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Obama Targets States' Drag on Economic Recovery

June 14, 2010

Over the weekend, President Obama wrote Congressional leaders urging action on a $50 billion aid package for the states designed in part to avert "massive layoffs of teachers, police and firefighters." Which is exactly right. Because while the federal American Recovery and Reinvestment Act has worked as intended to boost employment and GDP, the dire fiscal health of the states puts the pace of economic recovery at risk.
As Ezra Klein of the Washington Post and David Leonhardt of the New York Times detailed, the Congressional Budget Office (CBO) and the overwhelming consensus of economist have attested to the success of the Obama stimulus plan so far. Last month, the CBO estimated that GDP was up to 4.1% higher due to the stimulus package, and that by September, "3.7 million American jobs could be attributed to the Recovery Act."
But as Matthew Yglesias, Mark Thoma 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 makes Barack Obama's pain double. By settling for a much smaller than needed recovery package, Obama virtually guaranteed he would have to go back to the well and ask for more. And as Paul Krugman warned in January 2009, unified Republican opposition and Democratic squeamishness in the face of growing deficit hysteria make that a tough task. (As Steny Hoyer put it, "I think there is spending fatigue. It's tough in both houses to get votes.")
Even in its reduced form, the scaled back bill now before the Senate would do some real good. As the Times' Leonhardt noted, "Among other things, it would cut taxes for businesses, expand summer jobs programs and temporarily extend jobless benefits for some of today's 15 million unemployed workers." That, and deliver badly help for the states' empty coffers. And as the CBO documented in February, federal transfers to the states and individuals provide the biggest bang for the stimulus buck.
Which is what's needed - right now.
In February, as the New York Times reported, the nation's governors warned that despite the improving national economic picture, "the worst was yet to come at the state level, where revenues are still falling short of projections." Republican Jim Douglas of Vermont, chairman of the National Governors' Association, warned the fiscal year starting July 1 would be "the most difficult to date." His numbers tell the tale:

"Because of the decline in state revenues," Mr. Douglas said, "43 states cut $31 billion from their budgets in 2009. For fiscal year 2010, even with nearly $30 billion in new revenue, 36 states have been forced to cut $55 billion. Thirty states have cut elementary, secondary and higher education."

The next day, a report from the Rockfeller Institute of Government quantified just how bad the situation had become. "State tax collections shrank at the end of 2009 for a fifth consecutive quarter," the New York Times announced, "the longest period of continuing state revenue declines since at least the Great Depression." The impact?

The revenue decline comes despite the tax increases imposed by many states since the recession began. With less tax money coming into state treasuries and expenses for programs like Medicaid continuing to mount, many states will probably be forced to consider further tax increases, spending cuts and layoffs -- actions that some economists warn could put a drag on the nation's fragile economic recovery.

For their part, the Republicans' counter-proposal to extend jobless benefits by cutting the federal budget elsewhere offers no aid to the states at all. On this point, at least, GOP leaders are being consistent. Before the passage of the $787 billion stimulus bill last year, Senate Minority Leader Mitch McConnell argued in January 2009 that states constrained by balanced budget requirements merely defer their pain :

"If the money were lent rather than just granted, states would, I think, spend it wisely and the states that didn't need it at all wouldn't take any."

By August, of course, the numbers showed that President Obama was right and Senator McConnell wrong when it came to federal stimulus aid to the states. But now, nervous Democrats worried about their reelection prospects may help McConnell block the funding the states so badly need.
And that would be a real drag.


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

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