Why Politics Keeps Tanking a Bailout Idea That Works.
Nobody in Congress likes to give other politicians money. But the track record shows that writing checks directly to states could keep the recession from becoming way worse.
The last time the American economy tanked and Washington debated how to revive it, White House economists pushed one option that had never been tried in a big way: Send truckloads of federal dollars to the states.
When President Barack Obama took office in January 2009 during the throes of the Great Recession, tax revenues were collapsing and state budgets were hemorrhaging. The Obama team was terrified that without a massive infusion of cash from Congress, governors would tip the recession into a full-blown depression by laying off employees and cutting needed services. So the president proposed an unprecedented $200 billion in direct aid to states, a desperate effort to stop the bleeding that amounted to one-fourth of his entire stimulus request.
But the politics were dismal. Republican leaders had already decided to oppose any Obama stimulus. And even Washington Democrats who supported their new leader’s stimulus weren’t excited to help Republican governors balance their budgets. Most politicians enjoy spending money more than they enjoy giving money to other politicians to spend. And since state fiscal relief was a relatively new concept, the Obama team’s belief that it would provide powerful economic stimulus was more hunch-based than evidence-based.
Ultimately, the Democratic Congress approved $140 billion in state aid—only two-thirds of Obama’s original ask, but far more than any previous stimulus.
And it worked. At least a dozen post-recession studies found state fiscal aid gave a significant boost to the economy—and that more state aid would have produced a stronger recovery. The Obama team’s hunch that helping states would help the nation turned out to be correct.
But evidence isn’t everything in Washington. Now that Congress is once again debating stimulus for a crushed economy—and governors are once again confronted with gigantic budget shortfalls—a partisan war is breaking out over state aid. Memories of 2009 have faded, and the politics have scrambled under a Republican presidential administration.
Democratic leaders have made state aid a top priority now that Donald Trump is in the White House, securing $150 billion for state, local and tribal governments in the CARES Act that Congress passed in March, and proposing an astonishing $915 billion in the HEROES Act that the House passed in May. Republican leaders accepted the fiscal relief in the March bill, but they kept it out of the last round of stimulus that Congress enacted in April, and they have declared the HEROES Act dead on arrival. Though they’re no longer denouncing stimulus as socialism, as they did in the Obama era, they’ve begun attacking state aid as a “blue-state bailout.”
Polls show that most voters want Washington to help states avoid layoffs of teachers, police officers and public health workers, but Senate Majority Leader Mitch McConnell, Fox News personalities, and other influential Republicans are trying to reframe state aid as Big Government Democratic welfare spending. Trump doesn’t want to run for reelection during a depression, and he initially suggested he supported state aid, but in recent weeks he has complained that it would just reward Democratic mismanagement.
“There wasn’t a lot of evidence that state aid would be good stimulus in 2009, but now there’s a lot of data, and it all adds up to juice for the economy,” Moody’s chief economist Mark Zandi says. “It’s baffling that this is getting caught up in politics. If states don’t get the support they need soon, they’ll eliminate millions of jobs and cut spending at the worst possible time.”
The coronavirus is ravaging state budgets even faster than the Great Recession did, drying up revenue from sales taxes and income taxes while ratcheting up demand for health and unemployment benefits. But as Utah Republican Senator Mitt Romney pointed out earlier this month: “Blue states aren’t the only ones who are getting screwed.” Yes, California faces a $54 billion budget shortfall, and virus-ravaged blue states like New York and New Jersey are also confronting tides of red ink. But the Republican governors of Texas, Georgia and Ohio have also directed state agencies to prepare draconian spending cuts to close massive budget gaps.
Fiscal experts say the new Republican talking point that irresponsible states brought these problems on themselves with unbalanced budgets and out-of-control spending has little basis in reality. Unlike the federal government, which was running a trillion-dollar deficit even before the pandemic, every state except Vermont is required by law to balance its budget every year. State finances were unusually healthy before the crisis hit; overall, they had reserved 7.6 percent of their budgets in rainy day funds, up from 5 percent before the Great Recession.
But now, governors of both parties are now pivoting to austerity, which means more public employees applying for unemployment benefits, fewer state and local services in a time of need, and fewer dollars circulating in the economy as it begins to reopen.
Federal Reserve Chairman Jerome Powell, who has approved a plan to buy up to $500 billion worth of state and local government bonds to help ease their money problems, recently suggested that direct federal aid to states also “deserves a careful look,” which in Fed-speak qualifies as a desperate plea for congressional action.
Nevertheless, some Republicans who traditionally pushed to devolve power from the federal government to the states are now dismissing state aid as a bloated reward for liberal profligacy. Some fiscal conservatives have merely suggested that the nearly trillion-dollar pass-through to states, cities and tribes in the House HEROES bill is too generous given the uncertainties about the downturn’s trajectory. McConnell actually proposed that states in need should just declare bankruptcy, which is not even a legal option. Former Wisconsin Governor Scott Walker wrote a New York Times op-ed titled “Don’t Bail Out the States.” Sean Hannity told his Fox viewers that more fiscal relief would be a tax on “responsible residents of red states,” while Florida Senator (and former Governor) Rick Scott said it would “bail out liberal politicians in states like New York for their unwillingness to make tough and responsible choices.”
It was not so long ago that governors like Walker and Scott were burnishing their own reputations for fiscal responsibility with federal stimulus dollars. Obama’s American Recovery and Reinvestment Act was a bold experiment in using federal dollars to backstop states in an economic emergency, and its legacy hangs over the debate over today’s emergency.
By the time Obama won the 2008 election, the U.S. economy had already begun to collapse, and his aides had already given him a stimulus memo proposing a $25 billion “state growth fund.” The goal was anti-anti-stimulus: They wanted to prevent state spending cuts and tax hikes that would undo all the stimulus benefits of federal spending increases and tax cuts. The memo warned that states faced at least $100 billion in budget shortfalls, and that “state spending cuts will add to fiscal drag.” Cash-strapped states would also cut funding to local governments, accelerating the doom loop of public-sector layoffs and service reductions, pulling money out of the economy when government ought to be pouring money in.
The memo also warned that the fund might be caricatured as a bailout for irresponsible states and might run counter to the self-interest of politicians who enjoy dispensing largesse: “Congress may resist spending money that governors get credit for spending.” House Speaker Nancy Pelosi of California wasn’t keen on creating a slush fund for her state’s Republican governor, Arnold Schwarzenegger, and House Majority Whip James Clyburn of South Carolina was even more suspicious of his GOP governor, Mark Sanford, an outspoken opponent of all stimulus and most aid to the poor.
After President-elect Obama addressed a National Governors Association event in Philadelphia, Sanford and other conservative Republicans publicly declared that they didn’t want his handouts—and many congressional Democrats were inclined to grant their wish. Even Obama’s chief of staff, Rahm Emanuel, was worried about the politics of writing checks to governors who might run against Obama in 2012 on fiscal responsibility platforms.
There were plenty of studies suggesting that unemployment benefits and other aid to recession victims was good economic stimulus, because families in need tend to spend money once they get it, but there wasn’t much available research about aid to states. Congress had approved $20 billion in additional Medicaid payments to states in a 2003 stimulus package, but that aid had arrived much too late to make a measurable difference in the much milder 2001 recession.
Still, Obama’s economists speculated that state aid would have “reasonably large macroeconomic bang for the buck.” And the holes in state budgets were expanding at a scary pace, doubling in the first week after Obama’s election, increasing more than fivefold by Inauguration Day; Robert Greenstein of the Center on Budget and Policy Priorities remembers giving the Obama team frequent updates on state budget outlooks that seemed to deteriorate by the hour.
Obama ended up requesting $200 billion in state fiscal relief in the Recovery Act, eight times his team’s suggestion from November, 10 times more than Congress had authorized in 2003. Emanuel insisted on structuring the aid through increases in existing federal support for schools and Medicaid, rather than just sending states money, so it could be framed as saving the jobs of teachers and nurses. (One otherwise prescient memo by Obama economic aide Jason Furman suggested the unwieldy title of “Tax Increase and Teacher & Cop Layoff Prevention Fund.”) Republicans overwhelmingly opposed the entire stimulus, so Democrats dictated the contents, and they grudgingly agreed to most of their new president’s request for state bailouts.
“State aid was the part of the stimulus where Obama met the most resistance from Democrats,” Greenstein says. “It had such a huge price tag, and nobody loved it. But we can see how desperately it was needed.”
The Obama White House initially estimated that each dollar sent to states would generate $1.10 in economic activity, compared with $1.50 for aid to vulnerable families or infrastructure projects that had been considered the gold standard for emergency stimulus. But later work by Berkeley economist Gabriel Chodorow-Reich and others concluded the actual multiplier effect of the Medicaid assistance in the Recovery Act was as high as $2.00. In addition to preventing cuts in medical care for the poor, it saved or created about one job for every $25,000 of federal spending—and the help arrived much faster than even the most “shovel-ready” infrastructure projects, landing in state capitals just a week after the stimulus passed.
“There were at least a dozen papers written on the state aid, and the evidence is crystal clear that it helped,” says Furman, who is now an economics professor at Harvard. “Unfortunately, it was incredibly hard to get Congress to do more of it, and that hurt.”
After all the bluster about turning down Obama’s money, the only Republican governor who even tried to reject a large chunk of the federal stimulus was Sanford, who was overruled by his fellow Republicans in the South Carolina Legislature. Sarah Palin of Alaska did turn down some energy dollars, while Walker and Scott sent back aid for high-speed rail projects approved by their Democratic predecessors, but otherwise the governors all used the cash to help close their budget gaps. Bobby Jindal of Louisiana appeared at the ribbon-cutting for one Recovery Act project wielding a giant check with his own name on it. Rick Perry of Texas used stimulus dollars to renovate his governor’s mansion—which, in fairness, had been firebombed.
Nevertheless, the Recovery Act covered only about 25 percent of the state budget shortfalls, and Republican senators blocked or shrank Obama’s repeated efforts to send more money to states, forcing governors of both parties to impose austerity programs that slashed about 750,000 state and local government jobs. In 2010, 24 states laid off public employees, 35 cut funding for K-12 education, 37 cut prison spending, and 37 cut money for higher education, one reason for the sharp increases in student loan debt since then. In a recent academic review of fiscal stimulus during the Great Recession, Furman estimated that if state and local governments had merely followed their pattern in previous recessions, spending more to counteract the slowdown in the private sector, GDP growth would have been 0.5 percent higher every year from 2009 through 2013.
The Recovery Act helped turn GDP from negative to positive within four months of its passage, launching the longest period of uninterrupted job growth in U.S. history. But there’s a broad consensus among economists that austerity in the form of layoffs and reduced services at the state and local level worked against the stimulus spending at the federal level, weakening the recovery and making life harder for millions of families.
“The states would’ve made much bigger cuts without the Recovery Act, but they did make big cuts,” says Brian Sigritz, director of fiscal studies at the National Association of State Budget Officers. “We’re seeing similar reactions now, except the situation is even worse.”
It took a decade for state budgets to recover completely from the financial crisis. 2019 was the first year since the Great Recession that they grew faster than their historic average, and the first year in recent memory that no state had to make midyear cuts to get into balance. Rainy-day funds reached an all-time high.
And then the pandemic arrived.
The government sector shed nearly a million jobs in April alone, which is more jobs than it lost during the entire Great Recession. The fiscal carnage has not been limited to states like New York and New Jersey at the epicenter of the pandemic; oil-dependent states like Texas and tourism-dependent states like Florida have also seen revenues plummet. The bipartisan National Governors Association has asked Congress for $500 billion in state stabilization funds, warning that otherwise governors will be forced to make “drastic cuts to the programs we depend on to provide economic security, educational opportunities and public safety.”
So far, Congress has passed four coronavirus bills providing about $3.6 trillion in relief, including $200 billion in direct aid to state, local and tribal governments for Medicaid and other pandemic-related costs. Republican Governor Charlie Baker of Massachusetts says the aid has come in handy in fighting the virus—not only for providing health care and buying masks but for helping communities install plexiglass in consumer-facing offices and pay overtime to essential workers. Massachusetts had more than 10 percent of its expected tax revenues in its rainy-day fund before the crisis, but its revenues have dried up, putting tremendous pressure on the state as well as its 351 local governments.
“You don’t want states and locals to constrict when the rest of the economy is trying to take off,” Baker said. “So far, we’ve gotten close to what we need, but the question is what happens now, because no one knows what the world is going to look like in a few months.”
In the initial coronavirus bills, Democrats pushed for state aid, and Republicans relented. But in the most recent stimulus that Congress enacted, the $733 billion April package focused on small-business lending, Democrats pushed for state aid and Republicans refused. McConnell has said he’s open to another stimulus package, but he has ridiculed the $3 trillion Democratic HEROES Act as wildly excessive, and rejected its huge proposal for state relief as a bailout for irresponsible blue states with troubled pension funds. Sean Hannity expanded the critique, warning Fox viewers that they were being set up to help Democratic states pay off their “unfunded pensions, sanctuary state policies, massive entitlements, reckless spending on Green New Deal nonsense, and hundreds of millions of dollars of waste.”
In fact, the state with the most underfunded pension plan is McConnell’s Kentucky, which has just a third of the assets it needs to cover its obligations, even though it had unified Republican rule until a Democrat rode the pension crisis to the governor’s office last fall. In general, red states tend to be more dependent on federal largesse than blue states, which tend to pay more taxes to the federal government; an analysis by WalletHub found that 13 of the 15 most dependent states voted for Trump in 2016, with Kentucky ranking third.
Trump initially suggested state aid was “certainly the next thing we’re going to be discussing,” before embracing McConnell’s message that state bailouts would unfairly reward incompetent Democrats in states like California. But California’s finances were also in solid shape before the pandemic, with a $5 billion surplus announced earlier this year in addition to a record $17 billion socked away in its rainy-day fund. Some of the partisan arguments against state aid have been flagrantly hostile to economic evidence; Walker’s op-ed actually blamed the state budget shortfalls after the Great Recession on “the disappearance of federal stimulus funds,” rather than the recession itself, as if the stimulus funds somehow created the holes by failing to continue to plug them.
But plenty of Republican politicians support state aid, especially in states that need it the most. The GOP chairmen of Georgia’s appropriations committees recently asked their congressional delegation to support relief “to close the unprecedented gap in dollars required to maintain a conservative and lean government framework of services.” Some Republicans believe McConnell’s opposition to state fiscal relief is just a negotiating ploy, so he can claim he’s making a concession when it gets included in the next stimulus bill.
“Some aid to states is inevitable and necessary,” says Republican lobbyist Ed Rogers. “I suspect McConnell just wants to set a marker, and make sure aid to states doesn’t become aid to pension funds and public employee union coffers.”
That said, it’s not just Republican partisans who are skeptical of the Democratic push for nearly a trillion dollars in state and local aid. The current projections of state budget gaps range as high as $650 billion over the next two years, but some deficit hawks question whether it’s necessary to fill all of them before it’s clear how long the economic pain will last, and before the Fed has even begun its government bond-buying program. Maya MacGuineas, president of the Center for a Responsible Federal Budget, was already disgusted by the trillion-dollar deficits that Washington ran up before the pandemic, and while she says it makes sense to add to those deficits to prevent states from making the crisis worse with radical budget cuts, she doesn’t think federal taxpayers need to cater to every state-level request.
“We have a little time to catch our breath now, so we should make sure that we’re only getting states what they need,” MacGuineas says. “It’s not a moment to be padding the asks.”
Tom Lee, a Republican state senator and former Senate president, says it’s impossible to know how much help states will need without knowing how quickly the economy will reopen, whether there will be a second wave of infections, when Americans will return to their old travel habits, and at what point there will be treatment or a vaccine for the virus. More than three-quarters of Florida’s general revenue comes from sales taxes, so a lot depends on when Floridians start buying things again, and how much they’re willing to buy. Lee says it’s reasonable to expect Washington to help in an emergency, since the national government can print money and Florida can’t, but that the federal money store can’t be open indefinitely, since Florida’s finances were in much better shape than Washington’s before the emergency.
“No question, we need help, but we can’t expect the feds to make us whole,” Lee says. “We’re going to have to tighten our belts, too.”
That’s exactly what Keynesian economic stimulus is supposed to avoid: the contraction of public-sector spending at a time when private-sector spending has already shriveled. A recent poll by the liberal group Data for Progress found that 78 percent of Americans supported $1 trillion in federal aid to states so they can “avoid making deep cuts to government programs and services.”
But Obama White House veterans say they learned two related lessons from their experience with state fiscal relief: It’s better to get too much than not enough, and it’s unwise to assume you can get more later. Stimulus fatigue was real in 2009, and it seems to be returning to Washington. Republicans who spent much of the Obama era screaming about the federal deficit have embraced a free-spending culture of red ink under Trump, but lately they’re starting to talk more about slowing down—not only with state aid, but especially with state aid.
“We’ve already seen how state contraction can undo federal expansion,” Furman says. “This is the one part of the economy where we know exactly what needs to be done, and we don’t need to invent a brand new creative idea. But I worry that we’re not going to do it.”