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Will federal largesse be countered by state and local cutbacks?

There has been a general outcry for economic stimulus on the part of the North American, U.K. and Eurozone federal governments to counteract the fall in private sector consumption.  In the U.S. and the U.K. in particular, this message is being heard and largesse will be delivered in spades.

But, in the United States, there is a bit of a problem: state and local governments.  They will not, and often cannot, spend.  In fact some will be cutting.  Will local government budget cuts undercut federal fiscal stimulus?

To answer that question, we need to know why local governments in the U.S. are not spending more money.  The answer is two-fold.  First, state and local governments don’t have access to a printing press.  It’s not like they can tell their teachers, “wait a minute, let me just run out back and print off a few dollars to pay you.”   The federal government intends to do exactly that – print money.  This is what is commonly known as inflation, now given the hifalutin designation of quantitative easing.  So inflating one’s way out of crisis is not an option on the table for municipalities.

On the other hand, they are even more hamstrung by their own self-imposed rules.  In recent years, state governments have tried to exercise fiscal responsibility by balancing the budget.  Politicians are so eager to put their hand in the till that legislatures were forced to enact balanced budget amendments that forbade deficit spending to keep spending down.

Here’s how the National Conference of State Legislature puts it:

The Nature of State Balanced Budget Requirements

Some states have strict, explicit balanced budget requirements that force policy makers to ensure that expenditures in a fiscal year are within the cash available for that fiscal year. In other states, the requirement is derived from a constitutional limitation of state indebtedness or some other budgetary provision such as Virginia’s constitutional requirement that the governor keep spending within revenues, and may lack a binding enforcement mechanism. In some states, of which Michigan is an example, constitutional provisions that are designed to prevent budget deficits allow unavoidable deficits to be carried to the next fiscal year for resolution. Vermont , uniquely, has no constitutional or statutory requirement for a balanced budget.

Not all states have constitutional language that clearly requires a balanced budget and many even lack explicit statutory requirements. The General Accounting Office has commented that “some balanced budget requirements are based on interpretations of state constitutions and statutes rather than on an explicit statement that the state must have a balanced budget.” GAO’s observation is supported by appendix B, which prints the language that legislative staff in 49 states have identified as the constitutional and statutory balanced budget requirement. The link between the constitutional or statutory language and a balanced-budget requirement can be obscure.

Whatever the source of the requirement-constitutional, statutory, or traditional interpretation-there are three general kinds of balanced-budget requirements, with differences of detail within each kind:

  • The governor’s proposed budget must be balanced;
  • The enacted budget must be balanced;
  • The budget must be balanced at the end of a fiscal year or biennium (no deficit can be carried forward).

That is a problem now because tax revenue is imploding.  Sales tax revenue is down.  Income tax revenue is down.  Property tax revenue is down.  And when falling revenue and balanced budget amendments collide, the only remedy is budget cuts.  So, state and local governments in the United States are about to cut spending just as the worst recession since the 1930s hits.

What to do?  Ask for a bailout from the Federal Government, of course.  Here’s what Politico says about this:

A group of Democratic governors warned Friday that without as much as $1 trillion in federal assistance, many states will not be able to pay their bills in the next year.

“There are states that are talking as California has of not being able to meet their financial obligations in the coming months,” New York Gov. David Paterson (D) said on a conference call with reporters. California announced in December that all state employees would be forced to take two days of unpaid leave.

Paterson was joined by New Jersey Gov. Jon Corzine (D), Massachusetts Gov. Deval Patrick (D), Ohio Gov. Ted Strickland (D) and Wisconsin Gov. Jim Doyle (D) in warning that states across the country will be forced to make drastic budget cuts in the face of unprecedented deficits.

“We are not crying wolf, this is one of the worst situations our states have faced,” Strickland said. “This is a real crisis. These are real problems. And if we don’t get some significant assistance many of those in our states will suffer greatly.”

Strickland added that the situation facing the state of Ohio is so dire that in order to balance his state’s budget he would have to fund every state program at 75 percent of its current level. “If I were simply to flat fund the operations of this government I’d end up with $7.3 billion in deficit,” he said. “We’re just trying to keep afloat.”

In order to make up for the shortfalls, Corzine said the incoming Obama administration and Congress will need to free up $1 trillion in federal spending for state assistance. “We’re all going to be Herbert Hoovers if we’re not careful here,” he said.

The $1 trillion the governors are seeking would be spent to prevent cuts in social services and education, as well as “shovel ready” infrastructure projects that could begin with 18 months. The group has presented their plan to the transition team and congressional leaders. The New Jersey governor said both have been receptive to the idea.

“There is a need for the federal government to step in to bolster the social safety net,” Patrick said. “We’re really talking about a bridge from where we are and where we think the economy will be in two years.”

With the automakers and the banks already receiving handouts en masse and with the Obama Administration committed to massive fiscal stimulus, one can see that the United States is in for some trillions of dollars of deficits.

The question is whether states and municipalities should be welcome on the bailout gravy train as well. California is on the verge of bankruptcy and I have predicted at least one state will default and go bankrupt. Do we want that? Do we want teachers, police officers going without pay, firefighters being let go or trash collection being curtailed?

This is a predicament that was easily predicted as a result of the housing bust. However, with its consequences looming, there are no easy answers.

At a minimum, cutbacks at the state and local level would be very much working at cross purposes with federal stimulus. Ostensibly, state governors could play chicken with the Federal Government if they don’t get some bailout money. How the Obama Administration chooses to tackle this problem will be a contentious issue going forward.

Stay tuned.

Sources

State Balanced Budget Requirements: Provisions and Practice – National Conference of State Legislatures

States seeking $1 trillion to ‘keep afloat’ – Politico

About 

Edward Harrison is the founder of Credit Writedowns and a former career diplomat, investment banker and technology executive with over twenty years of business experience. He is also a regular economic and financial commentator on BBC World News, CNBC Television, Business News Network, CBC, Fox Television and RT Television. He speaks six languages and reads another five, skills he uses to provide a more global perspective. Edward holds an MBA in Finance from Columbia University and a BA in Economics from Dartmouth College. Edward also writes a premium financial newsletter. Sign up here for a free trial.