States of the Union

By WALTER ISAACSON

Reagan offers a plan to pass the buck, and the bucks, from Washington

The question is a historic one. It was confronted by the founding fathers, debated by each succeeding generation and fiercely fought in the country's only civil war. Which powers are the proper province of the national Government and which are reserved to the states? In his State of the Union message last week, Ronald Reagan dramatically raised the issue once again, proposing the most radical shift in governmental authority since the New Deal. His scheme would transfer programs to the states costing more than $49 billion by fiscal 1987, which is more than half the money Washington distributes in grants. Said he: "Our next major undertaking must be a program to make Government again accountable to the people."

The President's 41-minute televised performance, in which he outlined the idea of a New Federalism, was vintage Reagan, as flawlessly paced and as forcefully persuasive as any of his campaign speeches--which is what the address basically was. With a showman's instinct, he evoked the heroic spirit of Leonard Skutnik, who dived into the Potomac last month to rescue a drowning plane crash victim (see box), and stirring speeches to Congress by Winston Churchill, Franklin Roosevelt and Abraham Lincoln. Only when he touched on foreign policy did he shift about nervously, as if on unsure terrain.

The former California Governor has long been nurturing the seeds of federalism. But the notion was seized upon last November by those shaping the State of the Union message, in part because it was fine political strategy. Reagan badly needed a vehicle to avoid dwelling on the depressing but pressing problems of budget deficits and unemployment and to regain domination of the political debate. The White House, therefore, beefed up the federalism idea to give the second-act curtain raiser of the Reagan presidency a show-stopping wallop. Says one adviser: "We thought of it as another go-for-broke idea, a big idea, another way in which Reagan could shape the national agenda."

Thus Reagan, filled with faith that his course was correct, forged ahead with phase two of his revolution, partly as a way to avoid challenges to his as yet unfruitful first phase. He offered no new initiatives to conquer the economic crisis, supplying only amiable optimism that the Reaganomics package passed last year would stimulate the economy some time soon if given the chance to work. Though he had run on a platform of balancing the budget, the President all but ignored the projections of deficits approaching $100 billion. He scarcely noted that interest rates still hover at investment-ravaging levels. And the worst problem of all at the moment, unemployment (see cover story), prompted only a few passing words of concern. Summarized Reagan: "In the near future, the state of the union and the economy will be better, much better, if we summon the strength to continue on the course that we've charted."

Even Republicans, who gave their leader polite and occasionally enthusiastic applause at 21 other points, sat in stony silence when that line was delivered. Vermont Republican Senator Robert Stafford said he had trouble sleeping after he heard the speech. "The President didn't discuss 1982 or 1983 at all. We've got to live through them first." Said Democratic Congressman Morris Udall of Arizona: "He tried to change the subject, but the subject isn't going to change." Missouri's Richard Boiling, the Democrats' top parliamentarian, was the most scathing of all. Said the 33-year House veteran: "The worst State of the Union I've ever heard. He completely avoided all the issues everyone knows we have."

The Democrats, who actually let loose a disrespectful laugh when Reagan seemed to be understating the deficit problem, are unlikely to be diverted by the grandiose federalism play. Said Senator Ernest Rollings of South Carolina: "He's just shifted around the chairs on the deck of the Titanic." Nor, for that matter, will most of the Republicans. Said William Armstrong of Colorado: "The deficit problem will not go away. We can stand in front of the Capitol 24 hours a day talking about the New Federalism, but it won't change reality."

One aspect of the President's proposal is what he called "a financially equal swap." Starting in fiscal 1984, the Federal Government would assume the cost of the rapidly growing Medicaid program, while giving the states full responsibility for Aid to Families with Dependent Children and food stamps. The states would be spared Medicaid payments of $19 billion in 1984, rising to $25.4 billion in 1987, while picking up AFDC and food-stamp obligations of $16.5 billion in 1984, reaching $17.6 billion in 1987. This estimated benefit to the states is based, however, on the shaky assumption that Reagan's plan to make further cuts in these programs will be enacted by Congress this year.

The second part of the plan would turn over to the states 43 additional federal programs, expected to cost $30.2 billion, reducing the current messy hodgepodge of overlapping grants from Washington. This will take the Government almost entirely out of the fields of special education, youth employment, job training and transportation. To finance these activities, the states will be given a temporary trust fund of $28 billion a year, fed by revenues from the windfall-profits tax on oil and existing federal excises on gasoline, liquor and tobacco.

From fiscal 1984 through 1987, states can decide to continue any or all of the 43 programs using credits from the fund, or they can take the money and phase out the programs. After 1987, the federal programs would cease to exist, and the trust fund would fade out as the taxes that feed it are reduced by 25% annually for the next four years. The states can then raise their own excise levies to pay for any services they wish to continue. One problem: more than half of the trust fund will come from the windfall profits tax. It will be impossible for most states to take over that revenue source when Washington discontinues it.

Reagan presented his plan to restructure America's federal system with emotion and drama, lowering his voice at the end to recall Lincoln's words that the "trial through which we pass will light us down in honor or dishonor to the latest generation."* But the long-term initiative will do nothing to alleviate the budget deficits looming in the short term. Reagan plans to submit to Congress next week a status report on fiscal 1982 spending with a bottom line close to $96 billion in the red and a fiscal 1983 budget with an equally dizzying debt. The man who for years attributed almost every economic woe to Government's propensity to spend more than it takes in shrugged off this lapsed faith by saying, "There are too many imponderables for anyone to predict deficits or surpluses several years ahead with any degree of accuracy." Reagan has discovered that it is much harder than he once claimed it would be to increase defense spending, cut taxes and balance the budget all at once. When faced with the conflict, he decided the first two goals took a higher priority. But the clear prospect of continued high deficits has helped keep interest rates high and soak up the money available for private business investment.

Reagan offered only minor tax adjustments, amounting to $12.7 billion in fiscal 1983, to slightly alleviate the budget shortfall. Included in the package: reducing certain deductions, such as those for energy conservation, taxing income on uncompleted business contracts, withholding tax on interest earned by savings accounts, and strengthening the rules governing the minimum tax corporations must pay. In addition, the President will push for approximately $31 billion of further spending cuts, drawn up last December, in Medicare, Medicaid, food stamps and other programs that have already felt the blade of his budget ax.

Conspicuously absent was the much debated proposal to raise federal excise taxes. Said Reagan: "The doubters would have us turn back the clock with tax increases. Raise present taxes to cut future deficits, they say. Well, I don't believe we should buy that argument. I will not ask you to try to balance the budget on the backs of the American taxpayers." Ironically, most prominent among the "doubters" were Reagan's top aides, who strongly and unanimously urged new revenue measures. Chief of Staff James Baker and Budget Director David Stockman, and eventually the rest of the Reagan high command, were convinced that increased taxes were needed to save the Administration from increasing the nation's trillion-dollar debt by a whopping one-third during their first term. They tried to get Reagan to accept excise taxes as part of the trust fund for the transition of programs to the states. A week before his speech, Reagan agreed. But before he left for Camp David that weekend, he told his top aides that he had decided to stick with his own antitax instincts.

Reagan's ultimate and overriding mission, as he sees it, is to shrink Government permanently, which he feels can be done only by denying Congress the money to spend. Said he in his speech: "Raising taxes will not balance the budget. It will encourage more Government spending." He also believes that lower taxes will lead to more savings, and thus more money available for investment.

One of the implicit goals of Reagan's federalism plan is eventually to cap or reduce social spending at all levels of Government. By assuming full control of Medicaid, for example, the Federal Government will be more able to cut the program's cost. Some of the services once provided by Washington will simply be dropped by the states, a prospect that many liberals fear and many conservatives favor (see following story).

The White House would relish the chance to present what Reagan called his "single, bold stroke" of federalism as a package, subject to a few major up-or-down votes, such as the budget and tax tallies of last year, rather than subjecting the plan to scores of amendments and piecemeal votes in the House and Senate. During the speech, Vice-President George Bush, who tried to banter with a grim House Speaker Tip O'Neill, canvassed the Democratic side of the aisle for signs of support. "Only Gramm applauded," the Speaker gruffly noted later, referring to Phil Gramm of Texas, co-sponsor of the President's budget bill last year. O'Neill later passed the word to his lieutenants that the federalism proposals would be considered not as a package but with all the appropriate committees taking part in the action.

This could doom the initiative. Reagan's request last year to lump many domestic programs into block grants, a much less ambitious plan than the current one to turn back responsibility and money to the states, foundered on the rocks of the committee system, where it encountered resistance from both parties. As Democrat Leon Panetta of California points out: "The committee chairmen, who are the fathers of these social programs, will not be at all eager to see them terminated."

Most Congressmen felt that the New Federalism was simply irrelevant to the real issues facing the second session of the 97th Congress, and they vented wrath at Reagan from both sides of the aisle for ignoring the problems of deficits and unemployment. Republican leaders on the Hill fear that they will have to come up with their own plan to cope with the unacceptably high deficits, without any support Tom Reagan. The first problem will be to pass the badly unbalanced 1983 budget the President plans to submit next week. "Are any Republicans going to vote for it?" asked Robert Dole of Kansas, somewhat despairingly. "If not, what happens? The Budget Committee is out of business if it cannot pass a budget."

If the economy has not improved by spring, Dole says, then G.O.P. congressional leaders will have to go to Reagan and persuade him to trim his sacred defense budget and propose new taxes. Should the White House still not act, it will be even more difficult, if not impossible, for the Republican leadership to muster the votes to raise the debt ceiling when that becomes necessary this summer. Laments Republican Senator Pete Domenici, chairman of the budget committee, in a decided understatement: "It's obviously going to be a very difficult year."

In the Democratic House, Budget Committee Chairman Jim Jones has not been invited to take part in consultations with Administration policymakers in recent weeks. In fact, his committee technicians have even been unable to exchange routine data and numbers with Reagan aides. That may have to change. When Jones ran into Stockman in the corridors just after the President's speech, the Budget Director said jokingly, "I apologize, but I lost your phone number. I'll be back in touch with you in about a week."

The necessary cooperation will be hampered by the fact that this is an election year. The Democrats will make political capital of unemployment, deficits and the perceived unfairness of Reagan's programs to the poor. Says a woman, Irene O'Connor, 76, at the beginning of a televised documentary shown as the Democratic Party's response to the President's speech: "The elderly like myself on Social Security and my husband on retirement find it very difficult to make ends meet, and the oil companies and the big corporations get all the tax breaks. That really burns us up."

Reagan will hit the trail next week to sell his New Federalism around the country, traveling to six states over the next month. His goal will be to make his new plan, rather than the lingering recession, the focus of national attention. But until some progress is made in reducing unemployment, huge deficits and unacceptable interest rates, even the boldest new initiatives will probably have to take a back seat.

--By Walter Isaacson.

Reported by Laurence I. Barrett and Neil MacNeil/Washington

* The point of this speech, made in 1862 before Lincoln signed the Emancipation Proclamation, was to advocate a long-forgotten proposal to compensate owners for their slaves and pay for their transport and recolonization in Liberia or Haiti.

With reporting by Laurence I. Barrett, Neil MacNeil/Washington

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