Federal Grants Top Taxes as State Revenue Source

Some disturbing news this morning courtesy of the USA Today—for the first time in U.S. history, federal grants have overtaken sales, property and income taxes as the biggest source of revenue for state and local government:

The shift shows how deeply the recession is cutting. Federal stimulus money aimed at reviving the economy and a sharp drop in tax collections have altered, at least temporarily, the traditional balance of how states, cities, counties and schools pay for their operations.

The sales tax had been the No. 1 source of state and local revenue since the mid-1970s, according to the Bureau of Economic Analysis. Before that, property taxes were the primary source. That changed in the first three months of 2009. Federal grants — early stimulus money plus conventional federal aid — soared 15% in the first quarter to a seasonally adjusted annual rate of $437 billion, eclipsing sales taxes, which fell 2%.

The dominance of federal money is set to expand dramatically this year because tax collections are sinking while the bulk of federal stimulus aid is just starting to arrive. “This money isn’t manna from heaven. It comes with a price,” says Indiana state Sen. Jim Buck, a Republican. He worries that the federal money will leave states under greater federal control and burden future generations with debt.[…]

The federal government plans to provide about $300 billion in extra aid to state and local governments over the next two years, mostly for health care, education and transportation projects. State and local governments spend about $2 trillion a year, and the federal government is now paying about 23% of those costs.

States are counting on tax collections rebounding by 2012, when stimulus money starts to run out. The early flow of stimulus money helped lift total state and local revenue by 1.6% in the first quarter compared with a year earlier despite a 2.9% drop in total tax collections. Spending rose 1.5%.

It’s helpful to reiterate what’s fundamentally at play here. States have been addicted to spending for years. When their fiscal irresponsiblity started to catch up with them, the federal government—like an emotionally weak, enabling family member—dug into its wallet (read: our wallets) to help fund the states’ next spending fix, instead of holding them accountable for their profligate ways. As I wrote here back in November:

The least helpful thing to give to an addict to support them is more of what they’re addicted to. This sort of enabling behavior leaves a path of personal and relationship destruction in its wake. As Gov. Sanford implies, the solution to government’s spending and borrowing addiction cannot be giving them more money and standing by while they heap on more debt. It may offer some temporary relief, but only forestalls the inevitable day of reckoning to come.

What’s needed instead is an intervention. This necessarily involves invoking the will and fortitude to ignore the inevitable pleas and distractions (“the poor will suffer! the elderly will starve! what about the kids! we won’t be able to do our noble work!” yada yada…) and getting on to the business of rehab and detox. Instead of asking Americans to “sacrifice” by extracting more from their wallets, what we really need is for Americans to sacrifice their support for sprawling, bloated government and instead ignore (or vote out) those policymakers pushing new spending and new programs with a barrage of good intentions and empty promises. It’s our collective willingness to buy government’s snake oil that keeps us on an inherently unsustainable fiscal path.