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Stimulus and the States

As the new administration and policymakers generally mull over options for a Great Big Stimulus Package to be enacted perhaps as early as next month, the role of state governments in impediing or speeding recovery needs more public attention than it's currently getting. To make a long story short, states administer and partially finance a variety of federally-created programs and services that are intentionally counter-cyclical--costs rise as the economy sickens--but also labor under balanced budget requirements and borrowing restrictions that force them to cut those and other programs and services as revenues decline. So they are potentially working at cross-purposes from the feds.

I'm glad to see Matt Yglesias focus on this problem in the context of a column by Paul Krugman that suggests direct stimulus to consumers--e.g., tax rebate checks--or long-term infrastructure investments won't stimulate the economy deeply enough or quickly enough. Here's Matt:

This is one reason why I think it’s important for a stimulus package to have a heavy element of aid to state and local government and related agencies. The federal government contains a lot of automatic stabilizers (spending keeps going even though revenues fall) that should act as stimulus, but those stabilizers are offset by the pro-cyclical nature of state and local budget practices. A federal promise of aid will forestall state and local budget cuts, and thus allow the automatic stabilizers to work. All that can be mobilized on a rapid time scale.

I'd go further than Matt on this subject and observe that states have significant control over some of the "automatic stabilizers" that he's attributing to the federal government (e.g., Medicaid, SCHIP and transportation programs); without some new assistance, states may not only counter-act the "automatic stabilizers" but could actually subvert them. That's clearly what some Republican governors like Mark Sanford have in mind when they call for abolition of federal "mandates" rather than federal assistance: let us completely decimate Medicaid beyond what we are already allowed to do, and we'll be fine!

So an effective stimulus package must not only provide heavy assistance to state and local governments; it must also be sufficiently conditional to ensure that the Mark Sanfords of the world don't use the money to cut taxes as well as services.

As someone who worked for three governors back in the day, I can confidently point to another temptation facing state and local leaders that needs to be taken into account: the natural but completely absurd pretence that they can somehow turn their own economies around in the current global crisis. Sure, states and localities can critically influence their long-range economic prospects through a variety of policies such as educational and infrastructure investments. But their counter-cyclical clout is limited, and any "stimulus packages" enacted in the states, whether it's Democratic service expansions or Republican tax cuts, will probably only make things worse unless they are carefully coordinated with federal policies.

You can't take the politics out of politics, so don't be surprised to see some governors and mayors talk and even act as though they can accomplish economic miracles far beyond their reach. After all, a whole generation of Republican governors and state legislators in the 1990s boasted of their fiscal and economic genius as they cut taxes and expanded services during a national economic boom that they and their own party did virtually nothing to produce. But federal policymakers need to ensure that their friends and enemies in state capitals and city halls are pulling in the same direction, particularly if they are to become, as they should be, the beneficiaries of vast new levels of federal relief.