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The political economy of new deal fiscal federalism.

In 1930, the average American received somewhat more than 50 percent of his government services from local government, 20 percent from state government, and the remainder from the federal government. By 1940 this pattern had been reversed, with the federal government supplying roughly 50 percent, state government, 20 percent, and local government, 30 percent. Figure 1 shows how shares of non-military expenditures by the three levels of government shifted dramatically away from local governments toward the national government during the decade. The same was true of revenues. This transition in the relative importance of state, federal, and local government was dramatic and, from the perspective of the 1990s, permanent.

[FIGURE 1 OMITTED]

The most important cause of the shift, in fiscal terms, was the implementation of national relief programs under the New Deal: the Federal Emergency Relief Administration (FERA), the Works Progress Administration (WPA), the Social Security programs, and others. Between 1932 and 1940 direct relief expenditures account for roughly 45 percent of the growth in national expenditures, 60 percent of the growth in state expenditures, and 20 percent of the growth in local expenditures (almost all of which came from federal and state grants for relief purposes). Even more revealing are the figures for the period between 1932 and 1935: in those three years national government expenditures rose by slightly less than $2 billion, while expenditures for relief alone reached $2.2 billion in 1935 from zero in 1932. (1)

The increase in federal expenditures was significant, but an important reason why state and national governments grew, but local governments did not, lay in the fiscal structure of the relief programs. The extensive use of matching grants to finance relief expenditures created incentives for states to expand their fiscal effort, while local governments were effectively able to substitute national and state relief grants for their own funds. Matching grants also allowed the states to control the amount spent in each program. The national government was, and is still today, unable to control expenditures on these programs or to equalize welfare standards across states. Open-ended matching grants "entitled" the states to unencumbered access to the federal treasury. (2)

The programs also permanently altered the American welfare system. The categorical assistance programs of the Social Security Act brought about a basic realignment of financial and administrative responsibilities between the federal, state, and local governments. Old Age Assistance, Aid to Dependent Children, and Aid to the Blind were independently administered by state governments. The Act contained strong restrictions on the ability of the Social Security Board to influence the administration of programs within the states, explicitly forbidding the Board to set personnel policies. (3)

Why were open-ended matching grants and a decentralized administrative structure adopted rather than some other institutional form? Public finance theory suggests that it may have been the best way for the federal government to support relief expenditures without discouraging continued state and local participation. Matching grants are usually proposed as a remedy to problems of externalities. In this case the spillover is the movement of persons seeking relief from low-benefit to high-benefit states. They solve the externality problem through the use of fiscal incentives: as Gramlich [1977, 276] notes, "for [matching grants[ the central government is expressly trying to stimulate spending in a certain area." As we will see below, matching grants did have this effect: federal grants expanded rapidly, but the state and local sector did not substitute federal grant moneys for state and local tax dollars on a large scale. Recent empirical studies of matching grants indicate that they "result in somewhat less spending than the size of the grant" indicating that state and local governments reduce their own expenditures on grant programs slightly in the presence of matching grants, in contrast to lump sum grants where state and local governments are able to substitute significant amounts of federal grants for their own tax dollars. (4) Was this what happened during the 1930s? Was Congress trying to stimulate state and local contributions for relief and overcome the externality problems created by a mobile population?

I. AN OVERVIEW OF THE RELIEF PROGRAMS

Before 1930 public relief was largely the province of local governments. States often established legal guidelines for local relief, occasionally financed local relief, and typically provided state aid for some types of categorical relief, such as hospitals for the insane. The vast majority of financial responsibility for care of the needy, however, fell on local shoulders. By the same token, local political leaders reaped the political benefits created by the distribution of cash or in-kind benefits to voters and control of patronage jobs in public relief agencies.

By the summer of 1932, unemployment stood at 20 percent of the labor force and overburdened local governments strained to meet their relief burdens. Only seven states had spent money for unemployment relief before July 1932 when Congress authorized the Reconstruction Finance Corporation (RFC) to loan $300 million to state governments to finance relief. The loans were to be allocated between the states on the basis of need. (5) The states, which initially assumed they had a right to the RFC loans, were surprised to find that the RFC required them to demonstrate that they had exhausted their financial resources before loans could be made--an onerous criteria for the forty-one

states which had yet to spend anything for unemployment relief. Despite the fact that most relief was provided by local governments, only state governments could qualify for RFC loans. (6)

Conflict between the RFC and the states revolved around the ambiguity of "need" as a basis for allocating funds. Every state felt it was in need. Congress went part way towards solving the problem in the first large-scale federal relief program: the Federal Emergency Relief Administration (FERA), created by the Federal Emergency Relief Act in May 1933. The Act appropriated $500 million to FERA to be spent over two years. Half of the funds were to be allocated between states on a matching basis--$1 of federal money for every $3 of state/local expenditures--and half at the discretion of the federal relief administrator on the basis of need. Again, the states, not the cities, received the federal funds, which were then distributed by the states to the local governments which actually administered relief programs.

President Roosevelt appointed Harry Hopkins to head FERA. As Charles [1963, 7] tells the story, Hopkins set to work immediately, distributing over $5 million on his first day from a plain desk set up in a hallway in the Department of Agriculture. The $5 million went to seven states to match expenditures those states had made earlier in the year (FERA was allowed to match state/local expenditures made after January 1933, including expenditure of funds borrowed from the RFC). From the first day Hopkins faced two problems.

One was administrative. No one had ever run a federally-financed relief program, and, although Hopkins had been in charge of New York's Temporary Emergency Relief Administration, he had no federal bureaucracy to build on. His solution was to integrate existing state and local relief organizations into the FERA structure. (7) State and local emergency relief administrations (ERA's) were jointly financed by federal, state, and local funds. State and local ERA employees worked for state and local governments, not the federal government. Decisions about who received relief and how much they received remained largely a local responsibility, personnel decisions were a state responsibility (with some federal interference), while general financial and administrative policy was formulated in Washington. (8)

The second problem was financial. Table I indicates the size of FERA's program: quarterly totals for expenditures by level of government are given in the first four columns and annual averages of monthly case loads and numbers of recipients in the last two columns. The program was expensive. The financial constraints facing Hopkins were clear from the very beginning. The country's relief needs far exceeded the original two-year, $500 million appropriation. FERA and the programs that followed spent roughly $2,000 million a year from 1933 to 1940. (9)
TABLE I
Expenditures and Case Loads by Quarter
Federal Emergency Relief Administration 1933 to 1935
Expenditures in Millions $
Cases in Thousands

 Total Federal State Local Relief Relief
Year Expend Expend Expend Expend Cases Individuals

1933
III 181.6 119.1 22.8 39.7 3720 14723
 IV 194.8 114.7 40.7 39.4 3542 13881

1934
 I 184.7 88.4 64.5 31.8 3325 12655
 II 371.8 273.8 39.5 58.5 4393 17152
III 428.7 320.9 36.1 71.7 2614 18148
 IV 515.2 393.6 49.7 71.9 4939 19130

1935
 I 573.4 440.7 58.4 74.3 5349 20509
 II 553.0 420.2 62.0 70.8 4900 18425
III 434.0 328.4 47.9 57.7 4244 15669
 IV 290.1 184.3 58.4 47.4 3347 11958

As Share of Total Expenditures

1933
III 100% 66% 13% 22%
 IV 100% 59% 21% 20%

1934
 I 100% 48% 35% 17%
 II 100% 74% 11% 16%
III 100% 75% 8% 17%
 IV 100% 76% 10% 14%

1935
 I 100% 77% 10% 13%
 II 100% 76% 11% 13%
III 100% 76% 11% 13%
 IV 100% 64% 20% 16%

Source: Works Progress Administration [1942].

Expenditures: Table XVIII, p. 299.

Relief Cases: Table I, p. 127.

Relief Individuals: Table II, p. 135.


Hopkins was continually going hat in hand to Capitol Hill for another appropriation, often threatening Congress with the specter of millions of needy unemployed who would no longer receive federally supported relief if FERA funds were not supplemented. (10) Congress appropriated substantial resources for relief purposes in 1934 and 1935; in all slightly over $4,000 million was made available to FERA between 1933 and 1935 under five separate pieces of legislation (as well as the $900 million expended by the CWA under FERA direction). With the exception of the $250 million in matching grants in the original FERA legislation, Congress allowed Hopkins to distribute all of the funds at his discretion. And, after February 1934, he was allowed to distribute funds directly to local governments. In the summer of 1935 FERA was replaced by two major programs, the Works Progress Administration (WPA) and the categorical relief programs of the Social Security Board: Old Age Assistance, Aid to Dependent Children, and Aid to the Blind. (11)

II. THE ECONOMIC THEORY OF INTERGOVERNMENTAL GRANTS

The economic theory of intergovernmental grants is depicted in Figure 2. The graph represents the choice facing a state or local government that wishes to provide relief to its indigent citizens (measured as relief cases per capita), yet can only do so by sacrificing consumption of other goods, typically a composite private good. Without federal grants, the state government faces a budget constraint of MN and provides relief to C cases at a cost of (M-PG) units of the private good. (12)

[FIGURE 2 OMITTED]

The federal government can encourage the state to expand its relief program by offering a matching grant. With the matching grant the relevant budget constraint for the state is now MP which is M[N.sup.*](1+R), where R is the matching rate. If relief cases are normal goods, the matching grant increases the number of cases receiving relief from C to [ C.sup.*]. The grant raises or lowers state relief expenditures (i.e. M-PG [??] M-P[G.sup.*]) depending on the price and income elasticity of demand for relief cases at the state level. (13)

If, however, a federal administrator truly has the discretionary authority that Hopkins had, he can obtain the same result at a lower cost by offering the state an all-or-nothing proposition: take a grant of DE + $ and provide relief to [C.sup.*] cases, or receive no grant at all. Since the state is indifferent between the original combination of relief cases and the composite good (C,PG) and ([C.sup.*],P[G.sup.**]), as long as $ is positive it will be in the state government's interests to take the offer. Since BE > DE, the federal government can provide relief to [C.sup.*] relief cases with a smaller expenditure of federal funds, or equally, can provide relief to a larger number of cases with a given amount of funds if discretionary all-or-nothing grants are given in place of matching grants. In this case, unlike the straight matching grant, the state always ends up spending more of its own money for relief than it would in absence of the grant. (14)

The situation is more complicated when more than one state is involved. If the federal administrator has the simple goal of reaching the same number of cases in every state, he will either have to offer every state different matching ratios or different all-or-nothing grants. If the federal administration's preferred [C.sup.*] differs from state to state because unemployment rates differ across states or because the federal authority places more value on supporting relief cases in one state than another, then the matching rates or all-or-nothing grants will also differ between states. As long as the federal administrator has discretion over the matching rate or grant size, then different states will receive different rates or grants.

III POLITICS AND FERA GRANT POLICY

The Financial Problems

The relief of needy individuals required Congress to assess the need of prospective recipients in a way that allowed the most effective use of federal funds. By giving the federal relief administrator the responsibility for determining the need of the unemployed in the various states, Congress simultaneously gave the administrator discretionary power over the allocation of federal relief funds. Hopkins understood and used this power just as described in the model.

To implement his policy he needed two pieces of information. First a desired level of relief cases in each state, [C.sup.*], and second, an estimate of the state's willingness (or ability) to pay for relief corresponding to the distance P[G.sup.**]M. Systematic information was collected by FERA's Division of Research and Statistics and evaluated by the Municipal Finance Section which made monthly recommendations to Hopkins about the relief needs ([C.sup.*]) in each state and each state's financial resources (P[G.sup.**]M). (15) Every month Hopkins would review each state's request for funding in light of this information. Ultimately, however, these were only rough guidelines that Hopkins used in making allocations.

With information on state fiscal capacity and the relief situation in hand, Hopkins offered each state a monthly FERA grant on the condition that the state (from combined state and local sources) come up with some required amount of funds of their own. Hopkins occasionally required states to come up with additional funds or face withdrawal of the federal grant. These threats had teeth. On 20 December 1933 Hopkins discontinued grants to Colorado until the legislature acted "to cooperate on a reasonable basis." On 21 January 1934, Governor Johnson wired Hopkins "Just signed bill making money available $200,000 March 1. Make application for $500,000 advance until state revenues available." (16) Hopkins also suspended grants to Missouri and threatened to cut off grants in a number of other states.

In the month to month operation of FERA it was the power to alter the amount of funds that a state received that gave Hopkins the power to encourage the maximum financial contribution from state governments. As Table I shows, although the federal government expanded its financial involvement in relief from May 1933 through 1935, state and local governments also increased their relief expenditures. Hopkins's actions, and the resulting state and local relief expenditures, are consistent with the intergovernmental grants model. Hopkins was able to use the grants to encourage greater state and local participation, indeed he used the grants in an active, strategic manner. (17)

But this method of granting funds created significant political problems for Hopkins. Some state governors claimed he was "playing politics with relief," other governors vigorously disputed federal authority, and every governor must have wondered what kind of strategic behavior on his part would lead to the largest federal grant with the lowest possible state expenditure. Rather than the clean matching grant depicted in Figure 2, Hopkins was playing forty-eight simultaneous two-person games, where grants and relief expenditures were both endogenous.

Conflicts with state governments over finances eventually manifested themselves in Congress. One important way they surfaced were questions from Congress on how the relief level ([C.sup.*]) and the grant size (DE) were determined, a question that came naturally in the periodic investigations into charges that relief was being used for political purposes. This created a no-win situation for Hopkins. If he was playing politics with relief, then he would not want to reveal the allocation criteria in public, since any deviations of the actual criteria used from the published criteria would have been, per se, evidence of political manipulation of relief funds. (18) If, on the other hand, he was not playing politics, but really trying to aid the largest number of cases with limited funds, public revelation of the criteria for determining grants would lead to a situation in which the states would treat the discretionary grants as straight block grants. Each state would demand its due (say DE in the figure) from the federal government whether it put up its share of funds or not. The grant becomes a simple block grant, and this results in the smallest number of cases being provided for at any level of federal grants. (19) In either case, revealing the allocation scheme would tie Hopkins's hands.

Congress was very anxious to learn exactly what criteria Hopkins used when making grants. Yet, despite long hours of testimony before the Congress on several occasions, Hopkins never divulged how grants to the states were determined. Hopkins was, in fact, quite insistent that no explicit formula was used and that FERA allocated funds according to need. Hopkins also justified his policy of forcing some states to raise their relief budgets; he had a running battle with several southern states which wanted very small relief programs. (20)

The complaints of Congress and the governors about federal discretion were not without merit. From where the governor sat the federal administrator held most of the money and was in a position to demand cooperation from the governor. When faced with an all-or-nothing offer with unemployment at 20 percent, few politicians took the zero option (in the figure by construction, of course, if $ is positive the governor accepts the offer). More importantly, every governor and state relief administrator knew he was under the thumb of the federal administrator. Hopkins could, and did, alter the size of state relief grants to influence state relief policies and funding, in many cases because of disagreements between Hopkins and state officials. These tensions between state and federal officials ran high in the early years of the New Deal.

The Administrative Problems

Hopkins faced a number of administrative problems, and all stemmed from the independence of state and local relief administrations. Corruption was the most pressing and potentially the most damaging to Roosevelt, and it was a natural focus of Hopkins's attention. The difficulties Hopkins faced in dealing with corruption were similar to those he faced with the selection of patronage recipients and the overall coordination of relief policy. Therefore, this section examines closely Hopkins's attempts to deal with corrupt practices and officials.

Corruption was a direct result of the administrative independence of the state and local relief organizations. Public relief had been an integral part of big city machine politics for decades before the New Deal. (21) The more blatant forms of corruption involved taking kickbacks from relief recipients and administrative employees, granting relief to relatives, and improprieties in purchasing materials for work relief projects. There was also, in the words of George Washington Plunkitt, a good deal of "honest graft" in the relief programs (Riordan [1963]). FERA provided roughly 150,000 administrative jobs, available for patronage purposes and particularly attractive to patronage-minded Congressmen (Congress refused to place the relief programs under the Civil Service). (22) The right to decide the location and type of work relief projects--which streets would be built or resurfaced, where airports would be located, and where sewers would be laid--were administrative decisions with potentially valuable political uses. The problem was compounded by the controversial nature of the relief program and the consequent continuous investigation by the national and local press. Evidence of graft, corruption, and political manipulation of relief at any level of government reflected badly on Roosevelt.

Hopkins had three tools to deal with corruption. The first was criminal prosecution. A division of investigation, established in July of 1934, investigated 1,472 cases of alleged misbehavior, found the charges false in 940 cases, and obtained convictions in 97 cases. Several of the cases involved highly placed individuals. The most prominent was Governor Langer of North Dakota, who was implicated in a scheme using relief funds for political purposes. He and several aides were sentenced to prison terms.

The second tool had a defensive and an offensive edge. States were required to file requests each month for the next mouth's grants and to provide an accounting for all federal grant money spent in the previous month. By instituting strict financial controls, Hopkins could defend against the flagrant misuse of funds and detect patterns of expenditure which might indicate improprieties. On the other side, the monthly grants enabled Hopkins to make small adjustments in grants to each state on a regular basis and keep up continuous pressure on state relief administrators to adopt policies that Hopkins favored.

During 1933, while the matching grants were still in place, Hopkins's ability to use his discretionary fiscal power to keep the states accountable for their administrative policies was closely related to the share of relief expenditures in each state provided by FERA. States with small expenditures from their own sources received small automatic matching grants and were largely dependent on discretionary grants from Hopkins for funds. States with large expenditures of their own could ignore Hopkins and still claim their matching funds. For example, Hopkins was able to require state relief agencies to obtain federal approval for any personnel who were paid from federal grant money rather than from state funds.

Congress intended that the matching grants be the primary form of FERA grants, expecting that the discretionary funds would be used in emergency cases. Matching grants did make up the bulk of grants through the summer of 1933, but in November Hopkins urged Roosevelt to release the balance of the matching funds into the discretionary fund and allow him to make wider use of discretionary grants, which Roosevelt did. (23) Hopkins was partly concerned with the inability of poorer states, some with large numbers of relief cases, to qualify for matching grants; although at the time the amount remaining in the discretionary fund was ample for those purposes. But he was also aware that discretionary grants gave him much greater control over the administration of relief in all the states:

The discontinuation of section 4 (b)

[matching grants] was of importance

from still another point of view ...

Had this purely automatic scheme

of allocation continued, there is small

question that the FERA would not

have been able to prescribe the course

of relief policy which has been outlined

in chapter 3. (24)

Financial discretion, based on FERA's mandate to distribute funds among the states on the basis of need, gave Hopkins a very effective administrative tool.

Hopkins had a third tool, a sanction more powerful than withholding funds: FERA could take over the administration of, or "federalize," relief in a state. It did so in six states, and, in all but one case, it was due to the unwillingness of the state administrators to bear their share of the relief burden and administer the relief program in a manner consistent with Hopkins's intention. (25) For example, relations between Hopkins and Governor Martin Davey of Ohio became so heated that Davey had an arrest warrant for Hopkins sworn out after Hopkins "federalized" relief in Ohio in March 1935. FERA had a long-running dispute with Ohio over the state's contribution to the relief program, and Davey had been implicated in corruption. As Hopkins wrote to Davey:

It has come to the attention of this

administration by incontrovertible

evidence that your campaign committee

shortly after your election,

proceeded to solicit money from men

and business firms who sold goods

to the Ohio Relief Administration.

The frank purpose of this shakedown,

because it can be termed fairly

by no other name, was to pay off

the deficit of your campaign and

the expenses of your inaugural. The

further apparent purpose was to solicit

these funds in order to retain

their jobs. (26)

The Davey case was unusual, but not an exception. Governor Olson was forced to step down as the head of the Minnesota Relief Administration because of political allegations, although Hopkins did not have to resort to federalization. FERA federalized relief in Oklahoma because Governor Murray would not accept relief funds unless he was allowed to spend them without regard to federal rules and regulations. Similar intractability of state governors caused federalization of relief in Georgia and Louisiana. (27)

These problems were also present at the local level. Local differences with state governments were often as deep as state differences with FERA. A source of Hopkins's conflict with Governor Davey, for example, was a disagreement between the relief administration in Cleveland and Davey, in which Hopkins favored Cleveland. Hopkins was also required to deal directly with the large urban relief administrations. As Dorsett [1977] documents, political bosses from several large cities critical to Roosevelt's re-election had direct access to Hopkins.

As with financial relationships, disagreements between FERA and the state and local authorities eventually reached Congress. Ties between Congressional delegations and political organizations back home were strong, and Congressmen were particularly interested in strengthening those ties through the judicious use of federal patronage--in this case, the 150,000 or so administrative jobs directly or indirectly under Hopkins's control. Of course, attempts by Hopkins to put relief above politics looked to the politicians like a conspiracy to shoulder them aside from the trough. Hopkins was not able to withstand congressional demand for patronage (indeed, it was not clear that it was in his or FERA's best interest to do so), thus forging an even closer link between Congress and the state and local relief administrations. But Hopkins did actively resist the appointment of political hacks, and disputes over patronage were a regular feature of congressional relations for FERA. (28)

In the spring of 1935 one governor was in jail and six states had lost control over the administration of relief within their borders, five because of conflicts with Hopkins. FERA had withheld grants from an additional handful of states for a month or more because of disagreements with Hopkins over administrative policy or the state's contribution to the relief program. Every state governor made a report each month to FERA requesting funds for the next month, and no one knew before hand whether that request would be granted, cut, or even enlarged. Congress had been

unsuccessful in forcing Hopkins to divulge how he was allocating money between the states, and disagreements over patronage had become a fixture of the relief arrangements.

IV. RESOLVING THE CONFLICT: THE SOCIAL SECURITY ACT AND THE EMERGENCY RELIEF APPROPRIATIONS ACT OF 1935

The conflict between Hopkins and the politicians came to a head in 1935. The President had appointed a Committee on Economic Security (CES) in 1934 to propose legislation that would ultimately become the Social Security Act. The CES's recommendations included a proposal for the three categorical assistance programs (Old Age Assistance, Aid to Dependent Children and Aid to the Blind) that would be financed out of general tax revenues, funded by discretionary grants, and administered by FERA.

The CES recommendation that discretionary grants be used was based on the recommendation of the social work experts who advised the committee. The experts firmly believed that state and local control of relief programs was the primary reason that American relief, historically, had been of low quality and plagued with political scandal. As Patterson [1981, 68] puts it: "Reformers lamented especially the curse of localism." And, as we have seen, financial discretion allowed federal control.

When the CES bill reached the House, however, the wishes of the reformers and the plans of Hopkins and the CES were quickly laid aside. The discretionary grants were replaced by strict matching grants. By the time the Act made it through the House and Senate, both administrative and financial control over the programs had been taken from the national level of government and placed firmly at the state level. Control over patronage was given to the states through a provision explicitly prohibiting the suspension of grants to a state on the basis of personnel policy. FERA was replaced as the administering agency by an independent Social Security Board. The key provision was the substitution of matching grants for discretionary grants. Without that provision, no state would have been able to independently administer its own program in the face of opposition from the Social Security Board or Hopkins.

The importance that Congress and the states placed on independence from a federal administrator was recognized at the time. Edwin Witte, who headed the CES and became the first Administrator of the Social Security Board, reported that nearly all the members of both the House and Senate committee who considered the Social Security Act were concerned about federal interference. V. O. Key noted that FERA's attempt to restrict the appointment of personnel "undoubtedly had much to do with the inclusion in the Social Security Act of provisions specifically prohibiting the imposition of federal personnel standards in certain state activities." (29)

The legislation that led to the creation of the WPA, the Emergency Relief Appropriations Act of 1935 (ERAA), provides an illuminating contrast to the Social Security Act. The ERAA gave Roosevelt $4,800 million for unemployment relief, and, under the authority of the ERAA, Roosevelt created the WPA by Executive Order. The Social Security Act and the ERAA were both presented to Congress in February 1935. The ERAA, however, was "emergency" legislation, only intended to stay in force for two years (it was followed by a series of ERAAs through 1939), while the Social Security Act was permanent legislation. Under the ERAA, Roosevelt was granted complete discretion, not only with regard to the granting of funds to the states, but with regard to the establishment of federal agencies to spend the money. (30)

The latitude given to Roosevelt in the ERAA is in marked contrast to the absence of federal discretionary power in the Social Security Act. Remember that the Social Security Act was permanent, the ERAA was temporary. Congress understood and responded to the needs of the states and the complaints they had with the structure of FERA. The Social Security Board would never hold a state hostage to federal grant money as Hopkins had done with FERA grants. Patronage was firmly in the control of the states.

On the other hand, the WPA was not only temporary, in the sense of being an emergency agency, but its funding was subject to periodic review by Congress. While Congress gave Roosevelt and Hopkins an unprecedented amount of discretion in the ERAA of 1935, it was able to control the WPA indirectly through a subsequent series of ERAAs. Congress kept a set of discretionary grants for itself, and was able to use this discretion to gradually circumscribe the independence of the WPA and other relief agencies.

V. CONCLUSIONS

Why did the federal government adopt open-ended matching grants during the New Deal? Strangely enough, although the answer to the question is suggested by the economic theory of grants, the truth is not that the matching grants were an optimal policy for the federal government. At least not in the sense that they enabled the Executive branch of the federal government to provide relief to the most people for the lowest cost. As suggested by the theory, Harry Hopkins did use discretionary grants and all-or-nothing offers to the states, the policy that actually enabled the federal government to achieve that goal. But the political costs of the program fell primarily on the Congressional, state, and local politicians whose independence was hostage to Hopkins's discretion. Opposition from state and local politicians, exerted through Congress, forced an institutional change to a form of financing that took discretionary fiscal power out of the federal government's hands. Matching grants were an optimal policy for state governments and state and local politicians, not for federal administrators and the Executive branch. (31)

This history cautions the political economist not to ignore the importance of economic history. It is not simply an admonition that history is important; good economic theorists and economic historians have always known that. (32) It is instead a caution against using plausible, even compelling, theoretical interpretations of historical events as a way of inferring the motivations for those events. The public finance model does help us explain the fiscal importance of the New Deal financial arrangements codified in the Social Security Act. But post hoc ergo propter hoc, even when apparently justified in theory, is as poor a guide to analysis in political economy as it is elsewhere. The fact that the model accurately predicts the effect on behavior of the changes in financial arrangements does not entitle one to infer that legislators made these changes in order to alter behavior in that specific way. They may have intended some other objectives.

When institutions change, many interests will be involved which formal economic modelling alone cannot analyze. Standard comparative static results, as in Figure 2, will not capture the political benefits and costs to the relevant political interests that come with different institutional arrangements. Without historical awareness, theory alone will never suffice to show us what those interests are. In this case political history provides a superior interpretation of the same theory to that usually provided by economic analysis.

In the 1930s Congressional politicians were closely tied to their state and local political organizations. The impositions made on state governments by the (legislated) institutional structure of FERA resulted in a reaction against the excessive discretionary power given to Hopkins in the original FERA legislation, discretion ary power supplemented by Roosevelt's executive decisions. When Congress legislated a permanent relief program, it took care to secure the independent operation of the state-level relief programs. Viewing the use of matching grants in the categorical assistance programs as a means by which the federal government could exert closer control over the state and local governments is the opposite of what actually occurred. Matching grants offered the state and local governments relief from federal discretionary power and the opportunity to manage their own affairs for their own ends.

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Zink, Harold. City Bosses in the United States. New York: AMS Press, 1930.

(1.) See Wallis [1984] for a discussion of the government's financial statistics during the 1930s.

(2.) The effect of matching grants on state and local relief spending is discussed in Wallis [1984]. The Social Security programs utilize open-ended matching grants, which are somewhat unusual. In 1974 federal open-ended matching grants totaled only $5.4 billion, roughly 25 percent of all federal grants (Gramlich [1977, 227]). Most matching programs are closed ended, i.e. a limit is placed on the amount of matching funds available.

(3.) The Social Security Act also created Old Age and Survivors Insurance and Unemployment Insurance.

(4.) Gramlich [1977, 234] concludes that closed-ended matching grants result in "spending roughly equal to the grant," i.e. that state and local governments do not substitute federal funds for their own, and that the difference between open-ended and closed matching grants is slight.

(5.) See Monthly Report of the Federal Emergency Relief Administration, July 1934.

(6.) This policy had its roots in an earlier relief bill which had failed passage in the Senate in the spring of 1931. Division over the bill within the Senate was not over the amount of the appropriation or the necessity to provide relief. The disagreement was over the technical ownership of the funds, with one group of Senators unwilling to pass any relief bill that did not grant unconditional ownership of the funds to the states. The 1931 bill proposed grants, not loans, but foundered on the issue of fiscal responsibility.

(7.) In many cities relief was financed by local governments but administered by private agencies. FERA required that all money be distributed by public agencies, which resulted in private sector social workers becoming local government employees.

(8.) The Civil Works Administration (CWA) was a slight diversion from FERA's administrative pattern. Faced with the prospect of another winter with over 20 percent unemployment, Roosevelt, with Hopkins's assistance, launched the CWA in November of 1933. The goal was to employ four million persons on work relief projects (half from FERA rolls, half from unemployed workers not receiving relief). Roosevelt financed the CWA by withdrawing $900 million from the Public Works Administration allocation made under the National Industrial Recovery Act. Unlike FERA, the CWA was, in theory, a national operation, i.e. all employees were paid directly by the federal government. In practice, state and local FERA employees were simply sworn in as CWA employees. The small FERA work relief program stepped up its operation to provide jobs for new CWA recipients and many FERA cases were transferred to CWA jobs. In April 1934, the winter over and its task finished, the CWA was dismantled, its cases returning in large numbers to FERA rolls and its administrative employees to their old FERA jobs. The CWA was, in many respects, an administrative extension of FERA.

(9.) The table does not include cases or expenditures for the CWA, which explains the dip in case loads and federal expenditures in late 1933 and early 1934.

(10.) FERA received additional appropriations in February 1934, June 1934, and April 1935.

(11.) Unemployment insurance did not become important until 1938 and 1939 (it varied from state to state) and OASI was not fully operative until the 1940s.

(12.) The origin of the indifference curves in the figure is, of course, a real problem in public finance and political economy. For the purposes of this paper they can be thought of as the indifference curves of the local political leader(s), without affecting the conclusions of the paper in any way.

(13.) Since the federal government is providing a total grant of BE there must, in principle, be corresponding indifference curves and budget constraints for the federal government which determined that C* was the desired level of cases.

(14.) Assuming, of course, that $ is sufficiently small. A similar problem is examined by Chernick [1979].

(15.) The methods used by FERA to establish these guidelines are described in detail in Williams [1939, 203-215]. Copies of FERA work sheets are available in the National Archives, Record group #69. For an attempt to disentangle some of the determinants of FERA's allocation procedures, see Wallis [1981].

(16.) As quoted in Williams [1939, 203].

(17.) Estimates of these effects are given in Wallis [1984]. For every federal grant dollar, state spending on relief increased by 34 cents in the years 1937 to 1940 (data limitations prevent extension of the analysis to the earlier period).

(18.) There is some evidence that Roosevelt did allocate funds between states for political purposes, specifically that federal grants were largest in politically sensitive states. See Wright [1974] and Wallis [1984; 1987].

(19.) To see this, imagine a new budget line is drawn through point D in Figure 2, parallel with the original constraint MN. The state will choose to provide relief to less than C* cases.

(20.) Hopkins testimony on grant allocation criteria is reported in U.S. Senate [1936].

(21.) See Zink [1930] for a general view of political machines and Salter [1935] for a specific analysis of the Vare machine in Philadelphia, including a description of the machine in the years just before the New Deal.

(22.) The number of administrative personnel ranged from 97,000 to 186,000. U.S. Works Project Administration [1942, 85].

(23.) By November, roughly $250 million of the original FERA appropriation had been distributed to the states. Of this only $57 million had come from the discretionary fund. Monthly Report of the FERA, January 1934.

(24.) The material discussed in chapter 3 of Williams [1939, 187] dealt with the administration of the FERA program and the regulations set down by FERA to control state and local relief administrations.

(25.) The exception was Massachusetts. Massachusetts law prevented the state from allocating funds between the counties on any basis other than population. FERA stepped in and distributed money within the state on the basis of need, but allowed county and township governments to administer the program.

(26.) As quoted by Charles [1963, 81].

(27.) For discussion see Charles [1963, 74-76] and Williams [1939, 177-79].

(28.) Political pressures even came from within the White House. Texas, whose Congressional forces were headed by Vice President Garner, was a case in point. As Jim Farley, Roosevelt's main advisor on political matters, wrote to Hopkins: "In order to be certain that the interest of the Democratic Party is protected at all times, I am desirous that, on every appointment made in or from the state of Texas, you secure the approval of the Honorable John N. Garner, Vice President of the United States." As quoted in Charles [1963, 75]. The FERA files in the National Archives, Record group #69, give ample evidence of written requests from Congressmen for patronage favors.

(29.) Witte [1963, 152]; Key [1937, 273]; Alston and Ferrie [1985; 1986; 1989]; and Patterson [1981, 67-71].

(30.) It should be noted that Congress gradually impinged on Roosevelt's discretionary ability to allocate funds between the states by moving toward a "sponsorship" system where state and/or local governments had to contribute at least 25 percent of the cost of a WPA project.

(31.) When discussing the limitations of matching grants in providing equal levels of public services across jurisdictions Oates [1972, 90-91] notes that: "The point is that under matching-grant programs the final determination of the level of provision of the service is in the hands of the recipient of the grant. As a result, the realization of the minimum program level cannot be assured."

(32.) There are many examples in both fields, two of the best are North [1981] and Stigler [1988].

JOHN JOSEPH WALLIS, Associate Professor, Department of Economics, University of Maryland and Research Associate, NBER. I would like to thank Mark Plummer, Wallace Oates, Douglass North, Barry Weingast, Richard Sylla, Robert Schwab, and two anonymous referees for helpful comments.
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Author:Wallis, Jon Joseph
Publication:Economic Inquiry
Date:Jul 1, 1991
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