James Surowieki has stumbled upon the secret flaw in our nation’s fiscal structure:
But here are fifty culprits you might not have thought of: the states. Federalism, often described as one of the great strengths of the American system, has become a serious impediment to reversing the downturn.
He complains that states are lousy at coordinated action, like building national railroads and the magical “smart grid” that will solve our energy problems, and that the “disproportionate” influence of rural constituents on state governments will divert resources from productive urban centers, but here’s his curious insight:
[Fiscal stimulus is] built on the idea that during serious economic downturns the government can use spending increases and tax cuts to counteract the effects of consumers who are cutting back on spending and businesses that are cutting back on investment. So fiscal policy at the national level is countercyclical: as the economy shrinks, government expands. At the state level, though, the opposite is happening. Nearly every state government is required to balance its budget. When times are bad, jobs vanish, sales plummet, investment declines, and tax revenues fall precipitously—in New York, for instance, state revenues in April and May were down thirty-six per cent from a year earlier. So states have to raise taxes or cut spending, or both, and that’s precisely what they’re doing: states from New Jersey to Oregon have raised taxes in the past year, while significant budget cuts have become routine and are likely to get only deeper in the year ahead. The states’ fiscal policy, then, is procyclical: it’s amplifying the effects of the downturn, instead of mitigating them. Even as the federal government is pouring money into the economy, state governments are effectively taking it out. It’s a push-me, pull-you approach to fighting the recession.
The states, according to Surowieki, are working against federal stimulus by raising taxes and spending less, a combination that he refers to as “taking money out” of the economy. As if this is by choice, he complains that they’re “doing precisely the wrong thing.”
I’m no financial columnist, but when I last checked, states were still constrained not only by their various commitments to balanced budgets, but by things like Baa1 bond ratings. Then there’s the trifling detail that to keep the lights on and repay their bonds, state governments need real money. California, for instance, can’t pull the red lever labeled “Quantitative Easing” and start cutting payroll checks. So I’m not sure how Surowieki wants the states to help with fiscal stimulus, other than by ceasing to exist, admittedly an increasingly popular solution in certain quarters.
UPDATE: Over at Free Exchange, the point is made that being tied to the fiscal mast is California’s political choice, and the decision to run balanced budgets is what keeps those bond ratings low and prevents big deficits in lean times:
California had a gross state product in 2008 of nearly $2 trillion—larger than Russia, Spain, Brazil, or Canada. All of those countries carry significant public debt; Canada has debt equal to about 60% of GDP, for instance. If California could borrow, it could borrow.
This is true, and it’s fun to imagine the macroeconomics of a counterfactual California with both fiscal and monetary autonomy.