The (deficit) spender of last resort

Michael Sykuta —  10 August 2010

Todd posts below about the $26 billion bill before the US House today as a gift to teachers (or perhaps more accurately, teachers unions) and school bureacrats. In reality, only $10 billion of the funds is specifically slated to rehire laid off teachers and some other public employees. The other $16 billion is to fund another six months of increased Medicaid payments to the the States (according to this NYT article). In theory, States would use the freed up cash flow to retain more teachers, police and other public service employees. So it would appear the gift is more to the whole collection of public employee unions, not just the teachers. However, I want to focus on a different dimension of this bill: the use of the Federal government to circumvent State laws, rules and regulations regarding responsible fiscal spending.

According to the National Conference of State Legislatures, all but one state “have a legal requirement of a balanced budget” (see here).  State budgets have been hit by the downturn in the economy, just like everyone else’s. Most state legislatures have convened during that period and were able to choose for themselves whether to cut expenditures or to raise revenues in order to deal with their balanced budget requirements. In many (if not most) cases, the states chose to cut funding for the positions that would be refunded by the $26 billion bill in front of the House today. Legislators and executives in those states had to balance the needs of their states and the tolerance of their electorates in making those difficult decisions. These decisions were made much closer to the actual need–and the actual tax base–than anything done in Washington, D.C., and yet these were the choices made by our (more) local elected officials.

So now the Congressional Democrats and the Obama administration have decided (or are about to decide) to circumvent the balanced budget rules imposed on states by the citizens of those states and use the federal government’s seemingly unlimited ability to deficit spend in order to effectively allow the states to spend beyond their budgetary means. On paper, state budgets will appear balanced because the “revenue” from the federal funds will offset the increased expenditures they support.  But this simply shifts the state-level deficit to the federal level–where the voters have much less influence to restrain spend-thrift politicians and bureaucrats.

One can debate the merits of state-level balanced budget rules. However, the fact that the rules exist and that this federal pay-off to public service and teachers unions circumvents the spirit, if not the letter, of those rules should be taken into account. Then again, it seems there is little accounting–or accountability–for fiscal policy in the current political environment. It seems this Congress has expanded its role to include “the nation’s deficit spender of last resort.”

7 responses to The (deficit) spender of last resort

  1. 

    [for clarifying purposes, i meant to italicize only your sentences, which are:

    "it is the states’ appeals to shift state-level deficits to the federal government that flies directly in the face of the legal requirements by which those states are supposed to abide"

    and

    "your argument seems to rest either on the presumption that state-level taxpayers are a different group of people than federal taxpayers or on the general belief that the federal government knows best."]

  2. 

    it is the states’ appeals to shift state-level deficits to the federal government that flies directly in the face of the legal requirements by which those states are supposed to abide

    I don’t see the relevance of whether states appeal for federal help. In its quest to pursue anti-depressionary policies, the federal government has no obligation to follow states’ constitutions. This is as true for California, which sought help, as it is for South Carolina, whose governor, at least, opposed it. I’m not making a legal point here, just a logical one. (Would you suggest that a restaurant has an obligation not to serve dessert to someone whose spouse insists s/he diet, even when that spouse orders dessert?)

    your argument seems to rest either on the presumption that state-level taxpayers are a different group of people than federal taxpayers or on the general belief that the federal government knows best.

    Well, federal taxpayers include those in all states, which is obviously not true of any given state’s taxpayers, but that’s basically a side point for purposes of my argument (if not Galle’s).

    To the extent that the states actually believe balanced budgets are a good idea now and the feds don’t, well the “federal government knows best” is an extreme understatement. See 1936-37 for evidence on this point, and with disturbingly high probability, the next couple years.

    But actually, I think that most state governments are aware that their balanced budget provisions are a very bad thing during recessions in general, and mega-recessions like this one in particular. But for a variety of reasons, they’re stuck with them. So I think the states are largely happy to take federal deficit funds (and this includes supposed anti-stimulus poseurs who happily take federal stimulus funds when the cameras are off).

    Finally, I’d note that the poor put-upon state taxpayers all get to vote in federal elections. Those who supported the GOP over the last decade or so hardly have any serious complaint to lodge about deficits. Those who supported the Democrats are getting largely what they were promised, which is a sane fiscal policy. Sanity at the moment requires short-term increases and long-term reductions in deficits. So I’m still having a hard time understanding why anyone should be upset at the idea that elected fed representatives are doing what’s allowed under federal law, even if it would be against state law if it were done by state representatives who aren’t actually doing it.

  3. 

    Brian, by extension of your externalities argument, any state-level policy that affects interstate activity of any kind should then be nationalized. On that basis, we should have a nationalized education system, there should be no state-level taxes of any kind, etc. In fact, since every state policy affects behavior that potentially spills over across arbitrary state boundaries, the externalities argument would suggest we eliminate state governments entirely (and their supporting tax and budget structures). If that’s your preferred polity structure, we simply disagree on that.

    Also, while I agree that nations suffer less (at the margin) from exit pressures associated with debt, that is also more reason for being careful in how blithely one appeals to its use. Given the (defection) cost of using national debt is lower, there is an incentive to consumer more debt. Furthermore, since the perceived cost of spending is lower, in terms of both exit pressure and political pressure, one would expect excess deficit spending at the national level…regardless the macroeconomic environment.

    Jonah, why should states’ policies be given priority here? First, see above. Second, more specific to this case, because it is the states’ appeals to shift state-level deficits to the federal government that flies directly in the face of the legal requirements by which those states are supposed to abide. Now, yes, I may have a preference for (more) balanced budgets, but that preference is largely irrelevant in pointing out that states are effectively side-stepping their legal responsibilities.

    Finally, your argument seems to rest either on the presumption that state-level taxpayers are a different group of people than federal taxpayers or on the general belief that the federal government knows best. In the former case, the taxpayers that have maintained balanced budget requirements at the state level are the same ones who are being implicitly taxed by the substitution of deficit spending from the state to the federal level. It then becomes a shell game of redistribution and substitution across states, which has little redeeming social value. In the latter case, well, we may simply disagree.

  4. 

    I agree with Jonah on the unfortunate recession-enhancing implications of your position. Also, to the extent that your claim relies on the superior capacity of state voters to make fiscal decisions, you neglect externalities (such as regional economic ties) — it is unlikely local voters consider the nationwide macroeconomic implications of their own budgeting decisions. Also, state-level debt policies may be significantly more hostile to debt because of exit pressures, which the national government faces to a much lesser extent.

    For more detail on these arguments, I invite you and and other interested readers to http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1590466.

  5. 

    There’s a lot in this post with which I’d take issue, but most of it would just be a re-hash of stuff lots of others have considered. (For example, I think the idea of deliberately slashing public spending in a deep recession, whether at the state or federal level, is–to put it mildly–a poor one; obviously you disagree. I could also point out, vis-a-vis your “Congressional Democrats and Obama Administration” reference, that the Bush Administration at least twice promoted tax-cut stimulus packages that increased the federal deficit. But I digress.)

    But you actually have something novel: the notion that the use of federal deficit spending to cushion the depressing effects of state balanced amendments “circumvents the spirit, if not the letter” of those amendments, and that this circumvention “should be taken into account.”

    I don’t see any particular reason to suggest that the federal government’s fiscal policy should be constrained by state constraints. Indeed, one could as easily–and much more compellingly from a depression-avoiding point of view–suggest that state balanced-budget rules violate the spirit, letter, and fact of federal automatic stabilizers that drive much federal deficit spending. Aside from your apparent preference for balanced budgets, why should state rules, rather than federal goals, be privileged in this analysis? I’d argue that the fed govt has already taken into account the role of these state rules–and that’s precisely why it’s trying to blunt their impact.

  6. 

    Matt, I would prefer a landing that corrected the problems underlying the precipitating crisis, rather than one that perpetuates (or exacerbates) them.

  7. 

    Which do you prefer for the economy, a hard landing or a crash landing?