Emerging Issues: Countercyclical Fiscal Program: An Idea Whose Time Hasn’t Yet Come

October 26, 2009

Oddly missing in the past year of discussions about federal economic "stimulus" is the idea of a straightforward fiscal transfer to local and state governments.

Actually, states did get a round-about, backdoor version that freed up money to plug other holes in their budgets. This happened via reduction of the states' contributions to Medicaid payments and the Stabilization Fund for education.

There may be more of that sort of thing soon through efforts to "extend the safety net" to promote recovery. NOT - definitely not - to be referred to as a "second stimulus." It seems that's a political no-no, despite the observation of Congressman Barney Frank (D-Mass.) that most people would "rather be stimulated than recovered."

No such open-ended fiscal transfer, however, went to cities.

But let's not talk about what happened recently; let's talk about the next time.

There will always be a next time. Blithe claims that the business cycle has been abolished or ameliorated always turn out to be wrong, and the predictions just exacerbate the behaviors that produce a downturn.

It's important to be clear that the issue here is not whether the feds should coddle and bail out state and local budget-balancers in tough times. The issue is what works to bring national and local economies out of recessions.

Simply stated, the problem is that state and local governments' legally required behavior during downturns in the business cycle makes the situation worse. They must balance their budgets, so when revenues decrease, they cut spending or raise revenues. In turn, those actions take away necessary services and result in people losing jobs in both public and private sectors. That's the opposite of stimulus; it's pro-cyclical, not countercyclical.

Even while the feds are "pouring money into the economy," writes James Surowiecki in his "Financial Page" in "The New Yorker" magazine, the states are taking money out. In a genial New Yorker-ish reference to the Dr. Doolittle story, he calls it a "push-me, pull-you approach to fighting the recession." He really doesn't think this is a good way to do things: "fiscal policy is undermined if the federal government is doing one thing and the states are doing another."

Robert Frank, an economist at Cornell University, agrees: "The recent state and local spending cuts are a major setback to the stimulus program... Doing everything possible to limit state and local spending cuts will help end [the recession] faster."

Neither these observers nor the many others who would describe the situation similarly blame the state and local governments for balancing their budgets. They are required to do so by law or charter or constitution. So, this contradiction is built into the system.

emergingissueschartPaul Posner has a better idea. After a long, widely respected career in the federal government, he is now director of the public administration program at George Mason University and president of the American Society for Public Administration. He recommended, in an essay in "Governing" magazine in May, "a targeted, general purpose fiscal grant to state and local governments." He reports that the United States "is one of the only federal systems in the world" without such a program. Posner doubts there will be much receptivity to this idea in the Congress, but he says it "merits more consideration the next time we need to jump-start the economy." 

This is not a new topic. In a 1978 monograph, Robert Crider wrote, "it is important to determine how state and local governments fit into national antirecession policies." Hansen and Perloff, two prominent economists of that time, made much the same point in 1944.

The 2001-2002 recession elicited similar recommendations, which went similarly unheeded. Alice Rivlin, the Brookings economist who has held many top federal economic policy posts, said that "Congress could enact a permanent program of counter-cyclical revenue sharing, which would trigger automatic federal grants in a recession based on national or state economic indicators or a combination of both. Such a program would help to avoid state actions that would exacerbate thenext recession."

Max Sawicky wrote a 2001 report for the Economic Policy Institute optimistically titled "An Idea Whose Time Has Returned." He concluded that "Unrestricted fiscal assistance is a straightforward way to stimulate spending in a time of economic slowdown. It presents minimal federal intrusion into state/local fiscal decisions, and it benefits from low administrative costs."

Posner's recommendation, then, is part of a familiar tradition - a good idea that hasn't been adopted. Maybe next time?

Details: Posner's essay is at http://www.governing.com/column/stimulus-next-time/. Surowiecki's is in the July 27, "NewYorker." Rivlin's statement of December 6, 2002 is at www.brookings.edu. Sawicky's October 1, 2001, paper is at www.epi.org.

Bill Barnes is the director for emerging issues at NLC. Comments about his column, which appears regularly in Nation's Cities Weekly, and ideas about "emerging issues" topics can be sent to him atbarnes@nlc.org

Read previous columns on the Emerging Issues webpage.