LC» /‘‘/~/ 5/74 I56 800 /5' N C? 1. O N G E R P iii} P E RTY G E 0 L} N H B RA RY Washington University Issue Brief i I e __ ' . “J uL'l “- I‘ '5. _,fx,-.193.-av. ‘ «-.H‘¢I4 -.‘g‘-:3--‘jam! “"-v-... I 3. . I-‘.‘ 011.‘ *=a‘.“\Ifl| ‘ CONGRESSIONAL RESEARCH SERVICE LIBRARY OF CONGRESS GENERAL REVENUE SHARING: PROSPECTS FOR EXTENSION IN 1980 ISSUE BRIEF NUMBER IB80015 AUTHOR: Kean, Stacey M. Economics Division THE LIBRARY OF CONGRESS CONGRESSIONAL RESEARCH SERVICE" HAJOR ISSUES SYSTEM DATE ORIGINATED DATE UPDATED IOIO .'S’..*EZ UHU1 I242. I000 FOR ADDITIONAL INFORMATION CALL 287-5700 0225 CRS- 1 IB80015 UPDATE-O2/25/80 £§§Q§-2§ElEl$lQ! The program popularly called general revenue sharing, established under the authority of the State and Local Fiscal Assistance Act of 1972 (P.L. 92-512), was amended and extended through Sept. 30, 1980, by the State and Local Fiscal Assistance Amendments of 1976 (P.L. 9n-nae). Several measures have been introduced in the 96th Congress to extend the program past its current termination date. Legislation has also been introduced to terminate the State government share of funds allocated under the current program. The Carter Administration is expected to submit its proposal to Congress in early 1980. Thus, the 96th Congress will have the opportunity to decide whether to renew, alter, or terminate the program. EACKGRQUND AND PQL£QZ.A!ALl§l§ On October 20, 1972 Congress enacted the State and Local Fiscal Assistance Act (P.L. 92-512), creating the general revenue sharing program to provide $30.2 billion in payments to State and local governments during the five-year period from January 1, 1972, to December 31, 1976. The program was extended on October 13, 1976, for an additional 3 3/0 years, from January 1, 1977, through September- 30, 1980, by the State and Local Fiscal Assistance Amendments of 1976 (P.L. 9u—u88). The extension was financed by $25.6 billion in appropriations. Funds for the program are derived from. Federal personal income tax receipts and are paid automatically to approximately 39,000 qualifying State and local governments without requiring annual appropriation action by. Congress. Two-thirds of the funds are paid directly to general-purpose local units of government. The remaining one-third is distributed to State governments. Funds are paid out of the State and Local Government Fiscal Assistance Trust Fund, which was established for this purpose. when the general revenue sharing program was extended in 1976, the basic provisions concerning annual funding level and allocation formula remained the same. The extension legislation did, however, make several changes in requirements under the program. »It eliminated section 103, which required local government recipients to spend their allocation of funds received under the legislation for high priority purposes such as public safety, environmental protection, and health. It also repealed section 104 of the 1972 Act, which prohibited State and local governments from using any part of ‘their allocation as matching funds for other Federal grants. Extensive changes were made in section 122 regarding nondiscrimination, extending the prohibiiton against the use of funds for discrimination to include religion, age, and handicapping condition. (The 1972 Act prohibited discrimination against race, color, national origin, or sex.) The 1976 Act will expire on September 30, 1980. Again Congress is faced v‘*h the question whether to renew the general revenue sharing program as it cnrrently exists, to amend the program, or to terminate it altogether. Congress must examine the program and evaluate its results in the light of current economic and intergovernmental conditions. Debate preceding the enactment of the original general revenue sharing legislation centered largely around economic and intergovernmental rationale. cRs- 2, BS0015 UPDATE—02/25/80 The debate arose from questions of public finance, namely, the prospective fiscal health of the three levels of government. Literature in the field of public finance holds that the State and local governments were bearing disproportionate share of the tremendous growth in demand for expenditures necessitated in part by the growth in population following World War II. Yet the American Federal system did not provide the State-local sector with the financial resources necessary to accomplish the task. Thus the State-local sector was plagued by fiscal mismatch. State and local taxes tended to be iregressive, and tax receipts tended not to be very responsive to economic growth. This situation was exacerbated by the deficits in National Income and Product Accounts which the State-local sector experienced from 19n3 to 1966, with few prospects for improvement in its overall fiscal position. In contrast, the progressive nature of the Federal income tax caused revenue to increase faster than the economy, as taxpayers moved into higher tax brackets. This suggested that Federal Government revenues were in excess of Federal needs and, if left unspent, could cause a drag on the economy. Faced with projected Federal surpluses in .the years to come, Congress debated using the surpluses to aid fiscally strapped State and local governments. Revenue sharing was one of the alternative means of assistance discussed. The growth of Federal power and the proliferation of specialized Federal grant-in—aid programs were widely blamed for the loss of autonomy of State and local governments. It was suggested that State and local governments were more efficient than the Federal Government at allocating resources in accord with taxpayer preference. A general revenue sharing program was seen as a vehicle for combining what the two sectors did best: raise revenues with the income-responsive Federal tax-system and spend them through the State-local sector, which allowed for diverse preferences. Critics who said the program provided no-strings-attached assistance to State and local governments cited the dilemma of reconciling the importance of political" decentralization with the often conflicting, but equally important, government objective of fiscal accountability. They contended that the authority to collect taxes should not be separated from the authority to spend the resulting revenues. The price of public goods purchased with funds raised by another level of government might make the cost of those goods seem artificially low and might destroy incentives for the efficient and careful spending of those funds. T The passage of general revenue sharing represented the first major victory for the proponents of decentralization in their attempts to allow States and localities to set their own priorities and to devise programs to meet their own needs, problems, and goals. This" was followed by adoption of block grants, created through the consolidation of existing categoricals (grants made for narrowly defined purposes), which gave States and localities greater »flexibility in meeting needs in broad functional areas. The debate over the extension of the general revenue sharing program began early in the 96th Congress. Legislation has been introduced either to extend or to amend the program. Extension legislation would continue the program basically unchanged for another two, four, or five years. Amendment legislation would (1) eliminate the State share oft general revenue sharinc entitlements; (2) continue the current level of funding for the program; \ (3) provide alternative allocation formulas. T §linine2i2n-2£.2ne.§tate-§he2e cas- 3 IB80015 UPDATE-02/25/80 Battle lines were drawn early to determine whether the State share would last until the end of fiscal year 1980, when the program is scheduled to wire, or would end earlier. on January 31, 1979, Senators Lloyd Bentsen and William Proxmire introduced 5. 263 to terminate the State government share of funds allocated under the program. This was followed by the Joint Economic Committee's March 7, 1979, recommendation that Congress consider eliminating the portion of revenue sharing funds that go to the states. on April 13, 1979, the House Budget Committee approved a resolution eliminating the $2.3 billion State share of general revenue sharing from the 1980 budget. The House approved this resolution on may 7, 1979. But the House—Senate conference committee restored the full amount of the State share, and the resolution was passed by both houses. While the end result served as a strong statement of congressional intent to reexamine carefully all components of and participants in the program, the budget resolution itself could not have terminated the State share immediately, for ‘two reasons. First, the budget resolution is a target and does not bind Congress. Second, the existing revenue sharing law, which is a permanent appropriation, continues the program until September 30, 1980, without any necessary concurrence from the congressional appropriations committees. To terminate the program formally a year early or to alter the allocation of the funds, Congress would have to enact a statute. In both Houses, debate over the continuation or elimination of the State share highlighted the fiscal and philosophical differences that surround the issue of renewal, amendment, or termination of the general revenue sharing program. Fiscal arguments are related to the shift in the relative fiscal f tengths of the different levels of government. Those who would eliminate tne States as eligible recipients contrast State budget surpluses and tax cuts with concurrent massive Federal deficits and the increasing demand for a balanced budget. (In 1975 Rep. Wilbur Mills introduced legislation to eliminate the States‘ share for these same reasons (H.R. 16330, 93rd Congress).) Since the concept of the revenue sharing program was originally put forth, the Federal fiscal condition has shifted radically from one of relative ease to one of fiscal stress. According to the National Income and Product Accounts (NIPA), the Federal Government has gone from a surplus of $8.5 billion in 1969 to a deficit of $27.7 billion in 1978. In this period the State-local sector surplus rose from $2.1 billion to $27.4 billion. This surplus coupled with the fact that 19 States have been able to cut taxes since January 1978 further aggravates the differences in the relative fiscal positions between the Federal and the State-local sector. The relative surplus conditions of the two sectors must be cautiously interpreted for several reasons. First, because State constitutions generally prohibit deficits, States are required to keep some cushion against cyclically declining revenues, a cushion that does not necessarily represent a true surplus. Without this cushion, mandated expenditures might force States into illegal deficit spending. Second, while the NIPA figures are the most widely used data available on Staterlocal fiscal activity, the aggregate totals mask significant variations among the States and the differences between total funds and earmarked funds. M e than 78,000 local governments are lumped together with the States to arrive at the agregate figures for the State-local sector. The accounts provide no information on individual governments. Large surpluses in a relatively small number of governments can mask fiscal difficulties in a far greater number. (Huch of the surplus exists in three states--Alaska, California, and Texas.) CRS- u IB80015 UPDATE—O2/25/80 The accounts also do not provide detail on State‘ and local government financial structure. Data on general operating funds are lumped togethe with a number of special funds established for specific purposes and ofte_ financed by earmarked revenues. Funds from these special accounts are, therefore, not available for general operating expenses. of the $27.4 billion surplus in the State-local sector in 1978, $23.2 billion consisted of the surplus in “social insurance" or trust funds, such as -retirement plans, which are owned by the participants in the plan. The remaining $4.2 billion is listed in the “other funds” account, which has been declining, and which the Congressional Budget Office (CBO) projected would be in deficit in 1979 and 1980. Government debt is another crucial indicator of a government's «financial position. Although the RIP; figures show the spending by state and local governments of borrowed funds as well as revenues, they show neither the debts that the governments incurred to obtain the borrowed funds nor the resulting debt pressure that the governments must sustain. 9 of the proliferation of State tax cuts, three things can be said. First; the tax cuts in the Northeast were aimed at stemming the flow of population and businesses to lower-tax areas. It was thought that high taxes were inhibiting local economic growth and development. Second, many of the states that had a surplus are major energy or food producers. All had experienced rising revenues because of the effects of inflation on the prices of these basic commodities and found that their surplus enabled them to provide general-purpose tax relief. Third, some of the cuts came in the form of property tax relief targeted to special groups, rather than general tr‘ relief. Instead of redistributing the surpluses through programs of direu- expenditure, the mechanism of tax relief was used to provide funds to suchs special groups as the poor, near-poor, elderly, and disabled. Linked to all these fiscal arguments is the debate over philosophical differences, which harks back to the original debate concerning revenue sharing. while much of the cumbersome red tape and regulation associated with Federal aid are eliminated by the efficiency of the allocating mechanism for general revenue sharing, the separation of the functions of taxing and spending could cause excessive demand for Federal spending through the grant system, for the same reason mentioned earlier: the price of public goods may seem artificially low when they are purchased with_funds raised by another level of government. In addition, the State-local sector has been able to increase its revenue growth because it has increased its reliance on revenue sources that are more responsive to changing economic coditions, such as the income and sales taxes. They are no longer as dependent on sources of revenue that are less responsive to income. m Both the issue of renewal and the issue of maintaining the State share ,will be affected by the general condition of the economy. with the forecasts for recession, debate over possible gFederal Government responses centers around two arguments. On thei one hand, “tax cuts may be warranted to stimulate a sluggish economy. If tax cuts are needed, one way to hold ‘dc increases in the Federal deficit may be to cut all or part of revenue sharing funds. On the other hand, the Federal Government may be reluctant to cut back any program aimed at hard—pressed communities. State and local budget surpluses might disappear in the face of and economic downturn. And State governments would be hit harder than local governments because of their CRS- 5 IB80015 UPDATE-02/25/80 increased reliance on State income and sales taxes. The debate over eliminating the State share has largely ignored the important issue of the role of the States in the Federal system and the integral part they play in intergovernmental relations. States are the connecting link between the Federal Government and local governments. They play an important legal and fiscal role for local governments.» As creatures of the States, local governments hold functional responsibiliites and privileges that are mandated by State constitutions. state reform measures have over time created a more balanced fiscal system. First, they have made wider use of the income reponsive broad-based personal income and retail sales taxes. Second, they have taken over a larger portion of the so-called "big ticket" items-—public education and welfare. Third, they have begun to consider a wider role in providing aid to local governments, particularly to distressed urban areas in the Northeastern and North Central States; to rural areas in the Southeastern and South Central States; and to communities experienceing rapid growth in the western and Northern Plains States. In funding these activities, States pass on about no percent of their general revenue sharing funds to local governments. These funds, as well as other State aid to local governments, could suffer if general revenue sharing to States were cut. out of necessity, States might have to reorder their budgetary priorities to compensate for the loss of funds. Funds from other functional areas would have to be shifted into those traditional state expenditure areas such as education and public welfare to compensate for the loss of the revenue sharing funds. Consequently, State aid to local governments could suffer. Thus the important role that States play in filling the gap between locally raised revenues and direct Federal aid to " :alities might be adversely affected. Thg_gl;gggtigg_§ggmglg F Another issue that may receive consideration during any upcoming debate on the revenue sharing program is the allocation formula and the alteration of some of its factors. The allocation formula is based on such factors as population, extent of urbanization, relative poverty, State personal income tax collections, and general tax effort of the state or local government. It represents a compromise that provides more aid to "needy" governments while spreading the funds to 39,000 State and local governments. The degree to which the funds should be directed to needy governments has long been under dispute- While some maintain that revenue sharing should be allocated on the basis of need, others maintain that decentralization of budgetary decision making, and not need, was the primary motivating factor .behind revenue sharing. (This is not to say that the revenue sharing program does not distribute the funds in terms of need. The Advisory Commission on Intergovernmental Relations (ACIR),w developed figures using a composite stress index that measures public welfare burden, family tax burden, personal income growth, and per capita personal income for the 50 State-local tax systems. These figures show that revenue sharing, especially the States! share, is actually distributed quite well in termsi of need.) Those who advocate a change in the formula are looking for better ways to direct the funds where needed, realizing that the development of alternative formulas is difficult both technically and politically. on factor that has come under criticism is the use of per capita’ income data as a measure of fiscal capacity in the revenue sharing formula. Per capita income is used in many Federal grant formulas as a fiscal equalization factor to compensate for variations in fiscal capacity (tax wealth) among estates and localities. Criticism centers on two primary issues. First, a State's tax base, which is the primary source of revenue, consists of much CRS- 6 IB80015 UPDATE-02/25/80 more than personal income. Two tax bases which are not directly reflected in personal income statistics--the property tax base and the severance (of natural resouces) tax base-—can greatly strengthen the tax bases of Statev with rich farm land and industrial capacity and States with large natur. resouce bases. Second, per capita income data fail to take into account variations in the cost of living between different areas of the country. ACIR maintains that the use of personal income data significantly understates the real tax wealth of those States that can "export" a substantial share of their taxes to residents of other States. By understating the tax wealth of a jurisdiction, the use of the data automatically overstates the tax effort or tax burden.‘ For this reason, distortions are introduced into those Federal aid programs that use either the personal income or tax effort measure, and these distortions are especially severe in,programs like revenue sharing that use both. In 1962, ACIR developed the representative tax system to help provide a more accurate measure of fiscal capacity -- and thus, potentially, a better source of revenue sharing criteria -—- than‘ per capita income. It was refined by ACIR and simplified into a more usable form in 1978 by the National Institute of Education. The system “defines the tax capacity of a State and its local governments as the amount of revenue they could raise (relative to other state-local governments) if all 50 state-local systems applied idential tax rates (national averages) to their respective tax bases." The total revenue which a state and its local governments could raise by applying_ national average tax rates to its own tax base is .translated into a »per capita amount and then compared to the total State-local revenues (per capita) actually raised in the United States- Because the representative tax system is based on nationwide average ta” rates, supporters maintain that it reflects tax revenue potential relative other States and is, therefore, a better indicator than actual taxes. Another alternative to a change in the formula would be to incorporate revenue sharing into a three-tiered program that would consist of revenue sharing, targeted’ fiscal assistance, and standby antirecession aid. A program like this could serve the dual purpose of providing funds on a regular basis. to State and local governments to encourage the decentralization of budgetary decisionmaking and of targeting the funds to needy local governments. This could be a particularly attractive compromise to the extent that the economy moves into recession. The House has passed a bill (H.R. 5980) that would incorporate recession and targeted assistance provisions into the State and Local Fiscal Assistance Act of 1972, as amended. In light of the increased contributions that States have been making to the traditional big ticket areas of education and public welfare, _another option for altering the general revenue sharing program has been suggested. This proposal would extend general revenue sharing after FY 1980 with the legislative intent that the States continue or begin to use their funds in particular functional areas. Then, when the legislation came up again for consideration, these expenditures would be reviewed to determine whether the State share should be continued. This proposal could encourage some structural changes in State-local functional responsibilities, further encouraging State fiscal support of local governments as well as allowing f n more Federal control over the uses of general revenue sharing funds. Fiscal year 1980 could mark the end of the general revenue sharing program as originally enacted. Inflation has reduced the purchasing power of general revenue sharing funds by 40% since ‘1972. There have been efforts in CRS—-7 IB80015 UPDATE-02/25/80 Congress, through the mechanisms of amendment and budget resolution, to xeliminate the State allocation from the current program. Moreover, there is : .timent in Congress and elsewhere that the entire program should not be continued. By Sept. 30, 1980, Congress may exercise two options: it can extend the program in its current or amended form, or, it can take no action and thereby permit the program to expire. 6 Proponents of continued revenue sharing suggest, as an alternative means of reducing Federal spending, a reexamination of categorical and block grant programs. The tripartite approach to the Federal aid system-‘with categorical and block grants and general revenue sharing--was introduced in the 1970s. But the impact of inflation on revenue sharing and the narrowing of categories under the block grant system have reduced the flexibility of State and local governments in determining how to use their Federal aid. There is some concern that the advantages that the tripartite system fostered could be lost if the general revenue sharing program bears the burden of being the sole target in the effort to hold down Federal intergovernmental spending. LEGI§LAI£Q§ H.R. 2291 (Wydler, et al) Amends the State and Local Fiscal Assistance Act of 1972 to extend it for an additional four years through September 30, 1983. Introduced Feb. 21, I9 and referred to the House Government operations Committee. Similar bills: H.n. uu681(ncDade, 5/1a/79) * H.R. 5682 (Hammerschmidt, 10/23/79) > HsR. 2698 (Roberts)/ 5. 263 (Bentsen, Proxmire) Amends the State and Local Fiscal Assistance Act of 1972 to terminate, beginning with FY80, the State government share of revenue sharing funds without affecting the local government share. H.R. 2698 was introduced Mar. 7, 1979 and referred to the House Government Operations Committee. S. 263 was introduced Jan. 31, 1979 and referred to the Senate Finance Committee. Similar bills: H.B. 2708 (Wilson, 3/7/79) H.R. 2755 (Luken, 3/8/79) H.R. 2758 (Hattox, et al, 3/8/79) H.R. 3133 (Jones, 3/20/79) H.R. 3394 (White, Q/2/79) H.R. 6191 (Nelson, 12/19/79) S. 513 (Hoynihan) ' Amends the State and Local Fiscal Assistance Act of 1972 to extend through Sep. 30, 1982 the authorization of appropriations to the State and Local F*scal Assistance Trust Fund to pay for entitlements of State laws which p Jvide for the allocation of funds among county areas or among units of local governments. Introduced Mar. 1, 1979, and referred to Senate Finance Committee. CRS- 8 IB80015 UPDATE-O2/25/80 E§lBl!§§ 0.5. Congress. House. Committee on Banking, Finance, and Urban Affairs. Subcommittee on the Cities. Revenue sharing with the States. Hearings, 96th Congress, 1st session. May 3, 1979. Washington, 0.5. Govt. Print. Off., 1979. 372 p. "Serial no. 96-10” —---— Committee on Government Operations. Intergovernmental Relations and Human Resources Subcommittee. Intergovernmental fiscal assistance amendments of 1979 and termination of general revenue sharing to State governments. Hearings, 96th Congress, 1st session, on H.R. 3198 and H.R. 2698. Washington, U.S. Govt. Print. Off., 1979. 222 p. Hearings held Jun. 27-28 and Jul. 12, 1979. -—--- Senate. Committee on Governmental Affairs. Subcommittee on Intergovernmental Relations. General revenue sharing -- the issues before us. Hearings, 96th Congress, 1st session. July 24, Sept. 20, and Nov. 15, 1979. Washington, 0.5. Govt. Print. Off., 1979. 186 p. E§BQEQLQ§Z-Q£.§!§E$§ 01/OH/80 -- Carter Administration announced that it would recommend the continuation of $2.3 billion a year in revenue sharing funds to State governments. 07/27/79 -- Senate rejected, by a vote of 59 to 31, the Appropriations A Committee*s proposal to cut the State revenue sharing entitlement by $680 million for FY80, leaving intact the $2.3 billion for State revenue sharing. 06/28/79 - vHouse passed FY80 appropriations bill that included $2.3 billion for State revenue sharing. 05/18/79 -- House and Senate Budget conferees agreed on 1980 budget = resolution, including the full $2.3 billion State share. 05/07/79 —-House approved its Budget Committee's resolution including the elimination of the State share. 04/13/79 - House Budget Committee approved a resolution eliminating the State share of general revenue sharing. 03/07/79 5- The Joint Economic Committee recommended that Congress evaluate the general revenue sharing program and consider reducing or eliminating the State share. ADDEIIQEAL-B§EE§§E§§-§9QBE§§ Howell, James M., and George D. Brown. The revenue sharing gauntlet: a fiscal federalism at the crossroads. National civic review, CRS- 9 IB80015 UPDATE-02/25/80 v. 68, Nov. 1979: 535-5&1. Myers, Will, and John Shannon. Revenue sharing for States: an endangered species. Intergovernmental perspective, v. 5, Summer 1979: 10-18. Stanfield, Rochelle I. Revenue sharing survived this year, but 1980 may be a different story. National journal, v. 11, Aug. 11, 1979: 1331-1335. p U.S. Library of Congress. Congressional Research Service. General revenue sharing and alternatives: economic rationales past and present, by Barry Molefsky and Dennis Zimmerman. [Washington] April 1979. 57 p. (Hultilith no. 79-91 E) ----— General revenue sharing: an overview of the 1972 Act and a legislative history of the State and Local Fiscal Assistance Amendments of 1976 (P.L. 94-H88), by Haureen McBreen. [Washington] January 6, 1979. 27 p. 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