The Federalism Project

American Enterprise Institute

June 2001

Save Us from the States!

By Jonathan Walters

If you want to visit a key battlefield in America’s current devolutionary wars, you don’t have go any further than your nearest automatic teller machine. In recent months, as a host of states and localities have sought to outlaw some ATM surcharges, viewing them as little more than a big consumer gouge, banks have made it clear they don’t want any such state and local meddling in their affairs. And so they’ve taken their case to federal court, asserting that when it comes to ATMs, federal banking law preempts all state and local regulation.

At its conceptual core, this is an ancient issue. One of the main incentives for calling a Constitutional Convention in Philadelphia in 1787 was a desire to have some national entity supersede state leniency toward debtors. In the two centuries since, the state and local right to regulate in the name of public protection has collided regularly with the desire of business to work freely across state lines in the name of profit and efficiency.

But these days, the argument is growing more heated. Business is becoming impatient with myriad state and local statutes and more interested in the notion of a one-rule-fits-all world. “It’s interesting,” says Jean Ann Fox, of the Consumer Federation of America. “As soon as state legislatures started considering bills to protect bank customer privacy, the private sector financial folks started saying maybe we ought to strengthen privacy language in federal law. But the price is that it preempts all state law.”

Just how successful business will ultimately be at pushing for federal preemption is open to dispute. But it’s clear that efforts to replace multiple state and local statutes with a single federal standard are on the upswing. In the past few years, major corporations have successfully backed a wide sweep of legislation aimed directly at getting state and local government out of their lives, from the Securities Market Enhancement Act, which preempted state oversight of mutual funds, to the Telecommunications Act of 1996, which authorizes the Federal Communications Commission to preempt any local ordinance that discourages competition in the telecommunications industry, and outlaws local bans on cell towers.

Successful or not, business lobbyists do seem to be saying they’d rather deal with the single federal devil they know, than with the hundreds of pesky and unpredictable state and local demons they don’t. And there is a pretty simple reason for that. With the pace of business getting faster, the competition more fierce and geographical boundaries disappearing as though drawn in invisible ink, businesses want speed, certainty and efficiency out of their governmental overseers. “The business attitude today seems to be that no matter how bad a single federal standard might be, it’s better than 50 of them,” says Adam Thierer, who is in the thick of such federal-state-local issues as director of telecommunication studies for the Cato Institute.

But as the world of commerce gets more complex, there are those who argue that the state and local role in protecting the health, safety and welfare of citizens becomes more important. In a world of increasingly large, amorphous and distant corporations, who better to hold business accountable than those officials closest to the people? “Suppose,” says Frank Shafroth, of the National Governors’ Association, “you trudge through two feet of snow to your neighborhood ATM machine, you put in your card and you get nothing back. Who are you going to call to complain? Someone in Washington?”

The difficulties of the issue, however, are obvious. State and local government regulators, acting in what they view as the interest of their constituents, can create a system that’s clearly cumbersome for business. A gaggle of disparate governments slapping caps on ATM surcharges in some places and not in others is exactly the vision of conflicting regulatory behavior that drives businesses around the bend...and directly into the arms of federal courts, agencies and the U.S. Congress.

Nobody in government is more thoughtful or more outspoken on the dangerous consequences of such a law of political physics — that for every flurry of state and local business regulation, there is an equal and opposite sprint to Washington by business for a single standard — than Mike Leavitt, the governor of Utah. Leavitt has a favorite example that he uses in speeches to illustrate why business is chafing under the oversight of multiple jurisdictions.

“I have a friend in the insurance business who is an ardent defender of state regulatory responsibility,” Leavitt says. “But he told me about the process of trying to get licensed to sell life insurance in 50 different states, saying that it was beyond belief: 50 different applications; 50 different regulatory attitudes; 50 different checks. Now this ardent supporter of state regulation is going to Congress saying, ‘You’ve got to solve this problem for me; something’s got to be done.’ ” It’s no wonder, Leavitt concludes, that business is increasingly favorable to a one-standard world; a world in which he fears that a system long invigorated by competing levels of government will be dumbed down to a lethargic, monolithic, one-government rule: Washington’s.

The task at hand, in Leavitt’s view, is to find ways to capture the energy, creativity and responsiveness of 50 robust state governments acting in the interests of their citizens, and balance that against the legitimate right of business to operate efficiently across state and national borders. States, he says, need to do some hard thinking about where to step in, step out, or try to coordinate their activity — either among themselves or with the federal government. Because even when it’s obvious that states and localities are working to protect the health, safety and welfare of their own citizens, it can still be hard to argue with businesses’ bottom-line reasoning: that they deserve a level of certainty, consistency and uniformity in governmental standards and regulations. “We are talking about the new frontier of federalism,” says Leavitt. “This may be one of the great challenges to this American experiment: Can we adapt our version of federalism to accommodate rapidly changing technology and global business practices and still protect the essence of local control and self-governance?”

There are other reasons — besides the simplicity inherent in a one-rule world — that have driven business to view Washington as a more palatable venue for oversight. As a tactical matter, of course, it’s just simpler to focus on creating, changing or fighting a single federal standard than it is dealing with dozens of them as they bubble up from state and local government. “It is a business concept: It’s called economies of scale,” says Bob Stumberg, a Georgetown University law professor who studies the impact of international trade agreements on U.S. domestic policy. “It’s easier to focus your efforts in one place.”

The corollary to the economies-of-scale argument hardly needs stating: It’s not only easier for business to focus its efforts in one place, it increases the probability that business will get the other thing it wants: a relatively weak standard.

The classic example involves food labeling, as studied in a recent paper by Mary Graham, of the Kennedy School of Government at Harvard University. In the late 1980s, with nearly 70 food-labeling bills percolating in more than 20 state legislatures, food manufacturers had visions of being pecked to pieces in state capitols over what health and nutritional information ought to go on the back of a peanut butter jar or a soup can. And so manufacturers came together to support one uniform federal labeling law — the Nutrition Labeling and Education Act of 1990.

Once the game shifted to a single arena, the packaged food industry ably and effectively focused its full lobbying might on limiting the law to one that simply requires listing ingredients in relation to daily allowances, with no information included about the potential health impacts of their product.

While beseeching Congress for a better deal in specific areas of commerce, the business community also has been fighting the preemption battle on a broader, more philosophical front.

Two years ago, it managed to fight off a coalition of state and local government interest groups that came together with a small handful of U.S. senators to write a general manifesto on federal preemption.

Essentially, what the coalition wanted was for Congress and federal agencies to come clean on future preemption power grabs. Whenever the federal government intended to preempt state or local authority, it would have been required to state that on paper in black and white. Where no such intent was declared, state and local governments would retain jurisdiction. Backed by such groups as the National Conference of State Legislatures and the U.S. Conference of Mayors, the manifesto was released in the form of draft legislation in the summer of 1999.

It was hoped that the law would garner the same broad political support as legislation limiting federal mandates had in 1995. It didn’t work out that way. Instead, the bill ran into a buzz saw of opposition led by a group not known for its affection for any level of government: the U.S. Chamber of Commerce. With the Chamber coordinating the attack, Senate Bill 1214 — the Federalism Accountability Act of 1999 — was quickly and summarily routed.

It’s pretty obvious why the Chamber took such deliberate pains to kill the initiative: Its members like having federal preemption as a tactical weapon, and they don’t want anyone meddling with it. Of course, the chamber doesn’t come out and say it in those words. Jim Wootton, the president of the Chamber’s Institute for Legal Reform, merely says that his organization has always supported the concept of supremacy extended to the federal government under the U.S. Constitution. Asked which specific areas the federal government ought to be actively considering for preemption, Wootton turns the question around, listing those areas where he thinks states and localities should keep control. He answers that way because it’s much easier to; it’s a very short list. In fact, it seems to boil down to doing things like writing local building and construction permits. It does not represent a picture of robust federalism.

What would? Ideally, say state and local government advocates, it would be a world where states and localities took it upon themselves to coordinate regulatory and tax policy so that the feds wouldn’t feel compelled — or vulnerable to pressure — to preempt. It’s the only way, Mike Leavitt believes, to counter the business tactic of running to Washington for relief. “It’s going to take real statesmanship,” the governor admits. “States need to step up and do some real problem solving; federal officials need to realize that local control isn’t just a historical concept, it’s a human obsession.”

Leavitt’s short-hand description of a successful federal system is short and conceptually tidy: “Central coordination with local control.”

It has a nice ring to it. But there’s a huge complication, namely state and local government’s chronic and obstinate efforts to stay fragmented. For Leavitt’s view of federalism to work, there will have to be a revolution in state and local willingness to cooperate and coordinate, which has a long history of not happening. In recent years, there have been sporadic attempts at coordination among states and localities on a variety of narrow policy and fiscal issues. But no convincing evidence exists that state and local governments are ready to work together as a way to forestall business end-runs to Washington.

On the revenue front, for example, a long-standing effort to coordinate state sales-tax policy has taken on added urgency in the era of electronic commerce. States have always been concerned about sales taxes not collected on out-of-state mail-order purchases, but for years they’ve been unable to agree on a system for collecting and distributing those taxes that would be fair and relatively simple to implement. Coordinating state sales-tax policy is on the front burner of the Multistate Tax Commission, which was formed in the 1960s in the face of a strong push by corporations to preempt state corporate-tax policy. With 45 members, the MTC has made some progress toward consensus on how to handle sales taxes, but enough states are balking to keep the issue from ultimate resolution.

On the regulatory side, Congress last year actually extended to states a specific challenge to coordinate rules and regulations. The huge financial services overhaul bill that became law last year — known by its co-authors’ names, Gramm-Leach-Bliley — specifically stated that unless at least 29 states adopted a uniform method for regulating the insurance industry, federal oversight would kick in automatically late in 2002. The National Association of [State] Insurance Commissioners has drafted a set of uniform standards (see “The Riskiest Business,” Governing, March 2001), but consumer activists regard those regulations as extremely weak, and in any case there has been no stampede of state legislatures to adopt them. Leavitt predicts states are going to flunk this test with flying colors. “Congress will be doing the regulating for them,” he says.

While a handful of state and local public officials seem to want to experiment with uniform standards and coordination in taxation and regulation, the truth is that an ample supply of rogue states and localities aren’t interested at all — some for good reasons, some for mercenary reasons and some, as one long-time observer puts it, “for reasons of simple ego.” What will it take to get states to take the preemption issue seriously? It might require a large, painful shock to get the process of cooperation going.

As it turns out, a potential shock of that magnitude happens to be lurking offshore. It is preemption of state and local control by international trade agreement. No state or locality would find it easy to ignore a slap-in-the-face ruling challenging its sovereignty by some obscure international trade tribunal on behalf of a multi-national corporation.

Not only could this happen, it has happened. It just hasn’t happened yet in the United States. In a case with obvious close-to-home repercussions, Metalclad Corp., a U.S. company that disposes of hazardous material, was denied permission to dump toxic material in a small town in Mexico. The company appealed the local permit decision under the North American Free Trade Agreement, claiming that its right to do business was being “expropriated” by the local ban. A NAFTA arbitration panel agreed and ordered Mexico to pay the company $16.7 million dollars in restitution. Could the U.S. government actually be fined for not accepting a foreign corporation’s hazardous product because of some state or local ban?

We may find out before very long, because such a case is being considered by a NAFTA dispute panel right now. Methanex, a Canadian multi-national, is suing California over that state’s decision to phase out the additive MBTE in all gasoline sold statewide. California health officials say that MBTE is carcinogenic and that it’s contaminating groundwater. Methanex officials claim the phase-out is not scientifically justified and that the state has expropriated the company’s expected profits — which justifies a claim under NAFTA. And Methanex clearly isn’t kidding around; it wants the United States to pay $970 million in restitution.

What’s a bit perplexing is that many state and local officials don’t know about cases such as Metalclad and Methanex. Or if they do, they’re not making much noise about them. “You can look at it two ways, one narrow, one broad,” says Georgetown’s Bob Stumberg. “The narrow way is the question of whether state engagement might influence the decisions of international arbitration panels themselves. The broader way is to look at the extent to which state governments might influence or inform larger trade negotiations.”

It’s not hard to think of things the state and local government lobby could be doing in this situation. California, in concert with organizations such as the National Governors’ Association and the National Conference of State Legislatures, could be taking out full-page ads in national newspapers raising alarm about the potentially disastrous impact on a state’s right to protect the health, safety and welfare of its citizens if Methanex wins its case. Governors, mayors and legislative leaders could be calling the Office of the U.S. Trade Representative, demanding a place at the table in discussions under any of the alphabet soup of trade agreements, from NAFTA to the Free Trade Agreement of the Americas (FTAA), to the General Agreement on Trade and Tariffs (GATT).

None of those tactics appear to be broadly used right now. That may be in part because state and local officials simply aren’t paying much attention, but there is another likely reason as well: a sense among politicians that these days it’s good to be seen as a free-trader. “People want to be seen as wanting to lower trade barriers,” says Heidi Heitkamp, a former North Dakota attorney general who served on the NAFTA Intergovernmental Advisory Committee. “There’s nothing wrong with that, except in those areas where it compromises health and safety standards and a state’s ability to protect its citizens.”

Among the new standards that should concern state officials, says Heitkamp, are those being developed by the World Trade Organization covering the services industry, rules that will be contained in what will be known as the General Agreement on Trade and Services. “States and their citizens need to at least engage in that debate,” she warns. “What are your citizens willing to give up in the interest of lowering trade barriers?” Under the new rules, for example, it’s not out of the question that states might lose control over licensing in a host of professional sectors, from the practice of law to the practice of medicine.

It is, of course, easy to be alarmist when the U.S. Chamber of Commerce is lobbying intensively for federal preemption rights, and when international trade tribunals are forcing local governments in one country to accept another country’s toxic muck or pay a big fine. But there is room for disagreement on just how serious this situation is.

There’s little question that the financial services and high-tech industries are serious about getting states off their backs. According to a Congressional Budget Office analysis, 35 bills were introduced in Congress in 1999 aimed at preempting state and local authority, mostly in the areas of telecommunications and finance. Just this spring, a telecommunications company requested that the FCC use the Telecommunications Act to preempt local oversight of rights of way. Meanwhile, banks seem very willing to fight for federal standards whenever it’s in their direct financial interest to do so. Given all this, it may be plausible to see the situation the way Mike Leavitt does: in very stark terms. “States are going to have to reinvent themselves,” he declares. “Because if we don’t, at least in the view of many in the economic world, we’re going to become functionally obsolete.”

But it’s equally plausible to see things a different way: For every issue on which Congress has preempted state and local authority in the past decade, there are several on which it has merely talked and done nothing. Indeed, one can easily recount a long list of regulatory issues on which the feds have simply abdicated, leaving it to the states to enact whatever they may choose. Congress failed to agree on a health care bill in 1994; the states have responded with patients’ rights and prescription drug laws. Congress debated bills to deregulate the electric utilities industry but passed nothing; more than 20 states went ahead and did it. The major federal effort in social policy in the 1990s was legislation turning control over welfare back to states. It might reasonably be argued that Congress is currently too weak from stalemate to pass any major regulatory bills, whether they involve preemption or any other approach.

Meanwhile, states and localities are proving day in and day out that they have a critical role to play in regulating business. Whether it’s addressing such chronic and annoying consumer concerns as ATM surcharges, or whether on a host of arguably much more important issues — gun control, the cost of prescription drugs, dirty-air emissions, gasoline additives, genetically engineered crops, tobacco and questionable banking and lending practices.

All of these are controversial areas that citizens as well as businesses care a great deal about, and they will continue to provide fodder for battles over federalism and preemption. When it comes to regulation in any federal system,” says Dan Bucks, executive director of the Multistate Tax Commission, “there’s always an ebb and flow. And the ebb and flow always intensifies during times of economic change and upheaval.” This, says Bucks, is clearly one of those times.

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