State Budget Crises Hamper Economic Recovery

by Ryan Greenfield

So here we are, still losing jobs one year after President Obama took office. The Labor Department reported on January 7 that, after one month of the slenderest job gains (4,000) in November, payrolls again dropped by 85,000 jobs in December. The economy and jobs constitute the most important issue for both American voters and the most difficult policy challenge to resolve: how to get people back to work? But one of the often overlooked effects of the Great Recession is the havoc it has wreaked on state budgets.
Periods of economic contraction squeeze both state revenues and expenditures. Because states are forbidden to run budget deficits in bad times and rarely save surpluses in good times, they are faced with extremely difficult budgetary choices during recessions. As people lose their jobs and the value of real estate, stocks, and corporate profits tank, states lose a huge percentage of the tax revenues they depend on. At the same time, the spending needs are higher than ever. As people become unemployed and lose their health insurance and even their homes, their states need to pay out ever more in unemployment checks, food stamps, Medicaid benefits, and funding for public housing. To deal with this situation, some states raise taxes and some cut truly wasteful spending, but many cut deeply into the social safety nets that are particularly important in times of need. Additionally, state Medicaid budgets tied to health care costs increase faster than inflation every year, so they need revenue growth higher than inflation just to keep pace even when times are good (U.S. Department of Health & Human Services 2008).

When states are coping with situations such as the current recession, they often skimp on even the very basics of public services on which their citizens depend. The Center on Budget and Policy Priorities reports that, even though the American Recovery and Reinvestment Act (ARRA) closed about 30-40% of the budget deficits in the current fiscal year (Lav, Johnson, and McNichol 2009), through enhanced Medicaid funding formulas as well as transportation and education grants, states are still cutting essential social services (Johnson, Oliff and Williams 2009). Twenty-eight states cut their health care budgets, 24 states cut services to the elderly and disabled, 27 (plus the District of Columbia) cut funding for K-12 education, 36 cut their budgets for higher education, and 42 have reduced their state workforces. Many states cut back on snow removal budgets so much they had to hire many temporary workers just to handle the massive snowfall across the country over the past month (Simon and Gold 2009).

California’s budget crisis is particularly acute (Goldmacher and Halper 2009). California was hit hard by the real estate meltdown and because of strictly limited property taxes under Prop. 13 (1978), the state government must contribute a large percentage of the budgets for localities (O’Leary 2009). California has dramatically increased tuition for state schools, slashed Medicaid enrollments, and raised sales taxes, with many more cuts to come with a projected $20 billion deficit to close (the latest budget proposal by Governor Schwarzenegger would bring the state back to 2004 levels) (Goldmacher and Halper 2010). Because California constitutes an eighth of the nation’s economic output, the state’s budget woes have a disproportionate effect on the economic recovery of the entire nation.

The fraying of social safety nets is not only a problem from a moral standpoint. The deep job cuts by states and localities across the country are counteracting much of the job-creation impact of the stimulus. Federal aid to states is going to completely dry up at the end of 2010, meaning states will have to make even larger cuts to their 2011 fiscal year budgets. This situation could lead to the exacerbation of the dire financial straits that create what New York Times columnist and economist Paul Krugman calls “50 Herbert Hoovers,” a reference to state governors cutting their budgets (as President Hoover did at the beginning of the Great Depression) just when the economy needed demand to be stimulated rather than reduced (Krugman 2008). Thus, state budget cutbacks become a vicious circle, as reduced economic demand and more layoffs of workers providing services lead to greater drains on state budgets and reduced revenues leading to the need for more cuts and a potential economic death spiral.

And the worst is yet to come: even after states cut 5.4% of their budgets, on average, between 2008 and 2009, they still face collective budget deficits of $14.8 billion for the current fiscal year (Merrick 2009). Without additional aid to states, there could be an additional 900,000 job cuts (due to public layoffs and service provider cutbacks) and 0.9% lower GDP nationwide, hampering economic recovery (Lav, Johnson, and McNichol 2009). Combined fiscal year 2011-2012 state budget deficits could reach an incredible $260 billion if none of the ARRA aid to states is renewed (Lav, Johnson, and McNichol 2009). States will already begin to write their 2011 fiscal year budgets this fall, so if more aid is to be taken into consideration by legislators, it must be passed quickly.

Studies of the multiplier effects of economic stimulus measures vary widely, but they generally show that spending on aid to states, social programs, and infrastructure far outweigh the simulative effects of tax cuts. While an additional dollar spent on extending or creating new permanent tax cuts adds only $.40 to GDP (Lav, Johnson, and McNichol 2009), that same dollar spent on (or not cut from) food stamps creates $1.70 of economic activity, $1.64 for extending unemployment benefits, or $1.57 for spending on infrastructure. Aid to states and localities prevents cuts to programs and each dollar spent will raise GDP by around $1.40 according to Mark Zandi, Chief Economist at Moody’s (Zandi 2008). So there are clear economic reasons to focus future stimulus and job preservation measures on the states rather than long-term tax cuts (temporary tax cuts raise GDP by $1-$1.25 per dollar cut).

Both morality and economic recovery demand greater federal aid to states and hopefully Congress and the Obama Administration will step up to the plate to make this a reality in the New Year. Until the economy begins to rebound solidly, the federal government is the only entity that can halt the states’ race to the bottom.


Goldmacher, Shane and Halper, Evan. 2009. Schwarzenegger to Seek Federal Help for California Budget. The Los Angeles Times, December 23, 2009.,0,7164018.story.

Goldmacher, Shane and Halper, Evan. 2010. Governor Warns of Deep Fiscal Crisis as He Unveils California Budget Plan. The Los Angeles Times, January 9, 2010.

Johnson, Nicholas, Oliff, Phil, and Williams, Erica. 2009. An Update on State Budget Cuts. Center on Budget and Policy Priorities, December 18, 2009.

Krugman, Paul. 2008. Fifty Herbert Hoovers. The New York Times, December 28, 2008.

Lav, Iris J., Johnson, Nicholas, and McNichol, Elizabeth. 2009. Additional Federal Fiscal Relief Needed to Help States Address Recession’s Impact. Center on Budget and Policy Priorities, December 18, 2009.

Merrick, Amy. 2009. Pawlenty Pushes Caps on Spending. The Wall Street Journal, December 28, 2009.

O’Leary, Kevin. 2009. The Legacy of Proposition 13. Time, June 27, 2009.,8599,1904938,00.html.

Simon, Stephanie and Gold, Russell. 2009. Snow-Removal Bills Leave States Scrambling. The Wall Street Journal, December 29, 2009.

U.S. Department of Health & Human Services. 2008. Medicaid Spending Projected to Rise Much Faster Than the Economy. News Release, October 17, 2008.

Zandi, Mark M. 2008. Assessing the Macro Economic Impact of Fiscal Stimulus 2008. Moody’s, January 2008.

Email Ryan Greenfield at



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