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Averting Local Fiscal Crises—and Resolving the “Trilemma”—by Centralizing Infrastructure Funding

Written among other purposes as a policymaker’s handbook, David Schleicher’s “In a Bad State” develops important—and timely—lessons from the long history of domestic state and local fiscal crises. His compelling account contextualizes this (understudied) history through insights from the academic literatures of public finance and political science, as well as the law of municipal bankruptcy, to conceptualize a new framework for understanding the specific tradeoffs that have shaped federal actors’ responses to past subnational public debt crises. With many American cities and states now encountering new budgetary pressures amid economic headwinds and the end of COVID-era federal transfers, Schleicher’s contribution could hardly have come at a better time. His account helps answer big questions about the resolution to fiscal crises, while raising others about their origin—particularly about the extent to which our (comparatively anomalous) local funding structures are implicated.

The book’s motivating insight is that, when such fiscal crises arise, “the [U.S.] federal government does not have any good options” (p. 7). Its policymakers instead must navigate a “trilemma,” where any response (or its absence) will achieve no more than two of three policy goals—namely, to avoid (1) exacerbating current local economic distress via pro-cyclical fiscal withdrawal; (2) encouraging future fiscal imprudence (“moral hazard”); and (3) the subsequent withdrawal of credit to states and local governments that aspire to finance public investments. Previous accounts had emphasized the tradeoff between only the first two goals, but Schleicher demonstrates that our federal policy has been shaped by public actors’ collective desire “to promote future development and investments in infrastructure by states and cities by protecting creditors” (p. 27).

At least, that has been the case in the United States. But perhaps one reason why this dynamic—so central to Schleicher’s account—had been underemphasized by others (who drew primarily on the comparative experience) is that our federalism design uniquely places the primary responsibility for funding such infrastructure, and other public services, on fiscally-constrained subnational governments. (As I have written, “The bondholders’ veto derives from [American] cities’ reliance on debt, which in turn is created by the absence of redistributive transfers across geography.”) Under such a system, the ability of local communities to make future investments indeed is limited by their direct access to private credit—thus giving rise, during moments of subnational debt crisis, to the trilemma. More than that: as Schleicher observes, “the problems of regionalized state and local fiscal crises” are themselves tied to “our fiscally independent states and cities” (p.157). And while his book provides an invaluable guide about how to respond to localized fiscal crises, it too-quickly dismisses the possibility that federal policymakers could largely avoid such occurrences altogether—and ultimately escape the trilemma—by centralizing the funding of public infrastructure.

It is certainly true that the United States “has always relied on states and local governments to build and maintain most of our civic infrastructure” (p. 9). But on this point, Schleicher in several places seemed to go beyond historical observation (that things have been so) to policy justification (suggesting that they necessarily are)—identifying two primary reasons for why “the federal government is not able to be the major builder of infrastructure” (p. 163). The first reason is the challenge of acquiring information about territorially-diffuse potential investments: the “information burdens associated with making decisions in Washington about the infrastructure needs of a continent-sized country” (p. 9). The second reason concerns the practical difficulty of acting on those needs without wasteful distortions introduced through the territorial nature of federal electoral representation, which result in excessive spending on—and inefficient spatial allocation of—infrastructure (p. 9.)

To be sure, federal decisionmaking is indeed characterized by these practical difficulties—and Schleicher is right to emphasize their consequences for responsive (and responsible) infrastructure policy. But a central premise of his book is that we should not assess the downsides of a given policy option, or institutional arrangement, in isolation from those accompanying the available alternatives. And for reasons he discusses at length (here and elsewhere), it seems far from clear that American states and local governments are either less susceptible to these governing challenges or reliably better at overcoming them. After all: state and local elections are also geographically based—representing even smaller constituencies—and whatever information advantages subnational actors might gain from proximity are surely traded off against (significantly) reduced governing capacity, as compared to the federal bureaucracy. Moreover, fiscal centralization offers a number of additional—and unique—advantages with respect to addressing infrastructure needs and avoiding economic distress, which should be accounted for in a proper assessment.

Although a full treatment exceeds the scope here, many of the book’s historical examples—and other points made in the (excellent) concluding chapters, about designing policy responses to subnational fiscal crises—preview the general case. In Schleicher’s telling of the frenzy of local subsidization of speculative railroad development during the late 19th century—characterized by beggar-thy-neighbor bidding and wasteful overconstruction—the reader gets an illustrative example of what touted local “information” advantages can often look like in practice. Or consider the suspected source of high construction costs under our current system of (locally financed and administered) infrastructure: “Litigation and political pressure from highly interested groups forces highways to be built along ‘squigglier’ (i.e., less straight) routes and with greater protections for nearby property owners, increasing costs” (p. 163). One might reasonably wonder: are the political dynamics driving excessive and misallocated investment—cited here as the reason why infrastructure spending must necessarily be locally funded—really unique to the federal?

Indeed, the book’s final chapter—a stirring indictment of the shortcomings of state and local democracy—highlights the possibility that aspects of these problems might actually be worse at the subnational level. Due largely to low information and unrepresentative participation, Schleicher observes that local elected politicians generally lack “capacity to resist group pressure or ask the public to sacrifice for the greater good” (p. 168) and instead are “responsive to narrow and unrepresentative groups of voters and interests” (p. 170). He lays out a number of suggestions for how to improve this state of affairs, “start[ing] with voters paying more attention to state and local politics” (p.171). But an alternative (complementary!) approach might respond to the same set of facts by seeking to shift political decisionmaking to the level of government where voters are engaged and party heuristics work reasonably well—which also, and conveniently for present purposes, helps resolve the central dilemma of this book.

Nor is it simply that the federal government is not clearly worse at the governing aspects of infrastructure investment: centralizing its funding would yield important economic advantages. Whereas state and local budget rules demand pro-cyclical retrenchment during moments of pronounced distress, the federal government “can easily run deficits in a recession” (p. 7). This is no small detail: indeed, the difference in capacities is part of what gives rise to the trilemma in the first place. Federally funding local infrastructure also eliminates the need to subsidize private lending to subnational governments through regressive and inefficient tax subsidies (p. 80-81). Finally, by providing a guarantee of basic infrastructure investment according to some determination of need, centralization also would better distinguish between unwise fiscal profligacy—illustrated, perhaps, by the Arkansas example (p. 65-68)—and cases like Stockton (p. 91-96), where budgetary pressures are best understood as growing misallocation between the spatial [more precisely, jurisdictional] allocation of taxable wealth and social needs.

It also is worth noting that this proposed form of federal fiscal transfers to states and local governments—done across jurisdictions, on ongoing basis, and according to clear-ish rules—avoids the moral hazard concerns that constitute the “obvious downside” (p. 8) of such a response after the onset of crisis. These are hardly unique insights. Indeed, the just-listed advantages together motivate the book’s great section (p. 164) highlighting how “state and local budget crises adds to the case for nationalization” of Medicaid and other cooperative federalism programs. Although we may part ways on the degree to which a similar case can be made for infrastructure spending (or is sufficiently attainable such as to be worth making), the centralization arguments are collected here in the spirit of friendly amendment to an already comprehensive and compelling account.

No book can (or should) be about everything: managing a topic as rich as the history, politics, law, and economics of public debt crises in the United States already is ample task for any single account. So it is no shortcoming that he—in addition to providing “a practical guide to understanding the difficult choices that federal policymakers face in responding to state and local fiscal crises” (p. 6)—does not take on the additional challenge of entirely rewiring our longstanding fiscal federalism design to avoid them. Instead, he more modestly argues for a menu of compelling and well-selected “structural solutions that will make the country more resilient if (or rather when) it faces the next round of state and local budget crises” (p.122).

These proposed reforms stand as a near comprehensive (“shovel ready”) subnational fiscal crisis agenda. Nevertheless, Schleicher perhaps goes too far in accepting as inevitable some of the features of our state and local funding structure that make our subnational fiscal crises more frequent, damaging, and intractable than they should be. While this quibble is mere subplot in his essential account, it does seem to inform his ultimate conclusion: that “primary responsibility for addressing state and local fiscal problems lies with states and local governments themselves” (p. 167).

So while it may be true that “federalism as we know it is inconsistent with the regular provision of [substantial federal transfers] to states and cities” (p. 8), I wonder: would that really be such a bad thing?

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