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Fiscal Relief for State and Local Governments | American Jobs Plan

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Fiscal relief for state and local governments

The second component of the American Jobs Plan is to provide additional fiscal relief to state and local governments. The recession has led to much lower tax revenues at the state and local levels and to higher spending for state safety net programs, but unlike the federal government, state and local governments are legally required to balance their budgets.

As a result, while federal policy makers are enacting expansionary fiscal policy, state and local policy makers are cutting spending and raising taxes, moves that will lead to lower consumer demand and more unemployment. And these contractionary fiscal efforts have just begun: state and local budget gaps are likely to be as large or larger this fiscal year and next.

If not offset through federal policy, state and local budget cuts will result in the loss of millions of jobs—most of them in the private sector—and create a drag on the economy.

Benefits of state and local budget relief

One of the most effective pieces of the Recovery Act has been the $144 billion in state budget relief, provided mainly in the form of Medicaid and education funds. EPI economist Josh Bivens estimates that the $52 billion in state and local budget relief expended so far boosted the economy by $73 billion through the end of October and is responsible for an additional 360,000 to 500,000 jobs that would otherwise not exist. According to a recent report by Mark Zandi, chief economist at Moody’s, each dollar of budget relief has provided nearly twice the economic stimulus as temporary tax cuts.

Budget relief prevents tax hikes and spending cuts, the latter of which are particularly harmful to the economy for two reasons. First, laying off teachers, firefighters, police officers, and bus drivers deprives individuals of needed public services like education, safety, and transportation. Second, spending cuts disproportionately impact low-income households because they are highly sensitive to reductions in services: a decrease in Medicaid benefits, for example, reduces their disposable income, forcing them to cut back their consumer spending on a nearly one-to-one basis. Businesses’ sales then fall, forcing firms to slash wages or lay off workers, who then cut their own spending. By rippling in this way across the entire economy, each dollar of spending reduction results in $1.41 in lost economic activity.

State and local spending cuts mainly hurt the private sector. Of the $1.41 in lost economic activity, 41 cents is spending taken right out of the private economy, while $1 is taken out of direct government spending (e.g., education) and transfers (e.g., Medicaid). Of that dollar, 25 cents is in the form of reductions in transfers to private individuals, while 75 cents is reductions in direct government spending. But even 30% of that direct government spending—or 22 cents—is in reduced demand for private supplier industries (those industries supplying the firetrucks and textbooks, for example), leaving 53 cents in actual loss to the public sector. Taken together, a full 88 cents of the $1.41, or 62% of the total economic impact of a dollar in budget cuts, falls on the private sector.

While the budget relief in the Recovery Act was beneficial to the economy, too little was provided. Between this current state fiscal year, which started July 2009, and the next, states face a $357 billion budget shortfall after drawing down rainy day funds; local governments face an additional $80 billion shortfall. Federal relief will shave off $106 billion, or about 25%, of this $437 billion two-year state and local budget shortfall, with the rest of the $331 billion translating into spending cuts and tax increases.

More immediately, between the mid-year shortfalls in fiscal year 2010 (currently underway) and the full shortfalls in 2011, state and local governments will raise taxes and cut spending by $204 billion.

Policy recommendation

We recommend that the federal government extend the state and local budget relief provided in the Recovery Act by $150 billion over the next year and a half, through state fiscal year 2011. The additional relief will save between one million and 1.4 million jobs.

Further Reading: Fiscal Relief for State and Local Governments

Dire states—State and local budget relief needed to prevent job losses and ensure a robust recovery by Ethan Pollack (November 19, 2009 / Briefing Paper)

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