Commentary | Budget, Taxes, and Public Investment

Cutting State Aid Will Lead to a Longer and Deeper Recession

The Nelson-Collins amendment to the Senate stimulus bill strips effective stimulus provisions from the bill, such as investments in transportation, broadband, and law enforcement.  The most concerning cut, however, is the $40 billion cut to state aid, which represents nearly 40% of the total cuts in the amendment.  This cut in particular will reduce the bill’s effectiveness as an economic stimulus, condemn hundreds of thousands to unemployment, and help prolong the recession.

In a recession, tax revenues shrink.  For state and local governments—which are required to balance their budgets each year—this means cutting spending, which has the perverse effect of making the recession even worse.  In a severe recession, state spending cuts can be so drastic that they significantly threaten the federal government’s ability to staunch the economic bleeding at all.

This recession is much more than just severe.  In the current fiscal year (FY09), states faced a $48 billion shortfall and responded in part by cutting jobs and services.  A majority of states have made cuts to K-12 education, higher education, and health care, while many are also making cuts to law enforcement and other government functions.  Last week California became the first state to institute a significant work furlough, ordering over 200,000 state workers to stay at home on Friday without pay.

Unfortunately, it’s only going to get worse.  The Center for Budget and Policy Priorities estimates that overall state shortfalls will total a whopping $350 billion over the next two and a half years.  As states exhaust their dwindling reserves, they will be forced to rely more heavily on pay cuts and layoffs.  These newly underpaid or even unemployed teachers, health care workers, social workers, and state or local government employees will now spend less in the economy, resulting in less sales revenue for businesses, which in turn are forced to lay off their own employees.  As business profits shrink, so will tax revenues, forcing states to make even more drastic cuts, leading to less consumer spending, and so on.

States understand the economic effects of these cuts, but they have no choice—their balanced budget requirements make them slaves to this vicious cycle.  Only federal aid to states can break the cycle of economic downturn—and the more aid, the less states will have to resort to recession-enhancing spending cuts.  For this reason, aid to states is highly stimulative, providing $1.36 in economic benefit for every dollar in aid and 33% more effective than across-the-board tax cuts.

The Nelson-Collins amendment will result in $40 billion worth of additional cuts that states will have to make on the backs of American workers, and ultimately, the overall economy.  If Congress is serious about economic recovery, it will restore the $40 billion in aid to states.

See related work on Public Investment | Recession/stimulus

See more work by Ethan Pollack