The Larger Context

California's troubles have been well-documented. But as I've said on multiple occasions, while we may be an acute example of the problems with state budgets in an economic downturn, we are not alone. And the decisions, some forced, some unforced, of the nation's governors in responding to these challenges are unquestionably threatening economic recovery.

It’s easy enough, of course, to mock state governments nowadays, what with California issuing I.O.U.s to pay its bills and New York’s statehouse becoming the site of palace coups and senatorial sit-ins. But the real problem isn’t the fecklessness of local politicians. It’s the ordinary way in which state governments go about their business. Think about the $787-billion federal stimulus package. It’s built on the idea that during serious economic downturns the government can use spending increases and tax cuts to counteract the effects of consumers who are cutting back on spending and businesses that are cutting back on investment. So fiscal policy at the national level is countercyclical: as the economy shrinks, government expands. At the state level, though, the opposite is happening. Nearly every state government is required to balance its budget. When times are bad, jobs vanish, sales plummet, investment declines, and tax revenues fall precipitously—in New York, for instance, state revenues in April and May were down thirty-six per cent from a year earlier. So states have to raise taxes or cut spending, or both, and that’s precisely what they’re doing: states from New Jersey to Oregon have raised taxes in the past year, while significant budget cuts have become routine and are likely to get only deeper in the year ahead. The states’ fiscal policy, then, is procyclical: it’s amplifying the effects of the downturn, instead of mitigating them. Even as the federal government is pouring money into the economy, state governments are effectively taking it out. It’s a push-me, pull-you approach to fighting the recession.

The stimulus package provided some money for state fiscal stabilization, but that turned a package designed to create jobs and circulate money into the economy into simply a life raft. The states have both sucked up some of that money and directly counteracted it through their actions, so that an already too-small stimulus shrinks even further. State and local governments are 1/8 of our total GDP, and their fiscal austerirty in the midst of crisis has a very damaging economic effect.

In this article, James Surowiecki argues that federalism is starting to crack in the face of extreme economic calamity. Some of the elements of the stimulus that are national priorities - high speed rail, a smart national power grid - must be funneled through an inefficient and often dysfunctional state and local process. It simply makes things difficult to have so much decentralization in projects designed to move across state lines. So what can be done? We can move big items like Medicaid under federal control with local administration. Or we can set up a permanent federal fiscal stabilization fund, maybe kicked off in a second stimulus, to massage the states through tough times. It's almost a rainy day fund at the federal level.

But something must be done. We are destroying ourselves from within by leaving things as they are.