Analysis by J. FRED GIERTZ

Go figure

On balance, Illinoisans might profit
from the GOP'S attempt to balance the federal budget

The tectonic shift in governmental relationships and programs promised by the massive Republican overhaul of the U.S. budget has been attacked by opponents as a disaster for state governments. In fact, however, states like Illinois could experience significant economic benefits from the congressional plan to slow the growth of federal aid to the states in exchange for fewer restrictions on the way that federal dollars are used.

Opponents argue that huge reductions in federal aid will force states either to raise taxes or make painful cuts in programs vital to many Illinoisans. They contend that the increased flexibility of block grants is unlikely to compensate fully for the reduced funding. Robert Creamer, head of the consumer group Illinois Public Action Council, told The Associated Press: "The congressional budget is a thinly disguised ruse to shift the federal deficit on to state and local governments. For the average Illinois family, it will mean less health care, a harder time sending their children to college and higher property tax bills."

This analysis is incomplete and unduly pessimistic, however, because it concentrates only on the fiscal position of the state government and not on the relative position of citizens of the state. Assuming that the country genuinely wants to balance the federal budget over the next five to 10 years, the only alternative to the type of cuts approved by congressional Republicans is a major increase in federal taxes.

Facing these choices, the people of a state such as Illinois must weigh the advantages and disadvantages of decreased federal aid to the state compared with increased taxes that would have to be paid to the federal government to maintain the aid. This choice has some interesting implications for Illinois — a state that pays a disproportionate share of federal taxes and receives a relatively small share of federal expenditures.

The silver lining

Figure 1 shows one estimate of the magnitude of the projected cuts in federal aid to state and local governments in Illinois compared to projected aid under current law. The projected reductions would be relatively modest in 1996 (5.9 percent), but they would then increase quickly. In 2002, federal aid would fall $3.8 billion (or 29 percent) below the levels projected under current law.

Currently about 82 percent of federal aid in Illinois goes to the state, with the remaining 18 percent going directly to local governments. Federal aid for Medicaid (a joint federal-state program to provide medical and nursing home care for the poor) accounts for the largest single share of federal aid and would also sustain the largest cuts. Overall, the loss of federal aid to the state would result in a loss of about 7 percent of the state's total revenues (including all funds) by 2002.

If there is any good news in this story, it is that reduced federal aid (and other federal cut-

20/December 1995/Illinois Issues

backs) means that federal taxes will not have to be increased substantially to balance the budget. This is a significant point to consider for the citizens of Illinois. Estimates for 1995 suggest that Illinois' per capita federal tax burden is 15 percent higher than the average for the United States ($5,739 vs. $4,996). With 4.6 percent of the population, Illinois pays 5.2 percent of the federal taxes, ranking eighth highest among the 50 states. This result is understandable and not unreasonable. Because Illinois is a high per capita income state and because most federal taxes are based on income (and are progressive), Illinois residents pay a disproportionate, but not necessarily unfair, share of total federal taxes.

On the expenditure side, the results are quite different. Illinois receives approximately 16 percent less than the U.S. average in federal spending, ranking 40th among the states. This ranking is also understandable since wealthier states receive less per capita for redistribution programs than do poorer states. In addition, Illinois is not a major producer of military equipment, nor does it have a large number of military bases. In regard to federal grants to state and local governments, Illinois currently receives about 4 percent of federal grants to all state and local governments compared to its 4.6 percent of total U.S. population and 5.2 percent of total taxes paid.

If federal taxes were increased to maintain in 2002 the current federal aid programs to all state and local governments in the country, Illinois' share of the taxes would amount to approximately $5 billion. This tax increase would forestall federal aid reductions of $3.8 billion to the state and local governments in Illinois. (These results are shown in Figure 2.) The net impact on the state would be an outflow of taxes over aid returned from Washington of $1.2 billion. Viewed in this way, it appears that Illinois would be better off to accept the federal aid cuts and to increase state and local taxes by $3.8 billion to make up for the federal cuts.

The down side

On balance, while the "go it alone" approach seems preferable from a narrow perspective for Illinois as compared with redistribution through the federal government, there are some potential negative consequences that must be considered. First, while Illinois might gain because of its high tax-low return position in regard to the federal government, many poorer states would experience exactly the opposite results. For states like Mississippi and Arkansas, the movement to reduce grants would generate a much greater decrease in federal aid than savings in federal taxes. Devolution of social programs to the states, along with reductions in aid levels, would tend to reduce the equalizing effect that federal policy now has among states and regions.

There would also be redistribution occurring within the state. It is not clear the state of Illinois would choose to continue all existing programs currently paid for with federal aid by raising state and local taxes. To the extent that program levels are not maintained in the state after federal aid reductions, low-income citizens would suffer disproportionately, while higher-income residents would gain by avoiding higher federal taxes. The solution to this problem, however, could be addressed more efficiently within the state, where a dollar of taxes collected provides a dollar of benefits to the citizens of the state, as opposed to sending the money to Washington where a dollar of Illinois taxes produces 75 cents in extra revenue for governments in the state.

From the Illinois perspective, this suggests that efforts to maintain adequate services in response to federal cutbacks are likely to be more productive than attempts to stop the changes at the federal level — attempts that are likely to be both ill- advised from a narrow economic standpoint and futile politically. 

J. Fred Giertz is an economist in the Institute of Government and Public Affairs at the University of Illinois at Urbana-Champaign.

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