States' Fiscal Disaster Threatens U.S. Recovery

By almost any measure, the $787 billion stimulus program has worked exactly as designed. The overwhelming consensus of economists is that the fed

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By almost any measure, the $787 billion stimulus program has worked exactly as designed. The overwhelming consensus of economists is that the federal package has been a success, while the Congressional Budget Office (CBO) estimates the American Recovery and Reinvestment Act has already added up to 4 points to GDP and 2.8 million jobs. But in the states, dire financial straits and draconian budget cuts are threatening to undo the progress of the stimulus. All of which makes continued Republican obstruction of the Senate bill to aid the states so dangerous - and unforgivable.

Across the country, state governments are being hit with a triple whammy. First, the unprecedented recession and especially the collapse in real estate values have drained state coffers. As Bloomberg reported last week, a study by the Nelson A. Rockefeller Institute of Government at the State University of New York at Albany found "For the first time since 1962, sales and income tax revenue fell for five straight quarters, through December 2009." Worse still, the well of federal funds from the ARRA will dry up on January 1; only $40 billion remains to be spent on fiscal year 2011 problems. And with 49 of the 50 states legally required to produce a balanced budget, the result is a mushrooming fiscal calamity.

That budgetary Armageddon is the picture which emerges from a recent analysis by the Center on Budget and Policy Priorities (CBPP). "48 states have addressed or still face such shortfalls in their budgets for fiscal year 2010, totaling $200 billion or 30 percent of state budgets - the largest gaps on record." And there's red ink for as far as the eye can see:

States' fiscal problems will continue into the next fiscal year and likely beyond. Fiscal year 2011 gaps -- both those still open and those already addressed -- total $112 billion or 17 percent of budgets in 46 states. This total is likely to grow as revenues continue to deteriorate, and may well exceed $180 billion. States will also face large gaps that could total $120 billion the following year (FY2012)...

These numbers suggest that when all is said and done, states will have to deal with total budget shortfalls of some $260 billion for 2011 and 2012.

As Pennsylvania Governor Ed Rendell summed it, the budgetary "bloodletting" and the resulting fallout from the loss of federal money could bring a halt to three straight months of job gains for the state. (Already, state and local governments nationwide have trimmed 231,000 jobs since August 2008.) Multiplied by 50 states, the "massive layoffs of teachers, police and firefighters" foretold by President Obama two weeks ago could undermine the nation's nascent economic recovery.

As Matthew Yglesias, Mark Thoma, Ezra Klein and others have noted, the federal spending is only a part of the stimulus picture. As Yglesias put it, "all the Obama administration's efforts plus the automatic stabilizers have done is mitigate the contractionary impact of state and local policy." Stephen Gordon described the grim dynamic:

But it's important to remember that the proper measure for fiscal stimulus is not spending by the federal government; it is spending by all levels of government. And when you look at the contributions to US GDP growth (Table 1.1.2 at the BEA site), total government spending has been a drag on growth over the past two quarters. The increases at the federal level have not been enough to compensate for the spending cuts at the local and state levels.

I suppose that this could be interpreted as good news: despite a contractionary fiscal stance, the US economy is in recovery. But it raises the question of how much better it could be doing if it had an expansionary fiscal policy.

Which is why economists of all stripes see additional federal aid to the states as so essential. The CBO documented in February that federal transfers to the states and individuals provide the biggest bang for the stimulus buck. (Unsurprisingly, business tax cuts provide the least.) As Ezra Klein of the Washington Post rightly noted:

Finally, state and local aid happens to be an uncommonly effective form of stimulus. The difficulty with most stimulus spending is that not all of it gets spent. Tax breaks, for instance, often get saved. Mark Zandi, the chief economist for Moody's Economy.com, estimates that cutting the corporate tax rate gets you only 32 cents in stimulus for every dollar you spend on it. That's not the case with state and local aid. When you're plugging state budget gaps, you know that money will be spent, because it was being spent before, and usually on something that the state's residents actually wanted.

Zandi estimates that every dollar spent on it actually gets you $1.41 in stimulus. It's the best anti-anti-stimulus you could ask for.

And to be sure, Mark Zandi is no radical. Zandi happens to be one of the leading lights from John McCain's 2008 economic advisory team.

Earlier this month, President Obama asked Congress to send him a $50 billion aid package for the states. But on Thursday, Senate Republicans aided and abetted by squeamish Democrats like Ben Nelson (D-NE) successfully filibustered the $112 billion jobs bill which included the needed funds. And despite warnings of a double-dip recession from Nancy Pelosi and Paul Krugman, the message to the states from the GOP remains "let them eat cake."

UPDATE: Thanks to GOP obstruction of expected aid in the Senate, the Republican strongholds of Georgia and Alabama are now scrambling to make up $375 million and $197 million budget holes, respectively.

(This piece also appears at Perrspectives.)

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