Two important instruments of federalism can affect the size of the federal deficit and the economic relationship between central and local governments: mandates and grants. An increasing burden of federal (unfunded) mandates for expenditures has been placed on the states and local governments, but these mandates provide only limited opportunities for federal budget reduction. A significant opportunity for budget cuts is provided, however, by the rapid rise in federal grants to local governments. This paper questions whether the appeal to federalist principles that is used to support these cuts in grant programs is valid. Given the moderate price elasticities and small income elasticities of demand for state and local spending, and the real possibility of a race to the bottom, budget savings at the federal level will be achieved only by drastic reductions in these programs.

John M. Quigley, University of California, Berkeley

Daniel L. Rubinfeld, University of California, Berkeley

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