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“Nothing is so permanent as a temporary government program.” -Nobel Laureate Milton Friedman (The Yale Book of Quotations, 2006)

As the opening quote from Nobel Laureate Milton Friedman illustrates, government programs can be hard to discontinue once they are created. The many New Deal programs still in existence seem to fit into this category. In his book, Crisis and Leviathan, Higgs (1987) even proposes a ratchet theory of government growth in which temporary government programs that are enacted in response to major crisis events become permanent, thereby providing an explanation for historical government growth.  Most recently, the federal stimulus response to the financial crisis has brought about a large increase in federal government spending accompanied by a host of new government programs that may linger much longer than anticipated.

A significant amount of the recent expansion in government spending has been carried out through a major increase in federal grants to states and local governments for new ―shovelready projects. If these temporary programs are hard to eliminate in the future, their permanence will require states and localities to eventually raise their own taxes to fund these programs once the federal funds are gone. Far from always being an unintended consequence, some federal grants are made with the intention that states will pick up funding the program in the future. In 2010, for example, the city of Morgantown, West Virginia, along with 39 other cities, began receiving federal funding for the hiring of two new police officers for three years, after  which time the city will have to fund these new permanent full-time positions using own source revenue.

The general question of whether federal grants to states cause subsequent state (or local) tax increases is the topic we explore in this paper. The implications are important because if this is the case, then the recent federal fiscal stimulus should not only be predicted to cause a permanent ratchet upward in federal spending, but also a permanent ratchet in the size of state and local governments in the United States. Far from being purely an academic question, this argument is in practice why South Carolina‘s Governor Mark Sanford attempted to turn down part of the federal stimulus monies for his state. Referring to when the temporary federal stimulus funding runs out two years in the future, he states: