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Federal Loans a Poor Alternative to State Fiscal Assistance

In a New York Times op-ed, Chris Edley rightly warns that state budget cuts and tax increases are undermining federal efforts to boost the economy; that’s why we’ve recommended (most recently here) that Congress extend the state fiscal assistance in last year’s Recovery Act.

In contrast, Edley’s proposed solution — to allow states to borrow from the federal Treasury and repay it through cuts in future federal payments for programs like Medicaid — isn’t workable.  Some states might not be able to borrow these funds, and many of those that could borrow them wouldn’t want to because it would worsen the already difficult fiscal situation they’ll face after the recession.

The constitutions of five states prohibit debt altogether, according to the National Conference of State Legislatures, which could make it impossible for them to accept the loans.  At least 16 other states require voter approval of debt backed by general tax revenue; while it’s unclear whether borrowing from the Treasury for operating expenses would fall into this category, the matter could be tied up in debate or litigation for a substantial period of time, and it would take further time until such measures could be placed on state ballots and voted on in states found to require such approval.

To keep deeper state budget cuts from slowing economic growth, however, and to protect critical state services from severe cuts, the fiscal relief is needed now, not at some potentially distant future point.

Even states that didn’t face these barriers would want to think twice about accepting the proposed loans, which would add to the very large budgetary obligations they’ll already face when economic conditions improve:

  • In response to the sharp increase in unemployment, states are now compelled to borrow heavily from the federal unemployment insurance trust fund to finance the basic 26 weeks of unemployment benefits for which they are responsible.  By 2013, some 40 states will have borrowed $90 billion.  States already will be required to pay this $90 billion back.  (Since this is borrowing for a state trust fund rather than for state general fund expenses, the legal limitations noted above do not apply.)
  • States’ “rainy day” budget reserves have helped them cope with the historic drop in revenues in this recession, but those reserves are now largely depleted.  If states do not rebuild them when the economy recovers, they’ll be much less prepared for the next recession — and more likely to need substantial federal help when it hits.  The need to replace the cut in future federal support for vital programs would compete with, and in many cases render impossible, the rebuilding of rainy day funds.
  • States also will have to repay the money they’ve borrowed from themselves (e.g., from state pension funds and future revenue streams) to help balance their budgets as the economy recovers.
  • And states will need additional revenues to restore an appropriate level of public services in the aftermath of the deep cuts they’re now making in education and other critical areas.

Facing all of these pressures, states will be very hard pressed to do what Edley’s proposal would  require — raise billions of dollars more in taxes or make billions of dollars more in budget cuts to compensate for future reductions in federal support.

Fortunately, we don’t need to adopt an untried, unworkable loan mechanism to provide temporary aid to states to help them weather the worst economic downturn since the Depression.  The fiscal assistance in last year’s Recovery Act, by closing part of states’ budget shortfalls, has preserved hundreds of thousands of jobs and kept state budget problems from acting as an even bigger drag on the economy.  With the economy very weak, unemployment very high, and state revenues deeply depressed, Congress should extend this assistance for a modest additional period, as legislation pending in Congress would do.