You've seen the stimulus. Now, meet the anti-stimulus.

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By Ezra Klein
Washington Post Staff Writer
Sunday, June 20, 2010

A multiple choice question for you: Did the stimulus a) work; b) fail; c) end up locked in an unexpected battle with the massive anti-stimulus that's ripped through the states?

Most people would choose "a" or "b" (though I'd say "a" has the better of it). They probably haven't heard of "c." But ask Bruce Bartlett, a conservative economist who worked for Ronald Reagan, George H.W. Bush and Jack Kemp, and you'll hear all about it. "When the history of the current crisis is written, much of the blame will be placed on the sharp fiscal contraction of state and local governments," he says. "I think economists will view this as a preventable error equivalent to the Fed's passive shrinkage of the money supply in the early 1930s."

Take my home state of California, with an unemployment rate of more than 12 percent. We need the government to help create jobs, and quick. But instead, Sacramento is raising taxes and cutting services. That's like bailing water into the boat rather than out.

The Golden State has its reasons. Its budget is in terrible shape, and the constitution doesn't allow officials to run deficits. But in an effort to do right by the numbers, they're doing wrong by the economy. And they're not alone. Some 46 states are facing budget gaps that will require them to cut spending or raise taxes. The Center on Budget and Policy Priorities estimates that in 2011, the states will have to come up with a total of $180 billion.

These budget shortfalls are the equivalent of a massive anti-stimulus, which some experts believe has overwhelmed the $787 billion stimulus passed by the federal government in 2009.

The argument goes to the very role of stimulus in the economy. People understand perfectly well that boom-time economies seem better than they really are. But the reverse is true for busts: They're generally worse than they need to be. In a downturn like the one we're in, there's idle labor and productive capacity (people, machines, shop floors, etc.) that could be working, but isn't. That's because the economic shock of 2007 left businesses and families cowering. Uncertain about the future, they spend less now. The role of the government is to step up and keep the economy moving until consumer confidence returns.

That's what the federal stimulus was supposed to do. It might have been too small, and there's plenty to argue over in its composition, but analysts say it did essentially what it promised: IHS Global Insight, Macroeconomic Advisers and Moody's Economy.com all estimate it created around 2.5 million jobs. The problem is that it wasn't alone.

Unlike the federal government, 49 of 50 states must balance their budgets (the exception is Vermont). So when the economy crashed in 2007, they went down with it. First, tax revenue dried up because residents lost jobs. Second, expenses went up as more unemployed people needed help. The states with the most responsible budget practices had reserve funds and tricks to hold them over for a year, and maybe even two. Three years in, they're all up against the wall. And because they cannot run deficits to hold them over until their economies improve, they're cutting services and raising taxes. Using the data for 2009 and 2010, and then projecting for 2011 and 2012, the Center on Budget and Policy Priorities expects the total state shortfall will reach $610 billion.

Because some of the federal stimulus dollars were saved rather than spent, the effective stimulus we've had has been less than the $789 billion that's often touted. It might even be less than $610 billion shortfall in the states. Which would mean the anti-stimulus overwhelmed the stimulus. Or, you could look at it in reverse: Nick Johnson, who directs the State Fiscal Project at CBPP, says that "the effect of the federal stimulus was to wipe out the negative effect of the state contraction."

Either way, the assumption that total government spending has leapt up to counter the recession might be wrong. Worse, the federal stimulus money is going to thin dramatically this year, but the state budget problems could grow. And with unemployment sitting stubbornly at 9.7 percent, we're not in any shape to let the federal stimulus peter out and leave the state anti-stimulus to drag us down.

That means that the federal government has to step in with aid for the states. The Obama administration has asked for about $50 billion for 2011, but experts say states really need about twice that. The trick, however, is that you don't want to reward bad budget practices under the cover of mitigating an economic disaster. And helping states solely on the size of their budget holes would do exactly that. All things being equal, a fiscally responsible state would get less than a fiscally irresponsible state.

The best idea I heard for getting around this was to apportion the aid based on labor conditions. In general, whether unemployment is 4 percent (as in North Dakota) or 14 percent (as in Michigan) has less to do with state government than broader economic factors. If you tied the aid to, say, payroll data, you could help the states hit hardest by the economic storm while at least partially rewarding the states who didn't save for a rainy day.

Finally, state and local aid happens to be an uncommonly effective form of stimulus. The difficulty with most stimulus spending is that not all of it gets spent. Tax breaks, for instance, often get saved. Mark Zandi, the chief economist for Moody's Economy.com, estimates that cutting the corporate tax rate gets you only 32 cents in stimulus for every dollar you spend on it. That's not the case with state and local aid. When you're plugging state budget gaps, you know that money will be spent, because it was being spent before, and usually on something that the state's residents actually wanted.

Zandi estimates that every dollar spent on it actually gets you $1.41 in stimulus. It's the best anti-anti-stimulus you could ask for.


© 2010 The Washington Post Company

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