New study says second round of stimulus aid to the states will be necessary

Posted by AzBlueMeanie:

Earlier this year, the Accidental Governor and several Republican state legislators toyed with the idea of rejecting federal stimulus aid to the state. It was purely ideological grandstanding. Wiser heads prevailed and Arizona accepted the federal stimulus aid. The current budget deficit would have been far worse without the federal stimulus aid.

A new study says that a second round of federal stimulus aid is going to be required to rescue state governments from budget deficits for several years to come, and to prevent a "double-dip" recession. Obama warns of a 'double dip' recession (Obama said it's important to recognize that if the nation keeps adding to deficit spending through tax cuts or more stimulus spending, at some point people could lose confidence in the U.S. economy and that could "lead to a double-dip recession.")

The lesson to take away from FDR's second term, Mr. President, is that his reduction of federal stimulus spending in 1937-38 out of concern over the federal deficit before the economy had fully recovered from the Great Depression triggered a recession within the depression. Too much federal spending was not the problem, Mr. President, it was too little to complete the economic recovery. The Great Depression ended only with massive federal government spending after the start of World War II.

The Center on Budget and Policy Priorities has issued a report that should be required reading for all Arizona legislators. Additional Federal Fiscal Relief Needed to Help States Address Recession’s Impact

States face a serious fiscal problem that could force them to institute additional deep budget cuts and tax increases in 2010, weakening the fragile economic recovery and harming vulnerable children, seniors, and people with disabilities, among others. The federal assistance that states received for their Medicaid programs under this year’s economic recovery legislation is scheduled to end with a “cliff” on December 31, 2010, and the assistance states received for education and other services also will be largely exhausted by then. Although that date is more than a year away, the problem is coming to a head now.

That’s because states — which continue to face huge budget shortfalls that they must close — are taking steps now to plan their budgets for state fiscal year 2011, which starts on July 1, 2010 in most states. Governors will send their budget proposals to their legislatures between next month and February 2010 in almost all states. The legislatures will have to pass budgets as early as March or April in some states and by the end of June in almost all states. If states do not know they will receive additional federal fiscal relief, they will begin implementing new budget cuts and tax increases by this summer, at the latest.

Presuming they will get no more fiscal relief, states will have to take steps to eliminate deficits for state fiscal year 2011 that will likely take nearly a full percentage point off the Gross Domestic Product. That, in turn, could cost the economy 900,000 jobs next year. Mark Zandi, Chief Economist of Moody’s Economy.com, recently warned that these state budgetary actions “will be a serious drag on the economy at just the wrong time.”

For economic and other reasons, federal policymakers should provide some additional fiscal relief, so that such relief is extended or phased down after 2010 rather than ending abruptly. That would constitute one of the most effective uses of additional federal dollars to boost the weak economy and preserve or create jobs.

States are continuing to grapple with record steep declines in tax receipts. Large job losses and declining incomes have caused state and local tax revenues to fall steeply, and this is occurring at the same time that high unemployment and rising poverty are increasing the need for state services such as Medicaid. The result has been large, widespread, and persistent state budget gaps of stunning magnitude. Deficits for the current state fiscal year, not all of which states have closed, total more than 25 percent of state general fund budgets, making these the largest shortfalls on record.

Deficits pose a particularly difficult problem for states during recessions because nearly all states are required to balance their operating budgets, no matter how bad the state of the economy. And many of the actions that states must take to achieve budget balance in the face of sharply falling revenues — cutting services, laying off workers, and raising taxes — further weaken the economy. Given the importance of encouraging job growth and bolstering the economy in the months ahead, federal policymakers have cause for serious concern that the actions which state policymakers will be compelled to take in the next two years will impede recovery and cause significant economic damage.

Some private forecasters have begun to ask whether the state budget cuts and tax increases that lie ahead will stall the economy. Goldman Sachs estimated last July that the fiscal drag from state budget cuts and tax increases could reduce GDP by 0.6% to 0.7% over the coming year as states move to close their deficits. The outlook for state fiscal year 2011 is even grimmer; as noted, actions states will have to take to eliminate deficits for that year are likely to drag down GDP by more than 0.9% and could cost 900,000 jobs.

Zandi recently told the Congressional Joint Economic Committee, “Fiscal 2011 budgets are likely to be more troubled than those for the current year. . . . [States] will be under intense pressure to cut jobs and programs and to raise taxes and fees. . . . For state and local governments to turn into a weight on growth will be a meaningful impediment to the broader recovery’s prospects.”

He recommended that “To avoid this, more federal aid to states for their FMAP and educational obligations may be necessary.” Zandi rates federal assistance to state and local governments as highly efficient stimulus; he estimates that every dollar the federal government spends on this assistance in a year translates into a $1.41 increase in GDP that year.

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The state fiscal assistance from the American Recovery and Reinvestment Act (ARRA) has helped substantially. Without it, both state budget cuts and state tax increases would be much larger. The best estimates suggest that the fiscal relief in ARRA — provided mainly for health care and education — has allowed states to close 30 percent to 40 percent of their budget gaps this year. (See the box on page 6 for a description of the fiscal relief provisions.) Without this aid, states would have been forced to institute even more severe actions that would have placed a greater drag on the economy.

The ARRA funding for state fiscal relief is creating and preserving jobs. The Department of Education found that more than 255,000 education jobs and nearly 63,000 jobs in other areas have been retained or created through the Fiscal Stabilization Fund in the Recovery Act, for a total of 318,000 jobs saved or created through September 30 by the Fiscal Stabilization Fund.

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Unfortunately, however, a serious problem now is looming. The Medicaid fiscal relief that ARRA provides will end with a “cliff” on December 31, 2010. States also will have drawn down most of their education fiscal relief funds by that time.

The December 31, 2010 date falls in the middle of the next state fiscal year, and that fiscal year is a period for which state deficits are projected to be at least as large as the deficits were for the current fiscal year (before state actions to close them). This means that states will have to institute rather massive new budget cuts and tax increases on July 1, 2010, a matter of great concern because the unemployment rate is expected to still be close to double-digit levels at that time and the economy is likely still to be fragile.

Moreover, state deficits of a very large magnitude are likely to persist for another two or three years. Despite some improvements in the economy as a whole, state fiscal conditions for state fiscal years 2011 and even 2012 look as bad, or nearly as bad, as those for 2009 and 2010.

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State deficit projections remain this large because, as discussed below, state and local fiscal recovery typically lags behind the resumption of economic growth and other economic indicators by two to three years. In both of the past two recessions, state budget deficits remained very large for several years after the recession officially ended. The current recession, in which there have been unprecedented drops in state revenue, could have an even longer recovery period.

As a result, allowing federal fiscal assistance to states to terminate in 2010 would pose dangers for the economy. The surge of state budget cuts and tax increases that would follow could place a significant drag on the economy and compromise the recovery. An extension or gradual phase-down of the current federal fiscal relief to states would represent sounder and more prudent economic policy.

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ARRA requires states to maintain — through December 31, 2010 — the Medicaid eligibility levels they had in place before the recession started, as well as to maintain at least their 2008 levels of spending for education. These are conditions for state receipt of the federal fiscal relief under ARRA. If federal fiscal relief ends while states continue to face crushing deficits, these requirements will lapse and health care and education will be cut, likely by large amounts in many states. The health agency in one state already has provided the governor with a proposal to terminate Medicaid eligibility for 80,000 low-income people on January 1, 2011. Other states are likely to follow suit.

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The revenue decline in this recession is unprecedented; it is the largest on record in the post-World War II period. State tax revenues have been declining since the fourth quarter of 2008. In the critical April-June quarter, when a major portion of state tax revenues are collected, revenues dropped 16.6 percent in 2009 compared to the previous year. The income tax was down 27.5 percent, and the sales tax was down 9.5 percent.

As a result, in the current state fiscal year (state fiscal year 2010, which runs from July 1, 2009 through June 30, 2010 in most states), 48 states have experienced budget shortfalls. These deficits were closed through a combination of budget cuts, tax increases, use of available reserves, and use of federal ARRA funds. Since states’ 2010 budgets were enacted, however, revenue collections have been much weaker than even the tepid projections on which those budgets were based. As a result, mid-year budget shortfalls totaling $22 billion have opened up in 31 states, requiring states to embark on a new round of mid-year budget cuts. Considered together, the initial and mid-year deficits total $181 billion, or 26 percent of state budgets. These are the largest state budget shortfalls on record.

Estimates based on economic projections, state data, and past history suggest that deficits in state fiscal year 2011 will total at least $180 billion, followed by deficits in state fiscal year 2012 of about $120 billion. Fiscal conditions are likely to stabilize in most states by 2013.

Some $40 billion of ARRA funding is likely to be available to help states close the $180 billion in state deficits expected in state fiscal year 2011. State actions to close the remaining deficits could reduce aggregate demand in the economy as states raise taxes and cut expenditures to balance their budgets.

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It is worth noting that the problems states currently are facing are overwhelmingly a result of declining revenues and not, as some have assumed or claimed, of excessive spending or mismanagement. State spending increases since the last recession were very modest. State spending fell sharply relative to the economy during the 2001 recession. And for states in the aggregate, it remained below the fiscal year 2001 level in state fiscal year 2008, before the current recession started. State spending as a share of the economy has declined since then and taken a particularly large dip in the current fiscal year (2010).

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Because of state budget calendars, it would not be effective for the Administration and Congress to wait until the fall of 2010 to consider additional aid to the states for state fiscal year 2011.

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States budget for their fiscal years as a whole, not for six-month periods. The spending cuts and tax increases that states will institute in order to balance their 2011 budgets will be determined based on the state’s budget projections for all of fiscal year 2011. Those projections will include a significant drop-off in ARRA funds for the final half of the state fiscal year (i.e., after December 2010).

Accordingly, many of the actions that states will take to balance their 2011 budgets will be implemented next summer (or in some cases even earlier if budget gaps have reopened for the current fiscal year). To gain maximum revenue, states that plan to adopt tax increases to help address their looming fiscal year 2011 shortfalls may want to put them in place as quickly as possible. The same applies to spending reductions; for example, many cuts in education spending are likely to take effect next summer, at the start of the 2010-2011 school year.

The bottom line is that unless states know that additional aid is coming — even if they do not actually receive the dollars until calendar year 2011 — they will institute large new budget cuts and/or tax increases by next summer to close the shortfalls in their fiscal 2011 budgets.