- State and local governments cannot run budget deficits. Many states have balanced budget language in their constitutions, and even those that don't are unable to borrow or print money like the federal government.
- Most states have income taxes, but they, along with county and municipal governments, also get a large portion of their revenue from sales and property taxes. In a recession, people lose their jobs (driving down income tax reciepts), buy less (driving down sales tax receipts) and especially in this recession, property values plummet (driving down property tax receipts).
- State-run programs like Medicaid, unemployment insurance and assistance, and other state-run health care programs for the poor are most in need during recessions, right when available funds plummet.
These factors are structural. They are also quite predictable. So when the Great Recession hit, how did the country deal with the problem? An ad-hoc combination of federal stimulus dollars and state-level tax hikes and spending cuts.
Why are the tax hikes and especially spending cuts so bad? They actually exacerbate the effect of the recession. When states start laying off employees and cutting back on assistance to the unemployed and working poor, those people stop spending money, worsening the economy and further lowering state tax revenue. It's a vicious cycle. That's the economic argument. The more moralistic argument is that cutting health care for the poor, laying off teachers, and letting our already crumbling infrastructure deteriorate further is just wrong.
The best weapon against this is federal deficit spending. I know it's hard to talk about deficit spending when so many are screaming that the sky is falling due to the national debt. But in a recession, basic economics says that the federal government must step in to replace the falling demand from consumers. Ideally, the government would have built up cash reserves during the good times, instead of racking up big deficits, allowing the spending to be less painful. Unfortunately, eight years of a fiscally irresponsible Bush administration put the kibosh on that. However, that's still no excuse to hang states out to dry. Accordingly, the American Recovery and Reinvestment Act included a large infusion of cash to state and local governments. It hasn't been enough, and it had to go through the political gauntlet of passing a polarized and politicized congress.
Therefore, it would make sense for there to be automatic stabilizers that kick in when a recession hits. The ad-hoc way we currently deal with recessions is not working. Are there any? I asked Nick Johnson, who heads up the State Fiscal Project for the Center on Budget and Policy Priorities:
The simple answer is no, there are no automatic stabilizers for state revenue that kick in during a recession. The more complicated answer is there are some potential such mechanisms, but they don’t work well
Well, that's disappointing. The potential mechanisms he refers to are the "rainy-day funds" that some states have but are too small to deal even with small recessions, and the automatically increasing federal Medicaid funds as more members enroll that must be matched by increasing state funds. So clearly, there's room for growth. As it turns out, Mr. Johnson already wrote an article for the American Prospect on the same topic, to which he pointed me.
When I was thinking about and researching this post, I realized that I had basically no idea what an automatic stabilizer would look like. I had only a vague idea of emergency funds being sent to states when the economy hits some benchmark that marks a recession. Thankfully, Mr. Johnson's article lays out some more specific ideas. For example, pegging the federal funds for Medicaid to the unemployment rate and working in recession boosts to the formulas that dictate the grants states get for education and human services. He also puts the onus on the states to do a better job of building up better rainy-day funds, and not falling into the trap of pro-cyclical policies.
That last piece of advice applies to the federal government. We need to do a better job of getting our fiscal house in order when the economy is flying high, so that we can better respond when it comes crashing down.
But overall, it's important that Washington take some steps to ensure that in future recessions there is a way to support state budgets without having to go through the time-consuming and policy-wrecking gauntlet that is the US Congress. Our current policy falls way too hard on the people who least deserve it.
(Published at MinnPost)