The Brass Tack

Let's get down to it.

Stimulate the states

Posted by srconstantin on July 13, 2009

Matt Rognlie is absolutely right: filling in state budget shortfalls is the best thing the stimulus does and the only reason we might consider a second stimulus.

There is, however, one kind of stimulus that we can be certain will decrease unemployment, in almost direct proportion to the amount we spend: aid to states. Lacking the ability to issue long-term debt during a downturn, states are forced to make massive cuts to their budgets, and the effects are devastating. Laid-off employees go onto the jobless rolls (costing the government in unemployment benefits), no longer provide vital services, and damage the broader economy by cutting spending. Yet some “budget hawk” Senators decided to remove a large fraction of this singularly effective measure from the last stimulus bill, when almost every other part of the bill was clearly less effective.

Aid to states is fast and adds jobs instantly, unlike slow infrastructure spending. That is, unlike most of the stimulus package, state aid actually stimulates the economy. Another point I would add is that one of the main arguments put forward as to why stimulus fails — that increased government spending crowds out private investment — falls apart when the grants are from the federal government to the state governments. And there’s not even a small-government case for refusing state aid: Christina Romer has shown that reducing revenue doesn’t have a “starve-the-beast” effect on government spending. (Paper here.) It seems to me that the budget hawks are misguided, as are the conservative governors who refused budget aid from the first stimulus.

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