Evolution of U.S. Fiscal Federalism

When the United States was formed, the power to raise revenue was given to the States, with the National Government assigning certain expenses to each one. Under the Constitution, Congress received the power to lay and collect taxes, duties, and excises to pay debts, and provide for the common defense and the general welfare of the United States. Thus the Federal Government had concurrent jurisdiction with the States in nearly all fields of taxation. The Civil War had the effect of weakening the role of State governments and restricting the powers of State legislatures and governors. The structure of the tax system changed radically during the first quarter of the 20th century. By 1927, income taxes comprised 64 percent of Federal and 10 percent of State tax revenues. In addition, consumption taxes had declined markedly as a share of total Federal tax revenue but were increasing at the State level. Property taxes provided almost all local tax revenue. The New Deal created a complex combination of public works projects, work relief, financial assistance, and a social security system under which the States and local governments were called upon to participate and were reimbursed for about half of the costs. The Federal Government's role expanded greatly, not only in terms of financial assistance, but also with respect to regulatory activities. World War II also had a dampening effect on State and local spending patterns. By the 1950's, State and local spending was devoted primarily to schools, roads, and suburban development. During the 1960's, because State and local governments were unable to expand their revenue bases as quickly as residents increased their demands for services, the Federal Government greatly expanded its grants to State and local governments. Some aid was provided for specific functions through categorical grants and some for more general purposes through block grants. Now, the President plans to reduce the number of categorical grants, replace them with block grants, and reduce Federal funding in many areas. It is too soon to project the long-term effects of these initiatives on intergovernmental fiscal relations, but it is fair to say that the balance of responsibility will shift somewhat from the Federal to the State and local levels.