I ought to get my wonk on and write about the priority of bolstering state and local government resources, since I’ve worked on this intermittently since the 80s. This crisis will blow a huge hole in state government budgets, due to increased expenses and greatly reduced revenues. 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. I was in the formula gang.
Federal efforts in this regard were notably inadequate. The state-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, we couldn’t tell Congress how much to spend on aid, but we could suggest the most efficient way to distribute it.
Ezra Klein once remarked that the Federal government was like a huge insurance company with an army. I don’t know if that witticism was original to him. The basic 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).
Services are delivered by state and local governments. 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 the government’s loan obligations will be honored.
An exception to strict budget balance is the practice of capital budgeting, which allows for long-term borrowing, principally for capital projects. The ability of governments to borrow, by selling bonds, hinges on their perceived ability to meet their debt-service obligations. If their finances are a mess, they 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 they are forced to rank debt obligations above other spending, even for basic services like public safety, water, or sanitation. It helps if a capital project comes with a guaranteed revenue stream, such as the tolls for a bridge. Those factors are what disciplines state and local budgeting. In a downturn, state and local governments can only deal with lost revenues by cutting services.
Years ago, I organized a seminar for a bond expert who noted that although the state government of Illinois was a financial basket-case, its law protected the bonds it sold. Creditors would be paid before anyone else. In this sense, state governments rarely go bankrupt. There are a few cases of local governments going bankrupt. 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. The citizens bear the burden of a downturn, in the form of a contraction of vital public services. The creditors are usually made whole.
Two key considerations 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 Gross Domestic Product at the state level. There are published numbers, but they involve some hocus-pocus.
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 to make the temporary increase in Medicaid grants sensitive to state economic conditions.
It isn’t perfect. The monthly state unemployment data is ‘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 the states, on the grounds that state governments will have a better handle on intra-state conditions. Their considerations, of course, will also depend on the state government’s solicitude towards 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.
In the fight over recovery act money during the Great Recession, Senator Jay Rockefeller of West Virginia played the heroic, selfless role. Senator Max Baucus only cared about what was in it for Montana. Certain Republican Senate staff were most concerned with how to screw California and New York. There was one in particular, whose name I have forgotten, with absolutely the worst hair plugs you have ever seen. It looked like it had been done by a first grader with library paste and dog hair. It was painful to look at.
For the most recent annual data available, state and local governments spent $2,364 billion. A ten percent downturn in GDP, right now an optimistic estimate, would roughly translate to a $236 billion hole in their budgets. You could double or triple that number to simulate the impact of a 20 or 30 percent fall in GDP.
To some extent, state shortfalls will filter down to local governments. Services of all types will have to be curtailed. That means police, fire, corrections, education, sanitation, etc.
The latest Congressional action provides $150 billion to the states, clearly inadequate, and an unnecessary brake to economic recovery. At this point, it looks like the money will be distributed on a straight per-capita basis. It’s the simplest option, which may be encouraged during an emergency, since it minimizes arguments. More sophisticated designs are possible, but once politics is involved, it becomes more of a food fight. With a more enlightened Congress, better technical fixes would be more feasible.
Speaker of the House Nancy Pelosi has noted that the state aid breaks with usual practice and fails to treat the District of Columbia like a state. The aid has a floor for states with the lowest population counts. For no rational reason, the district’s allocation has been set well below that minimum, even though the district has higher population counts than several states. It’s a disgrace.
One available pipeline to increase aid, used after the previous recession, is the Medicaid program, as the National Governors Association has proposed. What’s also in store, on top of the $150 billion noted above, is an increase in Medicaid matching rates for all states. Insofar as Medicaid eligibility expands, this will be eaten up in increased medical services. The rest is effectively unrestricted fiscal assistance, not a bad thing.
An even percentage expansion of Medicaid matching rates has the advantage of being somewhat sensitive to state conditions, but the data employed to determine the rates is not current. In the Obama recovery package, the increase in the matching rate was further modified to reflect up-to-date state unemployment rates.
The advantage of distribution by formula is that it broadcasts what every state will get, which facilitates planning. It is easy to agree upon and the mechanisms are already in place, so the money can be moved quickly. The provision of unrestricted funds in the current moment is justifiable, since it affords discretion to state governments that are better situated to assess needs in their own budgets than is the U.S. Congress.
State governments are not always the most solicitous of local needs in urban areas, but we have to go to this war with the system we have. Whether the politics of this struggle will yield a better system for the future remains to be seen.