and are organized in various ways according to the particular State constitutions and statutes under which they operate. As a result, there is considerable interstate variation in the kinds of local government and the division of responsibility between State and local governments for the provision of particular governmental services.

At the beginning of 1967 there were 81,253 local governments in the 50 States.1/ Two trends are evident: a sharp reduction in the number of school districts, partially offset by a marked increase in the number of special districts.27

United States Constitution, Amendment X.

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*Adjusted to include units in Alaska and Hawaii, which were
reported separately prior to adoption of statehood for these
areas in 1959.

**Includes about 1,700 entities which under earlier Census
classification practices would have been regarded as depen-
dent agencies of other governments rather than as separate
governments.

The number of local units of government varies widely from State to State. In 1967, Illinois, Pennsylvania, Kansas, Minnesota, Nebraska, South Dakota and California each contained more than 3,500 local governments, altogether accounting for almost two-fifths of the local government units in the United States, although accounting for only one-fourth of the country's population.3/ Connecticut and Rhode Island have no county government, and less than half of the States have organized townships. Independent school district governments provide public education in almost all States, yet in Hawaii, Maryland, North Carolina and Virginia this form of local government is completely absent. In Hawaii, public education is State administered, and in the other three States it is a county and municipal function. In about half of the States where independent school district organization dominates, public school systems are also operated by general purpose governments.

Regional differences in local government units are highlighted by data on the average number of local governments per county area. In 1967, 19 States-almost all of them in the Southeast--had less than 17 local governments per county area. At the other extreme 13 States--mainly, in New England and the Midwest--had 45 or more local governments per county area.4/

The implication of these numbers for fiscal federalism are far reaching. The large number of local governments means for example, that the property tax base--the principal support of local government--is divided sometimes rationally but often quite irrationally among governmental units. Throughout the system as a whole, some units enjoy relative local fiscal ease while others totter on the brink of fiscal exhaustion as they pass through various stages of development. The fiscally poor frequently must pressure the overlying State government for sustenance. The variety of ways in which States have responded is a credit to the ingenuity of man. The list includes shared taxes, local supplements to State imposed taxes, equalization grants, unconditional grants, and outright assumption

of fiscal and program responsibility.

One of the strengths of the federal system

is its demonstrated capacity to adapt to the diversity of local circumstances. In the process, however, a clear, orderly division of authority and responsibilities as between States and localities has been lost.

Intergovernmental Distribution of
Functional Responsibility

With few exceptions, domestic public functions have become the shared responsibility of several governmental levels. Indeed, if the source of financing is taken into account, there is hardly a functional area, even among those that traditionally have been considered strictly local like elementary and secondary school education and sewage and sanitation in which Federal, State and local governments do not participate to some extent.

As between State and local governments, the allocation of responsibility for the performance of particular functions also varies. The distribution of the 50 States in terms of the State percentage of State-local direct general expenditure is revealing (the U.S. average is 35.1 percent):

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For total general expenditure, the State share varies from more than twothirds in Alaska and Hawaii to less than a fourth in New Jersey and New York (Table A-2). The two newest States prefer to provide governmental services directly from the State level. Two of our oldest States retain the tradition of "keeping government close to the people."

The relationships for the major functions of education, highways and public welfare explain most of this variation (see Table A-2). Both Alaska and Hawaii provide as direct State services much or all of the elementary and secondary education, public welfare, and highway services and facilities. Public assistance--a particularly costly function in the more industrialized States--is administered at the local level in California and New York, as well as in about one-third of the other States. Some States, like North Carolina, Virginia and West Virginia, build and maintain local roads; others like New Jersey leave this function entirely to the localities.

The fact that the performance of certain functions is assigned to local governments in some States does not necessarily mean that the financing of those functions is left entirely to the localities. Although both New York and New Jersey are almost identically low in the State proportion of State-local direct general expenditure, they differ considerably in the way local spending for those

functions is financed. For example, New York localities obtain about one-third of their general revenue from the State while local governments in New Jersey until recently received from the State only about one-seventh of their general revenue.*

INTERSTATE DIVERSITIES AND DISPARITIES

As might be expected, decentralization of fiscal and political authority cuts two ways. On the plus side, it permits elected officials to tailor public policies and programs to fit wide variations in the willingness and ability of communities and States to finance public services. On the negative side, wide variations in tax burden and public service levels (particularly in welfare and education fields) take on the normative color of fiscal and social "disparities," thereby stimulating public debate over the fiscal need for equalization and the political necessity for State or Federal intervention and control.

Persistence of Demographic and

Social Diversity

The interstate diversity in a number of demographic, economic and social indicators is shown in data reported annually by the Department of Health, Education, and Welfare.5/ The interstate range in those indicators is shown in Fig. 4.

Despite its growing economic and cultural interdependence, the nation continues to manifest sharp political, social and regional diversity. The urbanrural mix, the social composition and the age composition of a State's population are the most important determinants of the public demand for services and its willingness to pay for them. While the income distribution has an important bearing on a State's fiscal capacity, social data, such as the number of welfare recipients and the amount paid to them, housing conditions and educational achievement, measure the extent to which a State will translate demand into public programs.

Convergence of State Personal Income and
State-Local Tax Effort

The amount of personal income received by residents of a State provides a basis for comparing the States' taxable resources despite its shortcomings as a measure of fiscal capacity.6/ In 1966 per capita personal income in the United States averaged $2,963 and varied from a low of $1,777 in Mississippi to a high of $3,690 in Connecticut--a range of 1:2.1 between the lowest and highest income State (Table A-3). Personal income has been growing at a somewhat faster pace in the low income States than in the high income States, so that the gap between high and low income States has been narrowing slowly. The measure that depicts the tendency of data to be grouped around an average is the coefficient of

*

Including Federal aid channeled through the States.

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