/A prolonged depression is guaranteed without significant federal aid to state and local governments

A prolonged depression is guaranteed without significant federal aid to state and local governments


Congress is currently debating a new relief and recover package—the HEROES Act—that would deliver significant amounts of fiscal aid to state and local governments—more than $1 trillion over the next two years, all told. This is a very welcome proposal. The incredibly steep recession we’re currently in is guaranteed to torpedo state and local governments’ ability to collect revenues . Further, nearly all of these governments are tightly constrained—both by law as well as by genuine economic constraints— from taking on large amounts of debt to maintain spending in the face of this downward shock to their revenues. The result will be intense pressure for large cutbacks in public spending by state and local governments in coming years. Such cutbacks would be absolutely devastating to the cause of restarting the economy and allowing people to find jobs, even if the virus has completely abated.

We know how devastating these cutbacks would be because we have lived through the mistake of allowing them to drag on growth in the quite recent past. State and local governments became relentless anti-stimulus machines during most of the recovery from the Great Recession of 2008–09. This post highlights a couple of findings from that period that should inform policymakers’ decisions this time around.

  • Growth in state and local spending was far slower during the recovery following the Great Recession than in any other post-World War II business cycle on record.
  • This state and local spending austerity dragged heavily on growth during that time. If this spending had instead followed the trajectory it established following the recovery from the similarly steep recession of the early 1980s, pre-recession unemployment rates could have been achieved by early 2013 rather than 2017. In short, this austerity delayed recovery by over four years.
  • Recent justifications for denying aid to state and local governments sometimes rest on claims that this spending has been profligate in recent years. This is absolutely not so—growth in state and local spending has been historically slow for nearly two decades. Given the importance of what this spending focuses on (education, health care, public order), this decades-long disinvestment should be reversed, not accelerated due to an unforeseen economic crisis.
  • If federal aid is passed that is sufficient to close the enormous revenue shortfalls the economic crisis will cause for state and local governments, it will create or save roughly 5–6 million jobs by the end of 2021. Without this aid, we will remain at least that far away from a full economic recovery by then.

Public spending austerity was a catastrophe for recovery and growth following the Great Recession of 2008–09. During the official recession from January 2008 to June 2009, policymakers instituted significant fiscal recovery efforts, including the American Recovery and Reinvestment Act that was passed in early 2009. However, one year after the recession’s official end, the unemployment rate was at 9.4%, and fully two years after it was still at 9.1%. The lesson here is simple: the criteria for whether or not the economy needs continued fiscal support is not “is it in official recession or not?” Instead, it is “is the economy at full employment or not?”

The spending austerity in the 2010s was the entire reason why it took a full decade to return to pre-crisis unemployment rates following the onset of the Great Recession. It is why millions of Americans struggled—through no fault of their own—to find work and it is a key reason why wages for tens of millions of Americans barely kept pace with price inflation over this time, as labor markets remained too soft to give workers the bargaining power they needed to demand better-paying jobs.

Figure A below shows state and local spending growth following each of the post-World War II recessions. The outlying red line on the bottom is growth in the recovery following the Great Recession that began in 2008. In the 31 quarters between the second quarter of 2009 (the beginning of the recovery) and the first quarter of 2017 (when the pre-crisis unemployment low was again attained), cumulative growth in state and local spending was fully 35% lower than the average that characterized comparably long recoveries in the 1960s, 1980s, and 1990s. In the beginning of 2017, this would have translated into roughly $1 trillion additional state and local spending in that quarter.

State and local spending austerity after Great Recession: Cumulative growth in real state and local spending per capita from recession’s trough

Quarters since trough 1949Q4 1954Q2 1958Q2 1961Q1 1970Q4 1975Q1 1980Q3 1982Q4 1992Q1 2001Q4 2009Q2 
-6 99.21049
-5 95.98653 99.59585 98.4434
-4 87.45925 93.38582 96.99375 96.98225 100.1163 98.29394
-3 90.46947 95.5001 94.79961 95.57069 97.6778 97.98188 99.60523 97.50095 98.53784
-2 95.01476 97.04909 96.52179 96.61648 97.94344 97.538 103.5001 99.75223 99.39109 99.10843 98.5735
-1 98.79923 100.1851 98.91675 97.19157 99.79753 97.34781 101.8539 99.48005 100.1569 98.39556 99.3568
0 100 100 100 100 100 100 100 100 100 100 100
1 102.0551 102.4456 101.6133 99.05 100.1255 99.03592 99.23718 100.1736 100.0833 100.691 99.62381
2 102.5024 102.3623 102.968 99.38233 100.5828 100.0317 99.77792 99.74852 100.3078 100.6018 98.70917
3 102.1346 106.0772 103.0454 101.683 100.6052 101.1012 97.65554 100.389 100.6839 100.6401 97.12091
4 101.6258 107.2396 103.0721 100.6232 101.5741 102.0339 97.08549 100.192 101.6806 100.6476 96.61888
5 100.57 106.6381 102.7018 100.903 101.5711 100.0476 101.2689 101.1935 99.99835 95.59836
6 101.6001 106.7915 101.6936 101.6938 101.145 99.09959 102.4039 100.8656 99.29139 94.49319
7 101.5425 107.4646 102.7812 102.466 101.7467 98.56461 103.896 100.4414 99.43448 93.2946
8 101.0936 108.1467 104.5983 103.9134 102.8506 99.3148 104.6949 100.4898 99.06154 92.30742
9 100.9666 108.3066 104.537 103.0684 99.64892 105.8278 100.9927 98.92554 91.2913
10 102.6331 108.8601 106.9331 103.022 99.26214 107.5151 101.1833 98.77291 90.7663
11 99.69963 111.1596 107.7875 103.8055 99.15237 108.9629 101.3488 98.15312 89.95222
12 101.3264 111.4046 109.1672 104.8678 98.8809 109.5027 101.49 97.92583 89.51449
13 103.1024 112.6864 111.2652 101.5881 111.3006 102.3446 97.84278 88.98217
14 102.6488 112.0603 102.467 112.1587 103.2147 97.60029 88.56814
15 112.8246 103.107 112.9152 103.2769 97.41108 88.48282
16 113.433 101.0918 113.0382 103.8072 97.27251 88.56243
17 116.0519 101.7876 113.4017 104.3367 97.50156 88.44135
18 118.9303 101.8454 113.4204 104.0975 97.65594 88.10658
19 120.1998 102.6851 113.5324 104.3275 97.71673 87.42725
20 121.3189 102.909 114.7379 103.8779 97.89243 87.78742
21 121.8949 115.7722 105.0663 98.2555 87.95363
22 122.9604 116.9909 105.6189 98.49864 88.52057
23 125.8256 117.2117 106.785 98.44128 88.93771
24 127.0726 118.3305 106.5341 98.4289 90.09964
25 127.3683 119.0341 107.019 90.69298
26 127.4523 120.0821 107.7368 90.56563
27 129.3421 120.9104 108.37 91.69795
28 131.3453 122.1948 109.0767 91.66886
29 133.6897 123.808 110.5485 91.86208
30 135.1927 123.6465 111.7521 92.01002
31 136.0137 124.0182 112.0435 91.94945

 

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The data below can be saved or copied directly into Excel.

The data underlying the figure.

Source: Author’s analysis of data from the National Income and Product Accounts (NIPA) of the Bureau of Economic Analysis (BEA),  tables 1.1.6 and 2.1.

This slow growth clearly delayed economic recovery for U.S. workers by years. If one takes the trajectory of spending that characterized the 1980s and assumes this had been replicated after the 2009 recovery began, state and local spending would have been $800 billion higher by the first quarter of 2013. At that point in the recovery, unemployment was still at 8% and the Federal Reserve was years away from thinking about raising interest rates. This means that this extra spending, if financed by federal aid, would have translated directly into extra economic output and jobs. $800 billion in spending, even with modest multipliers, would have supported roughly 8 million more jobs in that year, enough to restore the economy to pre-crisis unemployment rates (4.4%) even with higher labor force participation than prevailed in 2013. In short, state and local spending austerity by itself delayed the recovery to pre-Great Recession unemployment rates by probably about 4 years.

Another thing to note on this graph is that besides the recovery from the Great Recession, the next-slowest growth of state and local spending on record is during the recovery following the 2001 recession. This means that the past two recoveries have seen abnormally slow growth of state and local government spending. This in no way supports recent claims that states only need federal aid in the current moment because of their own profligacy. Instead, they need aid because a once-in-a-generation shock has smashed in the economy.

Finally, state and local governments are currently forecast to be facing revenue shortfalls as large as $1 trillion over the coming years. If no help is forthcoming from the federal government to close these shortfalls, the result will be an economic disaster—one that is not confined to these governments.

Besides the obvious loss of valuable public services, cuts of this size would quickly ripple out from the public sector and destroy private-sector jobs. Filling in these shortfalls and averting these cuts would save or create more than 5 million jobs by the end of 2021, with a majority of these in the private sector. The arithmetic of this is straightforward—$1 trillion of state cuts averted between now and the end of 2021 corresponds to an average annual increase in spending of roughly $570 billion. This corresponds to $740 billion in additional economic activity when taking multiplier effects in account (for multipliers for state and local aid, see table 1 in this). This represents just under 4% of total national income, and would support (all else equal) about 4% more employment in that year. Based on the severely depressed employment level of April 2020, this would be a bit over 5 million jobs.

These multiplier effects include the reduced spending on private sector businesses that would result if public sector workers were laid off as well as the income-depressing effect of cutting needed safety net programs (Medicaid) or public goods (like public transportation or education). As households have to pay out of pocket for goods formerly provided in part by the public sector, they would have less money to spend on other businesses output. In the first two years following the Great Recession, federal aid to states to support Medicaid spending has been shown to have been possibly the single most effective bit of fiscal support provided over the entire crisis.

In many ways, the economy is currently approaching a knife edge in how recovery will proceed. If the virus relents and effective public health measures are undertaken that allow a phased reopening of business, and if the federal government provides sufficient measures for relief and recovery during this crisis, then recovery could be rapid. Many workers who lost their jobs in recent months are on temporary layoff and could reestablish ties with employers quickly if confidence and demand for output was high. But this confidence and demand will be savaged if policymakers allow state and local governments’ spending to be hamstrung by the crisis. These sub-national governments spend about $4 trillion every year in the economy, making them the second-largest source of spending outside of the federal government. If they are forced into crash-cutting, the entire economy will suffer. And this crash-cutting is unnecessary—the federal government has the capacity to transfer resources to these governments to keep this suffering from happening. They need to use it.

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