A Stimulus For The States?

Yesterday on ABC, Joe Biden claimed that the Administration misread the severity of the economic crisis, and did not dismiss out of hand the need for a second stimulus package, though he preferred to wait and see how the first one takes once more of its money flowed into the system. If the White House failed to anticipate negative economic results previously, they need to fully anticipate the potential for continued losses this time around, and have some form of stimulus ready sooner rather than later.

Among the most pressing problems right now is the widespread revenue shortfall among the 50 states, most all of which have balanced budget agreements and must resort to mostly cuts to deal with the crisis:

Wait — there’s more bad news: the fiscal crisis of the states. Unlike the federal government, states are required to run balanced budgets. And faced with a sharp drop in revenue, most states are preparing savage budget cuts, many of them at the expense of the most vulnerable. Aside from directly creating a great deal of misery, these cuts will depress the economy even further.

Robert Kuttner details the troubles in the states more directly, finding that California is not alone in its fiscal problems, though they may be more intractable here. Cutting program spending directly runs against the purpose of federal stimulus, to make up for the lack of consumer spending and private investment by providing a money injection into the economy. The Center on Budget and Policy Priorities writes that 39 states have cut programs that go directly to the needy. We are not alone.

The combination of a creeping suspicion by economists about the need for a second stimulus and the crisis in state budgets have led many to wonder whether to combine the two. Though no state, and not California either, has called for a "bailout," there are compelling reasons to believe that fiscal stabilization would make sense at this time so that state government doesn't counter-productively nullify the goals of the federal stimulus. One of the last items cut from the stimulus package was a large fiscal stabilization fund for the states that could have mitigated budget cuts.

The Chicago Federal Reserve wrote a paper examining this possibility for state fiscal relief, by comparing today's situation to other recessions.

The idea of federal support for state (and local) governments in a downturn is hardly a new one. For example, in response to the recession of 1973-75, Congress enacted the Antirecession Fiscal Assistance (ARFA) program, which was combined with general revenue sharing grants and the Local Public Works (LPW) program to provide unrestricted grants and infrastructure funding to the states. In addition, Congress had passed the Comprehensive Employment and Training Act (CETA) in 1973, and in conjunction with these other programs, it became an antirecessionary mechanism for delivering job training. More recently, in 2003, Congress passed the Jobs and Growth Tax Relief Reconciliation Act, as states dealt with a slow recovery from the 2001 recession.

The purpose of such funding is primarily to stabilize fiscal behavior in the state government sector. This aid is intended to smooth the budgetary actions states would be forced to take in the face of declining revenues and increasing demands from programs such as Medicaid and unemployment insurance.

The Chicago Fed criticizes the 1973-75 efforts, but their critiques are primarily ones of timing. They say that the funding for state aid arrived while economic recovery was already taking place, coming too late to stop states from taking their budget actions. When it arrived, the aid "may have contributed to post-recession inflationary pressures."

I simply think we're in a different situation right now. Despite the talk of the "green shoots" crowd, the economy has not bottomed, and in fact may be about to head into a "double-dip," W-shaped recession. Rising foreclosure rates and continued unemployment threaten economic recovery, and many economists feel that the economy will not start to recover until mid-2010. So now seems to me to be the perfect time to work to deliver anti-recessionary aid targeted to the 2010 budget cycle in the states. There is a concern that the money to the states would go simply to building a surplus instead of being spent, but with the tough choices being made across the country right now, the possibilities of that seem remote, and anyway language could be written into any bill to negate that possibility.

Significantly, the 1973-75 aid was triggered by unemployment figures.

In the case of the 1973-75 recession, the federal relief programs used three triggers based on unemployment. Aid under the ARFA program was provided when a jurisdiction’s unemployment threshold rose above 4.5 percent. Aid from the LPW program was based on the total number of persons unemployed, as well as the number unemployed in excess of 6.5 percent, in that jurisdiction. And aid under CETA was prompted by all three triggers.

The use of the unemployment rate as a trigger has a number of advantages. First, the unemployment rate is readily available at both the state and local level, so it can be used to direct aid in a more focused manner – even potentially to steer aid to specific metropolitan areas within states. Second, it is available on a monthly basis. However, in evaluating the effectiveness of the federal government’s aid package of the mid-1970s, the GAO found that the structural change built into national labor markets caused this trigger to turn on well into the downturn and maintain aid well into the recovery.

I don't think this is a bug, but a feature. We hear a lot about unemployment as a "lagging indicator" of economic performance, but to the unemployed, it's the ENTIRE indicator. And given that income tax makes up such a large sum of state revenue (particularly in California), unemployment is intimately tied to state budget performance. The Chicago Fed worried about inflation, but again, this recession is not like all other recessions, and right now we're in fear of a deflationary spiral.

Finally, the Chicago Fed worries about rewarding "bad fiscal behavior" when budget shortfalls are caused by a "structural deficit caused by an inefficient tax system and/or unsupportable public spending." We can expect to hear a lot of this if a second stimulus really kicks into gear, and I would just say that it's not morally defensible to punish individuals for the tangle of their state political structure. I don't want the possibility of federal relief to disable local efforts to arrive at sustainable budget practices, but I think there's a way to provide help to those who need it while also not letting the legislative leadership off the hook for their failures.

That the Chicago Fed is putting out papers about state funding at all is a sign that such a prospect has gained momentum. I think their concerns, while legitimate, are all addressed by the nature of this downturn, and legislation can be drafted to allay those concerns as well. Any second stimulus must include state fiscal relief. My one hope would be that the solution is enduring, so that never again will states be in the position to forestall economic recovery through perverse and ill-timed budget cuts.

... Ryan Avent makes the case for denying California federal aid, or at lest conditioning it to changes in the long-term budgeting process. Like Robert Cruickshank, I don't believe that the federal government would provide such a great, progressive solution with their conditioned aid - it would probably look more like an IMF bailout. I agree in a roundabout way that any federal aid may give Democratic leaders the impression that their problems can be solved from outside rather than from within. But that's a leadership problem separate from the problem of real people's lives getting squandered because of a political stalemate.