Capping federal spending at 20 percent of GDP would decimate state budgets

My colleagues Josh Bivens and Andrew Fieldhouse recently released a report finding that Republican presidential nominee Mitt Romney’s budget plan would reduce employment by between 550,000 and 1.9 million jobs over the next two years relative to current policy, depending on whether his tax cut is deficit-financed or fully paid for with base-broadening. This job loss is overwhelmingly fueled by his proposal to cap federal spending at 20 percent of GDP.

But the impact of any fiscal plan goes beyond the job impact—after all, a little over 17 percent of non-interest federal spending flows directly to states (e.g., matching funds for Medicaid and unemployment insurance), and with a half trillion dollars in cumulative shortfalls that states have faced in the last few years and another $55 billion in shortfalls faced this year, states would have difficulty handling another blow to their budgets. So how would Romney’s proposed spending cap affect state budgets?

To make this calculation, I started with the U.S. Census Bureau’s Annual Survey of State Government Finances, which shows total expenditures and federal transfers to state governments, each by state. I then applied the Center on Budget and Policy Priorities’ estimate that a 20 percent cap on spending would require a 32 percent across-the-board cut by 2016 to all programs save Social Security, Medicare, and core Department of Defense spending (essentially excluding war costs) to the federal transfers for the estimated cut in transfers by state. I divided the estimated cut by each state’s total expenditure and also included the cut as a share of each state’s general fund (data from National Association of State Budget Officers) because generally, state budget shortfalls are calculated as a share of the general fund.

What I found is that a majority of states would see federal funding losses equal to at least 9 percent of their total expenditures, which translates into about 20 percent of their general fund (see map below). The darker the state, the higher the fiscal hit. The worst-hit state is Louisiana, which would see a funding loss of 12.3 percent of their total spending. However, as a share of their general funds, Vermont and Michigan fare the worst, with fund loss over 60 percent of their general fund (or 9.2 and 8.8 percent of their total expenditures, respectively).

Figure A Figure A (continued)

20 percent cap on federal spending would hit state budgets hard

20 percent cap on federal spending would hit state budgets hard

Source: U.S. Census Bureau and Center on Budget and Policy Priorities

Note that this is based on 2009 state budget data (the most recent Census data). This makes the calculations conservative because it is likely that the federal-state transfers will be significantly higher in 2016 than they were in 2009. In fact, state expenditures have historically risen with—if not faster than —economic growth: between 1990 and 2008, state expenditures rose from 8.3 percent of GDP to 9.5 percent. Furthermore, this calculation is based off of a baseline that assumes the expansion of Medicaid is repealed—measured against a current law baseline in which the Affordable Care Act is fully implemented, the fiscal impact for each state would be much higher.

  • Rick Taylor

    From 1960-2008, perhaps the golden age of Fed Revenues/GDP, the average rate of Fed Revenues was about 17.7%/GDP. The Fed has only been able to raise revenues beyond 20%/GDP only once since 1960 (and that was 2000 on the heels of artificial revenues created by the Community Reinvestment Act).

    So how can we keep spending beyond the means to create revenue?

    Economic Law strongly suggests a vanishing point is quickly approaching.

  • Glenn Whitehead

    Who cares what states it hits and how hard?! It HAS to be done, for the good of the entire country and economy. We are not paying for what we are spending and cannot continue this nonsense. You Libs are always coming up with some kind of nonsense. 20% of GDP has fine most every year for decades. After an adjustment period, no one will even notice, except lying liberals.