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.

Jack O'Connell Latest To Throw Down For Majority Vote

State Superintendent for Public Instruction Jack O'Connell discusses the impact of the budget on education today, and it's predictably negative. After going through the particulars ($7.4 billion cut to Prop. 98 funding, additional flexibility for local control, a repayment measure on the ballot to return $9.8 billion to education under Prop. 98 in the future), he makes a strong announcement:

The painful budget process at our state and local school district level calls out for reform of California’s dysfunctional budgeting process. It is time for a sincere and frank conversation about reform. Central to this conversation is the idea of throwing out the two-thirds vote requirement to pass a budget and simply using a majority vote. Nearly every state in the nation and Congress, as well as counties, and cities use majority votes to pass their budgets. California should follow suit.

I understand that the minority party may feel that this would make them irrelevant to the process but, if anything, it would hold their majority party colleagues even more accountable.

Most importantly, a simple majority vote would protect our schools and districts from the instability they are forced to endure anytime the Legislature cannot reach a budget compromise.

It is time to bring about substantive changes to the way we do business in Sacramento — we owe the people of California this much.

Good for him, and it's explained and framed well. And now we have to line up our lawmakers along the fault line of a majority vote restoring democracy versus an arbitrary shift like 55%.

Majority Vote
John Burton, Jack O'Connell

55%
John Garamendi, Gavin Newsom

Every leader in the Democratic Party should be able to articulate where they stand on this crucial issue, the most important one facing the state. Call your lawmakers and ask them what they prefer.

Department Of Funny Headlines

"Borrowing $23.3 billion for state budget won't be easy, analyst says"

I would replace "easy" with "possible." Banks are hording money from the bailout because they will need to raise fresh capital in 2009. The short version is that nobody will be investing in fuck-all for the near future. This is the entire thinking behind the federal recovery package, that government has to be the spender of last resort. So any budget package that fills the gap with $23 BILLION in borrowing is about as realistic as a budget based entirely on tourism revenue gained from the new unicorn park in Gilroy.

You could potentially borrow some money, but it would either be against ourselves (by pushing the debt into the 2010-11 fiscal year, though at some point that would need voter approval because it's somewhat illegal) or by giving borrowers a federal guarantee against default, which is the whole reason why investors are wary of California right now. This is what John Chiang has called for repeatedly. To Arnold, we can just show up to market with a bunch of worthless "revenue anticipation notes" and scream "COME AND GET IT!!!"

Of course, we could also listen to Rep. Devin Nunes and enact a part-time citizen legislature while throwing every business regulation out the window.

Thinking Strategically About a Post-Balanced Budget Future

Paul Krugman has a good column today about how state balanced budget needs lead to perverse outcomes during an economic crisis that demands fiscal stimulus.

But even as Washington tries to rescue the economy, the nation will be reeling from the actions of 50 Herbert Hoovers — state governors who are slashing spending in a time of recession, often at the expense both of their most vulnerable constituents and of the nation’s economic future.

These state-level cutbacks range from small acts of cruelty to giant acts of panic — from cuts in South Carolina’s juvenile justice program, which will force young offenders out of group homes and into prison, to the decision by a committee that manages California state spending to halt all construction outlays for six months.

As Krugman notes, it's crazy to cut public spending at the same time that private spending is drying up. It's a recipe for a Hoover-esque depression with no investment or economic activity, and no way to increase consumer spending or create jobs.

Krugman acknowledges that balanced-budget rules are only a part of this problem in the states.

The answer, of course, is that state and local government revenues are plunging along with the economy — and unlike the federal government, lower-level governments can’t borrow their way through the crisis. Partly that’s because these governments, unlike the feds, are subject to balanced-budget rules. But even if they weren’t, running temporary deficits would be difficult. Investors, driven by fear, are refusing to buy anything except federal debt, and those states that can borrow at all are being forced to pay punitive interest rates.

Are governors responsible for their own predicament? To some extent. Arnold Schwarzenegger, in particular, deserves some jeers. He became governor in the first place because voters were outraged over his predecessor’s budget problems, but he did nothing to secure the state’s fiscal future — and he now faces a projected budget deficit bigger than the one that did in Gray Davis.

That's absolutely true. And the suffocating 2/3 requirement is most of the problem here. But once we get out of this crisis, hopefully with some assistance from the federal government for Medicaid and public works, we need to think a little more creatively about how to reduce the risk of a state's fiscal trap on the greater economy. One idea is allowing state governments the ability to deficit spend, perhaps through the creation of some federal Stimulus fund that states facing certain deficits can tap. This is the framework behind the National Infrastructure Bank proposed by Sens. Dodd and Hagel last year, but I would broaden it out. There's also the option of federal guarantees for state bond markets to increase investor confidence, or allowing states in a fiscal emergency to borrow at lower federal rates in the short term. These are steps similar to those being used to bail out banks, with the Fed intervening in the commercial paper market, and they should be tools for the states as well.

With structures like this in place, just maybe we can phase out the balanced budget amendments that force these bad choices on the states. Ultimately, California can't ask for help until they help themselves. The bond market will simply not improve until investors are assured that the state can manage its own affairs. But after the failed Schwarzenegger Administration, the next governor should think seriously about giving the state flexibility in an economic downturn, rather than going along with the necessary steps to making things measurably worse.