[THS] Think the Economy Is Bad? Wait Till the States Cut Back

[Peter Webster]

http://www.nytimes.com/2008/06/01/weekinreview/01uchitelle.html?_r=2&oref=slogin&pagewanted=print&oref=slogin

June 1, 2008
The Nation
Think the Economy Is Bad? Wait Till the States Cut Back
By LOUIS UCHITELLE

Struggling as we are with the housing bust, the credit crunch, shrinking
consumption, rising unemployment and faltering business investment, we
can be forgiven for thinking that all the big shoes have dropped. There is
another one up there, however, and it is about to come down.

State and city governments have yet to shrink the economy; indeed, they
have even managed to prop it up. They have quietly maintained their
spending at pre-crisis levels even as they warn of numerous cutbacks
forced on them by declining tax revenues. The cutbacks, however, are
written into budgets for a fiscal year that begins on July 1, a month away.
In the meantime the states and cities, often drawing on rainy-day savings,
have carried their share of the load for the national economy.

That share is gigantic. At $1.8 trillion annually in a $14 trillion economy, the
states and municipalities spend almost twice as much as the federal
government, including the cost of the Iraq war. When librarians, lifeguards,
teachers, transit workers, road repair crews and health care workers
disappear, or airport and school construction is halted, the economy
trembles. None of that, or very little, has happened so far, not even in
California, despite a significant decline in tax revenue.

“We are looking at a $4 billion cut to public schools and deep cuts that will
result in thousands of Californians losing their health care,” said Jean Ross,
executive director of the California Budget Project, offering a preview of
coming hardships. “But the reality is we have not pulled money off the
streets yet.”

Quite the opposite, the states and municipalities have increased their
spending in recent quarters, bolstering the nation’s meager economic
growth. Over the past year, they have added $40 billion to their outlays,
even allowing for scattered spending freezes and a few cutbacks in advance
of July 1. Total employment has also risen. But when the current fiscal year
ends in 30 days (or in the fall for many municipalities), state and city
spending will fall, along with employment — slowly at first and then quite
noticeably after the next president takes office.

Sometime next year, the decline will reach an annual rate of $50 billion,
Goldman Sachs estimates. “It is a big reason to expect a weak economy in
2009,” said Jan Hatzius, chief domestic economist at the firm.

The $90 billion swing — from more spending to less — could be enough to
push down a weak economy to zero growth or less, because state and city
spending has accounted for as much as half of total economic growth since
last fall. (A robust economy has a growth rate of 3 percent to 4 percent,
compared with the 0.9 percent or less of the last two quarters.) The $90
billion would certainly offset most of the $107 billion stimulus package now
going out from the federal government to millions of Americans in the form
of tax rebate checks. The hope is they will spend this windfall on
consumption and in doing so sustain the economy. That might happen —
for a while. But with the cutbacks in state and city outlays canceling out the
consumption, the next president, struggling to revive a weak economy, will
almost certainly have to consider a second stimulus package.

But what should it be? Should it be a reprise of the checks, relying again on
private-sector spending for rejuvenation? Or should Washington channel
extra federal money to city and state governments so they can sustain their
outlays for the numerous programs that otherwise would be shrunk? The
answer, even on Wall Street, is often: subsidize the states and cities.

“If you want to make sure that federal money gets spent, and jobs are
created, you give it to them,” said Nigel Gault, chief domestic economist at
Global Insight, a forecasting firm.

Like many others, Mr. Gault contends that more than 50 percent of the
$107 billion in stimulus checks now going to households is likely to produce
no stimulus at all. Instead, it will be used to pay down debt or buy imported
goods and services. Imports bolster production in other countries; not in
the United States.

Still, rebate checks have been a standard tool for years in efforts to revive
the American economy. So have tax cuts and — the most popular tool of all
— the Federal Reserve’s lowering of interest rates. Each tool assumes that
people will respond to the incentive with more spending and investment,
and markets will then work their magic. Not since the 1970s, when
politicians still paid attention to the teachings of John Maynard Keynes, has
public spending — government spending — surfaced in mainstream political
debate as a potentially effective means of counteracting a downturn.

Government has to step in, Keynesians argue, when private spending is not
enough to lift the economy, despite the nudge from tax cuts or lower
interest rates or rebate checks. This downturn might be one of those
moments, involving as it does the bursting of a huge housing bubble. That
has precipitated sharp declines in various tax revenues on which the states
and cities depend, forcing them into extraordinary spending cuts — not yet,
of course, but after July 1.

The issue barely dents the presidential election campaign. The Republicans
in particular are less than enthusiastic about Keynesian economics, with its
use of government to rescue markets. They, and many mainstream
economists, for that matter, argue that government is inefficient,
bureaucratic, wasteful and unable to spend fast enough to counteract a
downturn. The two Democratic candidates, in contrast, argue that a second
stimulus package, if one is needed, should include federal subsidies to the
states and municipalities, not to start new projects but to prevent cutbacks
in existing ones.

No state seems more vulnerable than Florida, with its plunging home prices
and slashed property-tax assessments, not yet on the books but soon to be.
In anticipation, the legislature in May approved a $66.5 billion budget for
the coming fiscal year, down from $72 billion in the current one.

Schools are a target, said Michael Sittig, executive director of the Florida
League of Cities, “but none has been hurt yet. Nevertheless, everyone is
scared. Everyone is in the mode of trying to figure out how to get through
next year” — starting 30 days from now.