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U.S. and states need better ways to prepare for a recession

Living in Minnesota and being from Illinois, it is impossible for me to ignore the awful effect that the Great Recession has had on the state budget balance. Minnesota is looking at a deficit of over a billion dollars, and Illinois' budget is in the worst shape of any state not governed by an Austrian movie star. Why did state budgets take such a hard hit, and why is this problem?

Here's the background:

• State and local governments cannot run budget deficits. Many states have balanced budget language in their constitutions, and even those that don't are unable to borrow or print money like the federal government.

• Most states have income taxes, but they, along with county and municipal governments, also get a large portion of their revenue from sales and property taxes. In a recession, people lose their jobs (driving down income tax receipts), buy less (driving down sales tax receipts) and especially in this recession, property values plummet (driving down property tax receipts).

• State-run programs like Medicaid, unemployment insurance and assistance, and other state-run health care programs for the poor are most in need during recessions, right when available funds plummet.

These factors are structural. They are also quite predictable. So when the Great Recession hit, how did the country deal with the problem? With an ad-hoc combination of federal stimulus dollars and state-level tax hikes and spending cuts.

An exacerbating effect
Why are the tax hikes and especially spending cuts so bad? They actually exacerbate the effect of the recession. When states start laying off employees and cutting back on assistance to the unemployed and working poor, those people stop spending money, worsening the economy and further lowering state tax revenue. It's a vicious cycle.

That's the economic argument. The more moralistic argument is that cutting health care for the poor, laying off teachers, and letting our already crumbling infrastructure deteriorate further is just wrong.

The best weapon against this is federal deficit spending. I know it's hard to talk about deficit spending when so many are screaming that the sky is falling because of the national debt. But in a recession, basic economics says that the federal government must step in to replace the falling demand from consumers.

Ideally, the government would have built up cash reserves during the good times, instead of racking up big deficits, allowing the spending to be less painful. Unfortunately, eight years of a fiscally irresponsible Bush administration put the kibosh on that. However, that's still no excuse to hang states out to dry. Accordingly, the American Recovery and Reinvestment Act included a large infusion of cash to state and local governments. It hasn't been enough, and it had to go through the political gauntlet of passing a polarized and politicized congress.

Therefore, it would make sense for there to be automatic stabilizers that kick in when a recession hits. The ad-hoc way we currently deal with recessions is not working. Are there any? I asked Nick Johnson, who heads up the State Fiscal Project for the Center on Budget and Policy Priorities: The simple answer is no, there are no automatic stabilizers for state revenue that kick in during a recession. The more complicated answer is there are some potential such mechanisms, but they don't work well

Potential mechanisms
Well, that's disappointing. The potential mechanisms he refers to are the "rainy-day funds" that some states have but are too small to deal even with small recessions, and the automatically increasing federal Medicaid funds as more members enroll that must be matched by increasing state funds. So clearly, there's room for growth. As it turns out, Johnson wrote an article for the American Prospect on the same topic, to which he pointed me.

When I was thinking about and researching this subject, I realized that I had basically no idea what an automatic stabilizer would look like. I had only a vague idea of emergency funds being sent to states when the economy hits some benchmark that marks a recession. Thankfully, Johnson's article lays out some more specific ideas. For example, pegging the federal funds for Medicaid to the unemployment rate and working in recession boosts to the formulas that dictate the grants states get for education and human services. He also puts the onus on the states to do a better job of building up better rainy-day funds, and not falling into the trap of pro-cyclical policies.

That last piece of advice applies to the federal government. We need to do a better job of getting our fiscal house in order when the economy is flying high, so that we can better respond when it comes crashing down.

But overall, it's important that Washington take some steps to ensure that in future recessions there is a way to support state budgets without having to go through the time-consuming and policy-wrecking gantlet that is the U.S. Congress. Our current policy falls way too hard on the people who least deserve it.

Matthew Lewis, of Minneapolis, has a Bachelor of Arts degree in history and political science from Miami University. He writes a blog called Bullied Pulpit.

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Comments (5)

You state, "State-run programs like Medicaid, unemployment insurance and assistance, and other state-run health care programs for the poor are most in need during recessions, right when available funds plummet."

At their core, Medicaid and unemployment insurance are federal programs. Unemployment insurance dates back to the 1930's and Medicaid to 1965. Yes, states have leeway on many aspects of the program, but both are federally funded and rely on payroll taxes and taxes paid by employers.

"Automatic stabilizers" I have to assume mean automatic tax increases. In a word: NO. If taxes are going to be raised, it is the responsibility of our elected officials to support or oppose as appropriate.

Good luck with framing your arguement. In the last 8-10 years republicans have framed it as any excess monies in state coffers belongs back with the individuals. Yet any organization wants and needs rainy day funds wether it be a church or a business or club or whatever. I'm going to look at your blog. Keep writing!

John Olson-

States are given funding by the Federal Government for Medicaid and Unemployment, but that funding does not cover the entire program. They are administered through the states. In recessions, demand for the services goes up, without a corresponding influx of funds from the government. Like I pointed out, any increase in Medicaid funds must be matched by state governments, which just isn't possible in a recession.

And no, I'm not talking about tax hikes. The whole point of automatic Federal stabilizing funds is to *avoid* the tax hikes that are being put into place in nearly every state. Nobody wants to raise taxes in a recession, so the onus falls on the Feds to help the states out, with deficit spending if necessary.

Let's not dismiss the concept of budget reserves too quickly, even if Minnesota has a history of squandering them on "rebates" and/or funding additional programs that exacerbate the budget problems in hard times. Perhaps what's needed is an amendment to the state constitution that requires the development of a reserve equal to 10% of the annual average budget over the preceding 10 year period. That makes more sense to me than our most recent amendment, increasing the sales tax and dedicating the funding to a few limited areas.

Matt, both UI and Medicaid are structured to be insurance programs that are a combined federal/state effort. The more they layoff employees, the more they pay in UI taxes. And vice-versa

Federal law outlines the basic framework and states have some flexibility to work within each of those programs.

My original point is they are not simply "state" programs.