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Broke US States Pose Growing Threat to Recovery

Sunday, 08 Aug 2010 03:48 PM

The U.S. economy may sink perilously close to another slump, as cities and states cut jobs and curb spending to balance their recession-ravaged budgets.

Two-thirds of the 50 states projected budget gaps for their current fiscal year. They started out the period with a cumulative $84 billion hole, government associations estimate, an amount equal to 0.6 percent of total U.S. output.

Cities facing shortfalls may have to purge nearly 250,000 jobs from public payrolls over the next 18 months, according to a recent survey, potentially enough to drive up the jobless rate by roughly 0.2 percentage point.

None of that is welcome news for the White House or for politicians, ranging from U.S. senators to small-town mayors, who will face reelection in about three months.

The economy and jobs are the dominant issues in virtually every election this year. Budget woes are making both worse.

"We know state and local governments are struggling and they are going to be a drag on the recovery," Christina Romer, a top White House economic adviser, said in a recent interview with Reuters Insider.

The looming fiscal cutbacks are probably not severe enough on their own to trigger a fresh recession, but they could very well push economic growth to near stall speed and leave the economy vulnerable to another downturn.

The U.S. economy has been growing for a year, but state and local finances have worsened because high unemployment drained jobless insurance funds and reduced sales tax revenue, while the housing bust crushed property tax receipts. Neither shows signs of a quick recovery.

"Without economic growth, without a (healthy) housing market, most state and local governments are hurting buckaroos," said Joel Naroff, an economist who advises state and local governments.

Unlike the federal government, which is running a nearly $1.5 trillion deficit this year, 49 of 50 states have balanced budget rules that bar them from spending more than they take in — Vermont is the lone exception.

They must cut spending or raise taxes to plug the gap. The federal government has cushioned the blow by channeling $224 billion for education, health care and unemployment insurance to states as part of last year's stimulus package, which had a total price tag of $862 billion.

Even as the federal government ramped up its recession-fighting spending, state and local governments had to cut back, blunting the impact of the stimulus.

Federal spending excluding defense rose at an 18 percent annualized rate since the start of the recession in December 2007. By contrast, state and local government spending fell at a 2 percent pace over that time.

It is a similar story for employment. A survey released last week by three government associations estimated that local governments will cut 481,000 jobs between 2009 and 2011.

As of last month, local governments had laid off 234,000 workers, which suggests another quarter of a million job cuts still to come. By contrast, the federal government has added 214,000 since January 2009, although some of that reflects temporary hiring for the 2010 Census.

Washington's stimulus jolt may have limited the local job cuts. The municipal labor force is down about 1.7 percent from a September 2008 peak. In the deep double-dip recession of the early 1980s, the local labor force shrank by 3.8 percent.

The pace of layoffs, however, may be picking up.

Labor Department data released Friday suggested local governments aggressively cut jobs in July, which for most marked the beginning of their fiscal year. There were 38,000 jobs cut last month, nearly triple the number lost in June. State governments cut another 10,000 in July.

"That reflects their very tough budget situation," the White House's Romer told Reuters Insider Friday.

Government spending also looks likely to fall further. Most states have enacted budgets for the current fiscal year that include deeper cuts than in the previous two years, according to the left-leaning Center on Budget and Policy Priorities.

Those cutbacks are coming at the same time that the federal stimulus money is drying up. Taken together, it puts a drag on gross domestic product equal to 1.7 percentage points, Goldman Sachs economist Andrew Tilton said.

Economists in a Reuters poll forecast a GDP growth rate under 3 percent for the next four quarters, leaving little margin for error.

Tilton thinks the picture may be even more grim than the consensus view. The economy grew at a sluggish 2.4 percent pace in the latest quarter. Much of that gain came from government spending and the build-up of business inventories, two factors that are fading fast.

If growth is to accelerate from here, consumer spending will have to strengthen. Tilton thinks it will, but not robustly enough to prevent a significant slowdown.

"It's not just that it needs to pick up. It needs to pick up significantly in order to keep growth where it is now," he said.

The current quarter may be the toughest period because it includes the start of the fiscal year for most municipalities.

"They're already making those cuts now," said Naroff, the economist who advises local governments. "If it's going to have an impact, look at the third quarter of this year. That's a place where we've got to worry about it."

What to do about the problem is controversial. The White House argues that leaving states to fend for themselves risks driving up unemployment and derailing the recovery, and has pushed hard for further assistance.

But some conservatives counter that bailing out governments that overspent rewards fiscal irresponsibility.

The Federal Reserve Bank of Chicago weighed in this week with a research paper examining the effectiveness of fiscal assistance since the 1970s. The conclusion was that helping state and local governments is generally not a good way to boost the economy.

"If the federal government's primary purpose were to provide an economic stimulus, it would probably be better off simply spending the money directly rather than funneling it through the states," the paper said.

The researchers also warned that if states believe Washington will always come to the rescue, they have little incentive to make difficult budget decisions. The same "moral hazard" argument was raised over the bank bailouts in 2008.

Aside from a $26 billion aid package, which the U.S. House of Representatives cut short its summer break to vote on next week, it looks unlikely that states and local governments will receive any more help from Washington.

Naroff said that might be for the best.

"My personal view is, it's about time a lot of them started realizing that there's not an infinite well of money out there," he said.

© 2017 Thomson/Reuters. All rights reserved.

 
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The U.S. economy may sink perilously close to another slump, as cities and states cut jobs and curb spending to balance their recession-ravaged budgets. Two-thirds of the 50 states projected budget gaps for their current fiscal year. They started out the period with a...
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2010-48-08
Sunday, 08 Aug 2010 03:48 PM
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