Are States Ready for the New Federalism?

(reposted from LinkedIn)

or all of the talk of the imperial presidency, there's actually a quiet recession taking place in and around places that depend on the federal government. The DC metro area has been particularly hard hit. Some federal buildings have become empty zombies. Government contractors are tightening their belts. Nonprofits are going out of business. Whole agencies like USAID have been decimated.

President Donald Trump’s second term has ushered in a seismic shift in American governance: a new federalism that devolves power from Washington to the states. Over the last few decades, the U.S. has concentrated resources and expertise in Washington. Trump’s policies—deregulation, block grants, and emphasis on state-led governance — has reversed this trend, and it may have legs past his presidency. But this new federalism won’t work if the states don’t adapt too.

Take emergency management for example. Significant reforms at FEMA are on the horizon as we conclude this hurricane season. Over the past 45 years, the federal government’s role in disaster management has ballooned—from negligible in the 1980s to providing up to 70% of assistance in some responses today - causing some state capabilities to atrophy or become dependent. For example, federal emergency grants account for 75% of the annual budget of Vermont Emergency Management.

The result is that the shock may be substantial as the federal government reduces its role. A recent study by the Pew Research Center shows that the federal government accounted for 36% of state budgets, close to record highs. Already, states like Arkansas and Missouri have grappled with tighter federal assistance policies and states like Louisiana, Hawai'i and New York that have depended heavily on federal assistance in the past, stand to lose significantly once the new reforms are implemented, and Hawai'i already has the highest tax burden of any state.

This may just be the tip of the iceberg. If the first 200 days of this presidency are any guide, we can anticipate significant shifts in agencies like HUD, HHS, Education, EPA, and others, as their roles in supporting state operations evolve or diminish. States need to prepare for this new paradigm, yet there is uncertainty around whether all of them can rise to the occasion.

Many government observers that I have talked to are skeptical. Some states are already so hamstrung by debt and deficits that added burdens may lead to serious service shortfalls and financial restructuring. In some cases, state policymakers do not know what capabilities the federal government has assumed that they will need to re-create or compensate for at the state level. States face structural hurdles: lobbies for the status quo resist change, workforce agreements limit capacity building for new responsibilities, and political polarization stalls bold reforms. State legislative calendars may also delay consideration of new federalism reforms.

It will likely take two years or more for some states to re-configure themselves appropriately. Because of the long lead times for change, the winners in the new system will start having these conversations now, but there's a lot of inertia and "wait and see-ism" still.

Personally, if I were a state governor or legislature I would already have established a task force to study the implications of the federal government reorganization that is taking place now. The federal debt is already over $37 trillion and projected to hit $50 trillion by 2035. Ray Dalio, the billionaire investor who founded Blackwater Associates, believes the U.S. is headed for an "economic heart attack". Even if federal concentration of power were to resume, it will be hamstrung by the approaching fiscal cliff. The way the government is structured three quarters of it is earmarked to entitlements, defense, and interest. This means cuts will disproportionately come from the government's operating budget. At some point in the next 10-20 years, states will likely have to assume additional responsibilities no matter what.

Secondly, a confluence of ideologies and political interests may continue to drive the new federalism onward. Red states like Texas have long championed local control, while blue states like California and New York now seek autonomy for climate mandates and healthcare reforms. Texas’s school choice contrasts with California’s emissions standards, but both reflect a bipartisan push to wrest power from Washington. This rare red-blue consensus, locked in by the looming debt crisis, suggests this restructuring of state and federal government roles and responsibilities will have legs.

To get out ahead of this, state policy makers need to strengthen their capabilities and get their own fiscal houses in order, if only for competitive reasons. Citizens are already voting with their feet and running away from states like Illinois and New Jersey. However, state-level federalism will demand more than capacity building —it will require innovation and intelligent policy development. No matter what level of political jurisdiction, we cannot just spend our way out of our problems. States must overhaul outdated operations, and embrace technologies like AI and automation to stretch budgets while maintaining services.

Smart strategy beats dumb money every time. States will have to learn how to be more productive, create market incentives to achieve goals they cannot directly fund, and figure out how to stretch budgets and build capacity at the same time. State policy innovation isn’t optional; it’s survival.

The new federalism is a high-stakes bet that the country will be able to survive and thrive with less concentration of power in Washington. The proposed super block grants that the Trump Administration is considering will empower states to tailor solutions, but without fiscal stability, strategic muscle, and technological savvy, there will be hiccups, if not outright disasters. As the federal government steps back, states must step up—not just because of Trump’s agenda, but for their own economic safety and future prosperity. The success of continued positive U.S. domestic development, depends on state and local policy makers rising to the occasion and acting with wisdom and foresight in the months and years ahead.