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Lesson from the Great Recession: Don’t Let States Become the “Anti-Stimulus”

August 20, 2020

With the tens of millions of cash-strapped Americans teetering on the brink of financial catastrophe, Senate Republicans and President Trump are unable to act on a new package of COVID economic response programs. Three months after House Democrats passed a $3 trillion Coronavirus relief bill, GOP leaders in the Senate are trying to muster support for a “skinny” package of reduced unemployment aid and liability protections for businesses.

As Republicans dawdle, Americans should remind them of the two inescapable lessons of the Great Recession which began in late 2007. First, as the nonpartisan Congressional Budget Office (CBO) and the overwhelming consensus of economists concluded, the $800 billion Obama American Reinvestment and Recovery Act, the auto bailout, TARP, the Fed’s quantitative easing and other federal stimulus measures prevented “Great Depression 2.0.” Second, years of draconian spending reductions by state and local governments led to a contraction of the public sector, creating an unprecedented “anti-stimulus” which dramatically slowed the pace of the recovery.

To be sure, barring assistance from Uncle Sam, the ongoing Coronavirus pandemic will trigger a new wave of painful austerity measures in the states. With thirty million Americans on the unemployment rolls and businesses of all sizes stymied, tax revenues are already plummeting. Unlike the federal government, all but one state (Vermont) have balanced budget requirements. And with demands for jobless aid, Medicaid and other health services rising, states will have no recourse but to lay off workers, slash aid to counties and municipalities, and gut outlays for infrastructure and education. By June, the New York Times reported, states and localities had already furloughed 1.5 million employees.

Last week, the Times detailed that the severe austerity policies at the state and local level that slowed the recovery from the last recession could be even more devastating in the age of Coronavirus:

The same dynamic poses one of the biggest threats to America’s recovery from the pandemic downturn. State governments are again experiencing extreme budget problems as they pay out increasing sums to cover unemployment and health costs caused by the coronavirus crisis while revenues from sales taxes and corporate and personal income tax payments plummet. States could face a gap of at least $555 billion through the 2022 fiscal year, according to one estimate.

Economists warn that the long-term risk coming from struggling states could prove even more damaging this time than the last recession, which spanned 2007 to 2009, unless Washington steps in.

Even with the $150 billion in direct assistance provided by the CARES Act passed this spring, the fiscal picture for the states is horrifying. As the Center on Budget and Policy Priorities warned last month:

States are on the brink of budget shortfalls that could be the largest on record — totaling $555 billion. States will face the greatest challenges addressing shortfalls in fiscal year 2021, which started on July 1 in most states. State budget shortfalls are expected to total $290 billion in fiscal year 2021. Over the state fiscal years 2020-2022, states face cumulative shortfalls of $555 billion (see Figure 3), against which they can readily apply only about $100 billion in federal fiscal relief provided to date and $75 billion in state reserves, leaving an unaddressed gap of nearly $400 billion.

These estimates are for state budget shortfalls only; they do not reflect the additional shortfalls that local governments, territories, and tribes face. They also do not reflect the substantial new costs to states of addressing the pandemic. Nearly all states are prohibited from running deficits in their operating budgets, so without more federal help, they will be forced to make sharp cuts that will deepen and prolong the recession. [Emphasis mine.]

As the emphasized text above suggests, the true toll of the COVID fiscal train wreck could be more dire still. While President Trump retweeted his approval of letting “Democrat cities” rot, the New York Times recently cautioned on Monday (“The Recession Is About to Slam Cities. Not Just the Blue-State Ones.”) that “those with budgets that rely heavily on tourism, sales taxes or direct state assistance will face particular distress.” A new study analyzing the fiscal health of 150 cities nationwide concluded “the coronavirus recession will erode city budgets in many insidious ways.”

It will slash the casino revenues that Detroit relies on. It will squeeze the state aid that is a lifeblood to Rochester and Buffalo in upstate New York. It will cut the sales tax revenue in New Orleans and Baton Rouge, where a healthy government depends on people buying things.

The analysis also demolishes GOP talking points that supposed financial mismanagement in Democratic-controlled cities is responsible for their fiscal plight:

Many cities facing steep losses are in states represented by Republican senators, like Florida or Louisiana. And the analysis found little relationship between whether a place was fiscally healthy before the pandemic and the most dire projections of revenue shortfalls.

What matters more in this pandemic moment is how a city generates money: Those highly dependent on tourism, on direct state aid or on volatile sales taxes will hurt the most. Cities like Boston, which rely heavily on the most stable revenue, property taxes, are in the strongest position — for now.

As study contributor Howard Chernick, a professor emeritus of economics at Hunter College and the Graduate Center at the City University of New York summed up its findings, “The Great Recession was a story of long, drawn-out fiscal pain — this is sharper.”

As the New York Times recounted back in January 2015, that long, drawn-out fiscal drag was painful, indeed.

For a long stretch, government spending cutbacks at all levels were a substantial drag on economic growth. Now, finally, relief is in sight.

For the first time since 2011, local, state and federal governments are providing a small but significant increase to prosperity.

"There's not a lot of positive contribution coming from the government sector, but when you're talking about economic growth, less of a negative is a positive," said Chris Varvares, senior managing director and co-founder of Macroeconomic Advisers.

The Times' chart above does not fully capture just how big of a negative the public sector contraction has been on the U.S. economic recovery. The tragedy is that the Obama Economic Miracle could have been even more miraculous if Republicans on Capitol Hill and in state and local governments hadn't stood in his way. DC Republicans didn't just block Obama initiatives like the American Jobs Act and infrastructure investment that could have boosted employment when unemployment was mired at 9 percent and strangle job creation and consumer confidence with their debt ceiling hostage-taking. Those destructive austerity policies of state and local governments certainly created an anti-stimulus, with layoffs of public sector workers and cuts to spending that only served to undermine the gains from ARRA (see the second chart above). By May 2013, the Hamilton Institute estimated those austerity policies cost 2.2 American million jobs and resulted in the slowest recovery since World War II.

In April 2012, the Economic Policy Institute explained:

The current recovery is the only one that has seen public-sector losses over its first 31 months...If public-sector employment had grown since June 2009 by the average amount it grew in the three previous recoveries (2.8 percent) instead of shrinking by 2.5 percent, there would be 1.2 million more public-sector jobs in the U.S. economy today. In addition, these extra public-sector jobs would have helped preserve about 500,000 private-sector jobs.

That March, Paul Krugman expressed the same point, but with some inconvenient historical context for the Party of Reagan. "In fact, if it weren't for this destructive fiscal austerity," Krugman explained, "Our unemployment rate would almost certainly be lower now than it was at a comparable stage of the 'Morning in America' recovery during the Reagan era."

We're talking big numbers here. If government employment under Mr. Obama had grown at Reagan-era rates, 1.3 million more Americans would be working as schoolteachers, firefighters, police officers, etc., than are currently employed in such jobs.

And once you take the effects of public spending on private employment into account, a rough estimate is that the unemployment rate would be 1.5 percentage points lower than it is, or below 7 percent -- significantly better than the Reagan economy at this stage.

Yet even with all those barriers erected by his political opponents, Barack Obama was still "out-Reaganing Reagan." And Obama didn't triple the national debt while doing it.

It is worth remembering that Republicans opposed it all. Engineers of austerity in the states, all but three GOP House members opposed the Obama stimulus. Zero GOP Senators voted for it. As then-Senate Minority Leader Mitch McConnell (R-KY) boasted in November 2010, “The single most important thing we want to achieve is for President Obama to be a one-term president.”

But that was then and this is now. Now, Republican Donald Trump is presiding over an economic calamity largely of his own making. His own White House Council of Economic Advisers (CEA) bragged about its COVID stimulus response. As Reuters detailed last week:

The report said the U.S. government acted with “unprecedented scale, speed, and coordination, surpassing past efforts to mitigate previous crises,” and said it had helped ameliorate a stark economic contraction while improving expectations for a recovery in 2021.

However it cautioned that its findings were based on data through mid-July, and the longer-term impact was still evolving. [Emphasis mine.]

Which is exactly right. Most of the Coronavirus response measures enacted by Congress came to an abrupt halt at the end of July. Without renewed unemployment assistance, more funding to sustain payrolls and massive grants to the states to avoid hundreds of thousands of more layoffs, Americans’ financial pain will be severe, indeed:

State and local employment losses this year have already dwarfed those in and after the entire Great Recession. Back then, state and local governments cut about 750,000 jobs over nearly five years.

Just since February, about 1.2 million local government jobs have been lost. Moody’s Analytics researchers estimate that 2.8 million more could be on the chopping block without more federal help. If that happens, state and local job cuts stand to shave about 2.6 percent from overall pre-crisis employment levels.

If that anti-stimulus happens, the Coronavirus Contraction will absolutely, well, trump the Great Recession.


About

Jon Perr
Jon Perr is a technology marketing consultant and product strategist who writes about American politics and public policy.

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