These States: US Federal-State-Local Fiscal Relations in the Wake of Pandemic-Driven Recession

01/19/2022 12:00am

Introduction

Discussions of US economic growth and employment usually dwell on household consumption, aggregate employment, and federal spending. A neglected but key component of the economy is the state and local government sector (SLG). As the Congress debates the contents of the federal budget for fiscal year 2022 and beyond, the question of aid to SLGs remains salient. The crisis that began in 2020 could still blow a huge hole in SLG budgets, due to increased expenses and reduced revenues.

I’ve worked on this intermittently since the ’80s. When I was at the Government Accountability Office (GAO), I worked with the group that designed the Medicaid bump-up for Obama’s recovery act to aid the states. We called ourselves the formula gang; this is a sample of our work.

Federal efforts in this regard were notably inadequate. The state and local sector suffered a huge loss during the Great Recession, which meant less money for the full gamut of public services that people rely upon, and a slower national recovery from the recession. At GAO, our mandate was not to tell Congress how much to spend on aid, but to recommend more efficient ways to distribute whatever was decided upon.

It’s been said that the federal government is like a huge insurance company with an army. The point is that, aside from deploying military force all over the world, what the Feds mainly do is mail checks to health care providers (Medicare), seniors and the disabled (Social Security), and state governments (Medicaid).

In the US, most public services are delivered by state and local governments SLGs. These governments lack the borrowing and money-printing capacities of the national government. They are obliged by law and by economic reality to balance their budgets, at least approximately. They need to keep spending in line with revenues in order to convince lenders their loan obligations will be honored.

A limited exception to SLG budget balance is the practice of capital budgeting, which allows for long-term borrowing, principally for capital projects. The ability of SLGs to borrow by selling bonds hinges on their perceived ability to meet their debt-service obligations. In financing a capital project with debt, it helps if the facility comes with a guaranteed revenue stream, such as the tolls for a road or bridge. In general, if its finances are a mess, a state or local government must agree to pay higher interest. Borrowing will cost more. In any event, the scope for this off-budget borrowing is limited.

State laws regarding finance are relevant insofar as SLGs could be forced to rank debt obligations above other spending needs, including the most basic services, such as public safety, water, or sanitation. These factors are what disciplines state and local budgeting. In a downturn, state and local governments can only deal with lost revenues by cutting services. Higher tax rates on shrinking tax bases are self-defeating.

Years ago, I organized a seminar presentation at GAO by a municipal bond expert from Chicago. (State government bonds are typically described along with local government bonds as “muni bonds”). He noted that although the state government of Illinois was a financial basket-case, its law protected the bonds it sold. Creditors must be paid before anyone else. He asserted that there was no chance of the state of Illinois defaulting.

In this sense, state governments rarely go bankrupt. There are cases of local governments going bankrupt. New York City, Detroit, the District of Columbia, and Puerto Rico are notable examples. In extreme circumstances, the local governments are effectively superseded by some kind of control board. Residents of the jurisdiction bear the burden of insolvency in the form of cuts in public services. The creditors are often made whole. In effect, it is vital public services that go bankrupt, and the private sector—households and business firms—that bears the burden.

The State and Local Sector in the National Economy

In 2019, before the pandemic and economic shutdown of 2020 unfolded, the SLG sector comprised 11 percent of Gross Domestic Product (GDP). In the same terms the federal government’s share was less than 7 percent.

(A note on our income accounting: GDP by government sector, such as federal or SLG, is measured here in terms of output. It does not include transfer payments from government programs to individuals or to their health care providers, such as under Social Security or Medicare. Under income accounting conventions, a transfer payment does not change or comprise output.)

By December 2019, SLGs directly employed nearly 20 million persons, which was 13 percent of national employment. The federal government (including the Postal Service) employed nearly three million civilians.

Figure 1 depicts the output of SLGs, federal defense, and federal nondefense. (Again, these are production numbers and do not include benefit payments such as Social Security or Medicare.) The dominance of SLGs compared to federal nondefense spending is obvious.

Figure 1

Recessions exert a compounded negative impact on SLGs. Their expenses increase to finance the enlarged enrollment in their biggest program, Medicaid, as well as Unemployment Insurance (UI) and Temporary Assistance for Needy Families (TANF). For 2020, in addition to these traditional costs were those specific to the pandemic sustained by public health systems and facilities. By the same token, shrinkage of SLGs is a drag on the national economy, accentuating the negative feedback between GDP and SLGs. On top of these difficulties is the claw-back of pandemic expansions of UI benefits by federal and state governments.

An economic slowdown reduces SLG tax revenues that, absent federal assistance, can only be replaced from available rainy-day reserve funds. If the funds are inadequate or exhausted, disruptive service and benefit cuts become necessary. All of this raises the question of federal support. Only the national government can alleviate the fiscal perversity—cutting spending and raising taxes in a recession—that are the standard, obligatory operating procedures of SLGs. Pandemic-related legislation in 2020 and 2021 has provided some relief. The question for this paper is whether it will be adequate.

After the Great Recession of 2007–2008: A Cautionary Tale

Figure 2 (vertical scale is truncated for illustrative purposes) shows SLG output as a share of GDP since the economic growth that preceded the Great Recession of 2008. The downward trend after 2008 is obvious, not interrupted until the special COVID-19 relief measures began in 2020. This lack of response to the 2008 collapse points up the chronic weakness of federal intergovernmental fiscal policy. It would not be an exaggeration to describe federal intergovernmental fiscal policy as one of neglect. For all practical purposes, it does not exist. The only limited exception is the automatic response of the Medicaid formula grant allocations to changes in states’ economic conditions.

Figure 2

An economic shock equivalent to a percentage point of GDP is a big deal for SLGs. In terms of 2019 employment, a percentage point is a million and a half jobs. The total decline in GDP from 2019 to 2020 was 2.2 percent, so holding SLG employment constant at its 2009 level would have meant a much faster recovery after 2008, a less severe downturn in 2020, and possibly a different electoral outcome in 2016.

In Figure 3, we show the contribution of SLGs to GDP compared to the federal government’s defense and nondefense outlays after 2007. We can see that, whatever the merits of savings in defense spending, the reductions between 2010 and 2016 could not have helped the recovery. In the same vein, the lack of any expansion in federal and the decline of SLG nondefense spending was acute fiscal malpractice.

Figure 3

All sectors combined, shown in the red line and the right-side vertical scale, constituted either a neutral role or a drag on growth from 2009 to 2014, an obvious lapse in fiscal policy. It is not until 2020, in response to the pandemic and recession, that any positive move is evident. Until then, the overall public role was anemic. Again, this reflected a failure of federal policy since recessions tend to tie the hands of SLGs. Only the national government has the fiscal and monetary resources to prop up SLG finance in a recession.

The data on output do not reflect anti-recession measures in the form of increased transfer payments. In that respect we do not claim to present a complete picture of activist fiscal policy. Our focus here is the ability of SLGs to maintain services and continue investment spending.

In Obama’s recovery act, one channel of aid to SLGs was the expansion of Medicaid grants, as mentioned above, which are classified as transfer payments. A clear intention of this policy was to bolster the overall finances of SLGs, since the grants could replace lost SLG own-source revenue. The fact remains that while this injection was clearly helpful, the evidence shows it was insufficient to translate into increased SLG output.

Investment

In a prior paper, the state of US public investment was surveyed. Just as it is the states that provide the bulk of public services, it is also SLGs under whose auspices most public investment is conducted and most public facilities are operated. As noted in the paper, in the past the bulk of such investment was roads, bridges, and school buildings. In light of climate concerns, rail, electric vehicles, sustainable energy, and a more efficient national power grid will command more emphasis.

The only point to add is that national stagnation of public investment documented in the previous paper has both immediate and long-term negative impacts on economic growth and employment. In the short-term, the fiscal drag generated by SLGs slows down economic recovery. In the long-term, the potential growth effects of a larger public capital stock are foregone.

The reluctance of Democrats to exploit the tools of fiscal stabilization for the sake of a vigorous anti-recession program has been rooted in ideological prejudices that are only now being cast aside. This reluctance ought to be understood as a factor contributing to their political misfortunes.

Forty Years of Austerity

The fiscal tribulations of SLGs are not a new development, but a consequence of the overall wind down in US public nondefense spending that began in the 1980s. As noted above, most public investment is carried on by SLGs, so stagnation of SLGs injects a permanent, negative factor in US economic growth. In this respect, the austerity of federal support for SLGs is two-dimensional: it is reflected in current outlays and in what can be expected in the future. Disinvestment implies greater pressure on future SLG spending, in the form of deferred maintenance of physical capital, and services to make up for shortfalls in the extent of physical capital. For instance, failure to invest in highway upkeep generates greater current costs, in the form of necessary short-term repairs.

Figure 4 shows the principal categories of federal investment in physical capital (infrastructure), research and development, and education and training. Roughly 80 percent of the total is federal direct spending, of which 40 percent is defense-related. Grants to SLGs for investment amounted to 21 percent of the total, at $146 billion, or 0.67 percent of GDP. (By contrast, the federal grant for Medicaid in fiscal year 2020 was $459 billion.)

Figure 4

The 40-year austerity program has the following dimensions:

  • An increasing share of grants going to programs of payments to individuals. Grants for payments to individuals consist primarily of public assistance and Medicaid/SCHIP. This comparison overstates the point somewhat since we expect programs of transfer payments to individuals (and to their health care providers) to offset the need for SLG services to some extent.
  • Diminished support for SLG current services, which we measure in terms of federal grants other than for payments to individuals, compared to SLG expenditures and own-source spending. The latter refers to spending financed by SLG tax revenue.
  • A decreasing share of grants most closely related to investment compared to GDP and to SLG investment.

Figure 5

Figure 5 shows the first trend from 1980 to 2020. (Note the uneven spacing on the horizontal scale.) The colors reflect the proportion of total grants devoted to payments to individuals, physical capital, and other. The latter includes education grants, logically an additional type of investment spending. The change in shares is obvious. The share, other than for payments to individuals, declines after 1980 from 65 percent to 27 percent by 2020. The explosion in the blue category is mostly grants for Medicaid and the State Children’s Health Insurance Program (SCHIP). Cash transfer payments (not shown) declined over this period, especially after the so-called welfare reform of 1996.

Figure 6

Figure 6 shows federal grants not including grants for payments to individuals compared to SLG expenditures. The decline in federal support is obvious. Ideally, we would like to compare the grants of interest here to their counterpart in the SLG sector (i.e., expenditures not used for public assistance and Medicaid), but there is no simple way to do this with available data. Once again, there is some understatement of federal support but the collapse over the course of the 1980s is clear.

Finally, we focus on investment expenditures. As noted above, it is SLGs that conduct and superintend most public investment in the US, so these trends are implicitly national, not confined to SLGs. In Figure 7 we show grants not for payments to individuals relative to GDP and SLG gross investment. In this case the numbers are somewhat biased upward, since some grants not for payments to individuals are not devoted to gross investment. The stagnation since 1980 is obvious.

Figure 7

Federal austerity policies are matched by long-term secular weakness in SLG budgets. The chief factors are:

  • the growth of health care costs, in the form of Medicaid expenditures and the health insurance of SLG employees.
  • the shift in consumer purchases from goods to services.
  • the shift in consumer purchases from bricks and mortar retail establishments to online and mail order sales.
  • the declines in petroleum prices, exacerbated by the reliance on ad valorem taxation of gasoline, and the decline of tobacco tax revenue due to changes in smoking habits.
  • the imposition of federal mandates on SLGs.

Health Care. The dominance of health care spending in long run SLG costs has been detailed in periodic reports of the GAO. These reports’ routine predictions of fiscal doom may be safely ignored, but the documentation of trends in health care costs is well-founded. The growth in health care costs naturally tends to diminish resources for all other public services and investments. As the GAO reported, from 2009 to 2019, SLG health care spending as a share of GDP rose from 3.45 percent to 3.94, while non-health care/non-interest spending fell from 11.78 percent of GDP to 9.59 percent. This is a period of economic recovery, from the depths of the Great Recession forward. The upshot is that health care spending absorbed SLG opportunities for improvement of services and expansion of investment spending.

Sales Taxes. Unlike the federal government, most state governments rely substantially on the taxation of consumption through sales and excise taxes. As noted above, transactions crossing state lines were able to avoid such taxes for decades until court decisions pertaining to mail order sales and more recently online sales.

Excise Taxes. Besides the changes in tobacco consumption noted above, gas tax revenue has also declined due to the impact of inflation on ad valorem taxes (taxes denoted in cents, rather than percentages).

Mandates. One way the federal government shifts costs to SLGs is through the imposition of mandates that require SLGs to take up certain public functions, often without funds to finance such duties. An example is the enforcement of federal environmental regulations.

The 2007–2008 and 2020 Shocks

Figure 8 shows SLG output by quarter adjusted for inflation. (Note the truncation of the vertical scale.) The business cycle peak prior to the Great Recession was the fourth quarter of 2007, shown on the chart with the black vertical bar. The trough of the recession was the second quarter of 2009, marked in red. The increase in real SLG output from peak to trough is just what we would like to see to replace lost output in the rest of the economy. However, the lack of follow-through is evident in the utter collapse of output growth after 2009. This can be attributed to the waning of federal counter-cyclical aid, the exhaustion of SLG reserve funds, and the failure of the Medicaid bump-up to propel non-Medicaid SLG spending.

Figure 8

Thus far with respect to the 2020 recession, a question mark remains. The picture looks good up until the first quarter of 2020, before the full force of the pandemic was manifest. There is some drop off in ensuing quarters. The most recent data available is the second quarter of 2021.

The question is what happens to the SLG sector during the hoped-for recovery. It could prove to be a drag on the economy, as it was after the Great Recession. To contribute to a recovery in 2021 and after, we would like to see at least modest growth in real SLG output, something like 2 percent annually in real terms. It stands to reason that SLG services should grow with GDP on average. A larger economy requires greater services that only the public sector provides, and rising household consumption implies a similar rise in the provision of consumption services by the public sector. Just in terms of constant dollar output, a 2 percent real increase in SLG output would be roughly $120 billion a year.

The denouement of the Great Recession illustrated that a falloff in SLG output can persist for much longer than a year or two, even though SLG own-source revenues grow along with GDP. An added cost for SLGs in that period is the need to replenish reserve funds. Usually, recessions are officially declared to be over after two quarters of GDP growth, but the repair of the SLG sector can take much longer.

Looking Forward

The National Association of State Budget Officers (NASBO) issues two surveys of state government fiscal condition each year, one in the spring and one in the fall. State government budgets’ fiscal years tend to run from July to June. Local governments are creatures of state governments, both under the US Constitution, and in actual fiscal terms, since state governments exercise considerable control over local governments, not least in the form of state aid. Obviously, state economic conditions reflect the conditions of localities in aggregate. At the same time, experiences among states can vary considerably.

The most recent fall report focuses on state budgets for the fiscal year 2022. The key finding is that the recovery in 2021 was more rapid than expected, resulting in improvement in state finances and a bit more optimism regarding the new fiscal years. In keeping with other remarks on long-term trends in the labor market, “recovery” in this context means a return to the economic situation in early 2020. The adequacy of policy at that moment is a separate question.

A wrinkle is that this realization of recovery dawned as state governments were in different stages of their budget formation. The later a budget was set, the greater the scope for increases were possible, as good economic news continued.

Even so, the post 2008 experience should caution us to be wary of premature optimism. With this in mind, expectations for the near term ought to be regarded with somewhat less confidence. In the same vein, since states are well aware of past experience, fiscal planning could be weighed down to a more conservative posture.

Recall our suggestion that spending after adjusting for inflation ought to grow at least 2 percent a year. Inflation estimates this year have ranged between 3 and 7 percent. In that event, it follows that planned spending in current dollar terms ought to be discounted by a similar amount. For instance, given prevailing inflation estimates in that range, 3 percent growth in spending amounts to very little. If inflation runs higher than 4 percent, the prospects for real growth in SLG output are dim.

NASBO reports state general fund spending growth of 3 percent for fiscal year 2021, below the trend prior to the pandemic. This finding is consistent with the dips at the extreme right of Figure 8, following the first quarter of 2020. If inflation meets or exceeds 3 percent in 2021, which seems quite likely, state fiscal drag has already begun.

Figure 9 shows SLG spending adjusted for inflation on a year-over-year basis, from the first quarter of 2020 to the second of 2021. Total SLG spending collapses after the first quarter 2020. It only begins to recover by the third quarter of 2021 (not shown in the graph). While SLG receipts increased significantly over this period, they did not find their way into spending, consistent with the intrinsic “fiscal perversity” of the sector.

Figure 9

State budget plans for fiscal year 2022 are more ambitious, though it should be realized that the pandemic-depressed fiscal year 2021 is a low bar to surpass. A better standard would be fiscal year 2020 (roughly July 2019 to June 2020, before the full force of the pandemic had manifested). Better still would be fiscal year 2019, which includes the business cycle peak in the fourth quarter of 2019.

In a similar vein, NASBO reports that to some extent, the projected fiscal year 2022 increases are bolstered by unexpected budget surpluses and the below-trend spending level in fiscal year 2021, the latter visible in the Bureau of Economic Analysis (BEA) data in Figure 9. There is also the factor of spending being pushed from fiscal year 2021 to fiscal year 2022 due to extension by states of state income tax filing deadlines. In other words, the fiscal year 2022 projections for some states are built on one-offs and do not ensure continued growth, which goes back to our caution about the short-to-medium term following the official end, the trough, of a recession.

A positive note is that state reserve funds, including rainy-day funds, are relatively high. Before the Great Recession, reserves of 5 percent of general fund spending were a conventional standard for adequacy. This proved grossly inadequate to the economy following 2008. Presently, median state reserves are estimated by NASBO at about 8 percent.

The Direction of Federal Aid

In September of 2001, the employment-population ratio (EPOP) for the US was 63.5 percent. It was nearly the same in January 2007. Before the onset of the pandemic, it was 61.1. The most recent level is 59.5. That difference of .016 is a conservative indication of slack that remains in the economy. By the latest population estimates, that translates into roughly four million jobs. Failure to approach this milestone indicates a weakness in fiscal policy, one avenue of which is the SLG sector.

Of course, our four million job gap is overstated in one sense due to the aging of the population; older persons tend to work less and there are more of them, though on average they are working longer now than in previous years. On the other hand, going by EPOPs, the pre-pandemic employment level is still a come-down from prior peaks in 2007 and 2000. In any case, its salience is magnified by widespread reports of supply chain problems, growing labor militancy, and labor shortages.

The EPOP for prime-age persons, meaning ages 25 to 54, was 76.5 in July 2021 (the most recent month available), also below its peak of 81.7, in April 2000. Since we refer to prime-age workers, aging and retirement are less likely to be a factor. Job losses remain most noticeable in the leisure, tourism, and accommodation sectors, magnifying the relevance of targeting federal stimulus aid by state economic conditions, since those sectors are disproportionately concentrated in specific geographic locations.

The sectoral job losses tend to obscure the overall growth in employment in 2021, and the most recent finding from the Economic Policy Institute that hires are exceeding quits in the labor market, signaling that workers are moving to better jobs, rather than any mass wave of vacationing. It is fair to note that employment has mostly recovered compared to its level immediately prior to the pandemic’s onset in March 2020. Whether that level is satisfactory, compared to prior peaks in 2007 and 2000, is a different matter.

A principle advanced for fiscal stabilization during and following the Great Recession was the “3Ts” mantra that stimulus should be “timely, targeted, and temporary.” This was founded on past experience with the duration of recessions, experience that was not reliable guidance for the post-2009 period. In the actual event, the recovery was slower than expected. It turned out that the premia on timely and temporary were overstated. Stimulus, including aid to states, could have been profitably spread over a longer duration than one or two years. Of course, it could have been more ample as well. Once again, this ought to be kept in mind regarding upcoming fiscal policy.

The downsizing of President Biden’s budget proposals by the Congress, as of the end of 2021, threatens to repeat the 2009 failure. Effects of the stimulus measures of early 2021 are fading away, with no automatic provisions for more in the event of a sluggish recovery, and SLGs are barely an afterthought in the budget debates.

A rational course of action would be to condition added doses of stimulus automatically, depending on economic trends. The most convenient datum upon which to base these triggers would be the monthly employment reports from the Bureau of Labor Statistics. Thus far, Congress has proven reluctant to employ such devices, in contrast to policies promoted by the Obama administration. The most relevant component is the one cited at the outset of this paper, with a minor contribution by this writer while employed by GAO. The disinterest in triggers by the Congress, coupled with its difficulties in making timely decisions, elevates uncertainty in state fiscal planning and commends more conservative state policies, adding to brakes on the recovery.

The Medicaid enhancement under the American Recovery and Reinvestment Act (ARRA) adhered to the 3T principle. While the wisdom of timeliness and temporariness of the policy proved to be dubious, the targeting feature deserves a revival. One criticism of state aid to combat recession is that some state governments will choose to divert such aid to tax cuts. In that case, the policy proves a weak form of support for state services and investment, but its value as stimulus remains. SLG tax cuts during recessions also provide some stimulus.

The truth is that it is difficult for the federal government to force specific state government fiscal policies. In practice, certain provisions for “maintenance of effort” (provisions of aid that aim to prevent substitution of grant money for own-source revenue) and the like might be cited, but in actuality both grantor and grantee have a political interest in exaggerating the force of such provisions. The grantor—the Congress—wants to claim an accomplishment, while the grantee—the states—wants to complain about federal intrusiveness.

A recent study points up the failure of aid targeted according to function, in this case highway spending, to affect SLG behavior. This study echoes findings in GAO research on this question in 2004 and is consistent with traditional economic theory, namely, that grants that fail to change the price of state spending (in other words, have some kind of open-ended matching provision) will not affect the type of spending being targeted.

The obstacle to reasonable federal regard for state fiscal conditions is twofold. Republicans tend to oppose aid out of hostility to federal nondefense spending in general. Democrats in Congress dislike taking the heat for taxes used to finance such aid, while their intraparty rivals in state and local government are able to take credit for the fruits of such aid.

At the time of this writing, about $450 billion in aid to SLGs is in the pipeline, due to be distributed over the next two years. By the terms of our suggestions above, this is a reasonable amount, at least for the time being. Beyond that is another matter.

Proposals for aid to states were described by Republicans in Congress as “blue state bailouts.” In fact, the rapidity of the recovery thus far has precluded the need for bailouts, by and large. State revenue collections have largely recovered. Many state budgets are in surplus, including such leading blue states as California. Limited exceptions are red states with a disproportionate reliance on the taxation of energy resources: examples are Alaska, Louisiana, New Mexico and Wyoming. It does not help that these same states are susceptible to disapproval of vaccines and other policies aimed at combating the pandemic, slowing their recoveries.

One form of aid subjected to vigorous debate over the past year has been the disposition of deductions for SLG income and property taxes for those who itemize on their federal individual income tax returns. Tax legislation during the Trump administration reduced the scope for these deductions, a change that particularly affected states with relatively heavy use of those taxes. Now a restoration of those tax preferences has been requested, naturally by members of Congress from the most affected states, particularly those in the Northeast.

The Trump tax cuts weakened state fiscal conditions in three ways. One is by shrinking the federal income tax base. State income taxes are said to piggyback on federal taxes because they are tied to the federal definition of taxable income and they use data from income reporting to the IRS. A narrower federal income tax base requires states with income taxes, again especially blue states, to either raise rates or cut spending to make up for the shortfall.

The second way is that a reduced federal marginal tax rate for those who itemize their federal taxes reduces the value of deductions, including those for state income and property taxes, also known as SALT.

The third problem is that the limitation on deductions of state taxes for federal income tax filers increases the price of public services provided by SLGs. This is thought to have an impact on state and local public spending. In this respect, estimates of the allegedly regressive distribution of SALT preferences (e.g., greater benefit for higher-income households) are only half the story. The other half depends on the impact of elimination of these preferences on SLG spending, which by and large has a less regressive distribution of benefits.

It follows that a claw-back of Trump tax cuts through a broader income tax base, higher federal marginal rates and restoration of SALT, can benefit SLG finances.

General Assistance (Revenue Sharing): Now More than Ever

The case for a revival of general assistance to SLGs is worth making here again, on two basic grounds. Disparities among states in terms of economic well-being and the implied ability to raise taxes, and the implied costs due to their particular circumstances, commend fiscal equalization grants to alleviate such disparities. These disparities prevail in good times and bad. Disparities unduly influence the location decisions of households and business firms, hence they detract from economic efficiency. Alleviation of disparities also promotes equity with respect to households.

As elaborated in this paper, economic downturns imply a need for general assistance to be further adjusted for purposes of fiscal stabilization. As the example of Obama’s ARRA bump-up in Medicaid grants shows, formula-based aid can be fine tuned to individual states’ economic conditions, both between states and with changes in their business cycles. It is not necessary to provide such aid through Medicaid. That was a convenience motivated by a desire to quickly jump-start a recovery in 2009.

General Assistance Mechanics. Two key considerations as mentioned above in designing aid provided according to formula are targeting and timeliness. Targeting benefits from more data, but in the case of state and local governments, some data is too infrequently available for use in combating a recession. Moreover, older data can fail to reflect changes on the ground, in the interim between when data is collected and when it is provided. Target effectiveness erodes over time.

Less data pertaining to state and local jurisdictions is available on a timely basis. You can forget anything like GDP at the state level. There are published numbers, but they involve some hocus-pocus. By and large, they are based on earnings data. For targeting, it is best to stick with the source: labor market data.

The best option is the local unemployment rate, which is revised every month. It is widely understood (at least, people think they understand it), and it is sensitive to local business conditions. It was the key variable used after 2008 to make the temporary increase in Medicaid grants sensitive to state economic conditions.

It isn’t perfect. The monthly state unemployment data are noisy, meaning subject to error. Moreover, a pair of states could have the same unemployment rate but different levels of personal income or poverty. In principle, other data would be relevant to allocations, but other data are only available on an annual basis, and with a lag.

Below the state level, meaning counties or cities, there is even less information to go on: less reliable, and less frequent. One resort is to leave local distribution up to state governments, on the grounds that they will have a better handle on intra-state conditions. Their considerations, of course, will also depend on the state governments’ solicitude toward their local counterparts, which is not always forthcoming.

When Congress considers formula options, it is a seamy business. Often suggestions to include this or that variable are self-interested. Members want to see how the numbers come out for their own state. If they like the results, they volunteer high-minded arguments for their variation that purport to advance the national effort.

This writer had a window into the fight over recovery act money after the Great Recession. Senator Jay Rockefeller of West Virginia played the heroic, selfless role, focused on policy that would be best for the nation. Senator Max Baucus of Montana only cared about what was in it for Montana. Certain Republican Senate staff were most interested in how to injure California and New York.

Conclusions

The role of the SLG in anti-recession policy should not be forgotten, since its impact on any economic recovery is inescapable and, absent federal intervention, that impact on recovery will be negative. Summing up:

  • State and local governments comprise a large share of national employment and a crucial source of services. It follows that the SLG sector is among the most important avenues for fiscal stabilization policies.
  • The SLG sector has been the victim of long-standing, bipartisan neglect by the federal government.
  • Failure to bolster SLGs after the Great Recession was an important drag on the recovery, especially beyond the immediate aftermath of 2009.
  • Currently the SLG revenues show, along with the economy, a surprising extent of recovery, but spending remains depressed and significant employment shortfalls in the national labor market persist. The future in this respect remains highly uncertain, both for SLGs and for the economy as a whole.
  • Use of SLGs for fiscal stabilization remains a priority, ideally with formula-based, automatic provision of ample, well-targeted federal general assistance.

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