Starting Up Stalled State Economies: Experts Give Some Do’s and Don’ts

November 14, 2008

With the election of a new president, officials in many states are hoping a renewed federal/state partnership will jumpstart the troubled economy. Until the new president takes office, however, falling revenues have prompted some states to take actions that are counter-productive rather than counter-cyclical.

States are in a tough spot. For example, Illinois officials predict a revenue hole this fiscal year of

$800 million or more

. The Center for Budget and Policy Priorities (CBPP) projects state budget shortfalls across the nation will total

$100 billion

in fiscal year 2010.

Since every state but one must balance its budget, without federal support lawmakers must raise taxes, cut services, or both. (Outright fiscal irresponsibility—e.g., failing to pay Medicaid bills, underfunding state employee pension funds—is another option: Illinois’ unpaid bills could top

$5 billion

by early 2009.)

New York Governor David Paterson has just proposed school and health care

funding cuts of $3.2 billion

over two years, similar to those that have

already occured

in other states. But CBPP economist Nicholas Johnson argues cutting services and income supports

makes the economy contract even more

as the purchasing power of struggling families falls.

Johnson cites the work of noted economists Joseph Stiglitz and Peter Orzag. They argue tax increases, by reducing savings and not just consumption, are less harmful to a depressed economy, especially when they fall mainly on wealthier taxpayers.

While some states have

enacted such tax increases

or closed loopholes,


have instead considered tax cuts. Yet tax cuts are the least effective way to stimulate state economies in a recession. They can lead to further

spending cuts

while reducing the buying power of public employees. Fortunately, voters in several states have

recently rejected

the tax cut mantra.

States would be better off

strengthening consumer demand

by extending unemployment insurance, preserving healthcare coverage, preventing foreclosures, and speeding up already scheduled public works projects. The federal government could help by providing grants, paying a larger share of Medicaid costs, and rescinding (or actually funding) burdensome, federally-imposed

unfunded mandates

that cost states nearly $34 billion in the last fiscal year.

States can help themselves by better tracking, targeting or terminating largely unmonitored business incentives and tax giveaways like

Single Sales Factor

. They could adopt comprehensive unified economic development budgets (UDB), like the

excellent UDB

proposed for Kentucky. While more federal support is needed, states can use the recession to make their own economic development spending less wasteful and more productive.