It’s not just California that threatens to sabotage the Obama stimulus. State and local governments across the nation are gradually unravelling federal efforts to revive growth.
The states have been inveterate stimulus eaters in the past. For most of the 1930s the expansionary policies of the federal government were just sufficient to offset the shrinking of state and local governments. Click here for PDF.
States also raised taxes in the recession of the early 1990s and in 2001. It was a problem that Obama — his team stocked up with renowned scholars of the Great Depression — was determined to avoid.
Sadly, the financial woes of the states and cities — many of them self inflicted — are overwhelming these good intentions. The maths now looks distinctly unpromising.
The Obama administration has pledged around $140 billion in fiscal assistance to the states with the express goal of saving them from tax increases, layoffs and painful cuts in services. But as state tax revenues have tanked, they now appear to be heading for a $370 billion shortfall over the next few years. Federal largesse will cover just 40 percent of the gap.
Nor is the roughly $200 billion fiscal drag from the states Obama’s only problem. America’s towns present a fiscal headwind as well, with an expected funding gap of nearly $100 billion, according to the National League of Cities. Taken together these could cancel out up to 40 percent of the federal stimulus.
Balanced budget rules put the states in the same position as crisis-ridden emerging markets — a pro-cyclical fiscal policy is their only option. Yet they do have the ability to minimize the damage to consumption.
It is an opportunity many states do not appear to be taking. Indeed some are going about their economizing in ways that would make a good Keynesian blanch. The lesser of evils in the current circumstances would be to focus revenue-raising on those unlikely to cut back spending — the rich.
Instead, all too many of the measures so far have been regressive, putting most of the burden on people who have little option but to tighten their belts. Earlier this month Massachusetts lawmakers voted to increase sales tax by 25 percent with a view to raising $900 million a year. Six other states are considering following suit.
So far 36 states have cut spending — mostly on education, health and programs for the poor. Arizona is cutting cash grants to 38,500 low-income families, while Rhode Island is slashing funds for affordable housing.
Again, these are exactly the kind of payments a Keynesian would normally recommend increasing in a recession — since low-income groups have a low savings rate and hence a high multiplier. At least 39 states have made cuts in state workforce.
More radical still, some towns are simply shutting-up shop and “disincorporating,” according to the Wall Street Journal.
Rio Vista and Vallejo could soon be the first Californian towns to do so since 1972.
There are plenty of improvements that could be made to state finances. Lawmakers could economize on expensive mandatory criminal sentencing rules and trim generous pensions. Ditching the supermajority requirement for tax increases would allow them to build up larger rainy day funds in the future. But none of this would help now.
The hard fiscal logic offers few ways out. Going back to Congress for more money is not politically viable. Aid to the states was a hard-sell last time and had to be watered down.
Damage limitation is now the only option. At the very least states should seek to balance their budgets in such a way that minimizes the drain on personal consumption.
This may mean following the lead of Delaware, where the governor has proposed increasing the top income tax rate by a percentage point to 6.95 percent. Minnesota lawmakers are also attracted to this idea.Extracting more from the wealthy won’t fully plug the gap. But as the centrepiece of state revenue-raising, it may be the least economically harmful choice