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Why It Makes No Sense for States to Cut Services and Raise Taxes Now
With the real economy continuing to shrink, and unemployment or underemployment now claiming almost one out of six American workers, the economy will almost surely be more than $1 trillion short of its capacity this year, and another $1 trillion short next year. That means the $787 billion stimulus package covering 2009 and 2010 won't nearly do the trick-- even if every federal dollar of it stimulates $1.5 dollars in private spending (about the most that can be expected). Don't count on the bank bailouts to stimulate much of anything except fat paychecks for bank executives and directors. Unless or until Americans get their jobs back and feel more secure about the future, they won't borrow.
Sinking or vanishing American incomes are also causing tax revenues to drop. That's not much of a problem for the federal government, which can run deficits. But most state governments are required by their state constitutions to balance their budgets. Even though the states will be getting some stimulus money, their revenues are falling even faster.
The result? States continue to cut back vital services. They're chopping K-12 school budgets, whacking after-school programs, cutting back on child health, reducing aid to the homeless, and cutting other social services that are more important now than when the economy is doing well. And when they aren't cutting services, the states are raising taxes. At least ten states are considering major increases in sales or incomes taxes -- including Connecticut, Illinois, Massachusetts, New Jersey, Minnesota, Oregon, Washington, and Wisconsin. California and New York have already instituted multibillion-dollar tax increases that went into effect earlier this year.
All told, state service cuts and likely tax increases will total about $350 billion over 2009 and 2010. This is nuts -- exactly the opposite of what government needs to be doing. That $350 billion is a huge fiscal drag on the U.S. economy. It essentially negates almost half of the federal stimulus.
Let's hope the Obama administration returns to Congress soon for a second stimulus -- a large chunk of which should help the states maintain vital services and avoid tax increases, and that Congress heeds the request. (And let's hope the administration makes this pitch to Congress before it tries to get more money for the bailouts of Wall Street, the automakers, life insurers, or any other industry whose bondholders and shareholders should be taking the hit rather than taxpayers.)
Sinking or vanishing American incomes are also causing tax revenues to drop. That's not much of a problem for the federal government, which can run deficits. But most state governments are required by their state constitutions to balance their budgets. Even though the states will be getting some stimulus money, their revenues are falling even faster.
The result? States continue to cut back vital services. They're chopping K-12 school budgets, whacking after-school programs, cutting back on child health, reducing aid to the homeless, and cutting other social services that are more important now than when the economy is doing well. And when they aren't cutting services, the states are raising taxes. At least ten states are considering major increases in sales or incomes taxes -- including Connecticut, Illinois, Massachusetts, New Jersey, Minnesota, Oregon, Washington, and Wisconsin. California and New York have already instituted multibillion-dollar tax increases that went into effect earlier this year.
All told, state service cuts and likely tax increases will total about $350 billion over 2009 and 2010. This is nuts -- exactly the opposite of what government needs to be doing. That $350 billion is a huge fiscal drag on the U.S. economy. It essentially negates almost half of the federal stimulus.
Let's hope the Obama administration returns to Congress soon for a second stimulus -- a large chunk of which should help the states maintain vital services and avoid tax increases, and that Congress heeds the request. (And let's hope the administration makes this pitch to Congress before it tries to get more money for the bailouts of Wall Street, the automakers, life insurers, or any other industry whose bondholders and shareholders should be taking the hit rather than taxpayers.)
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The stimulus should have been larger in the first place and the tax-cuts were unnecessary.
April 9, 2009 5:05 PM | Reply | Permalink
Right. More money to kindergartens and the homeless. That'll really stimulate the economy. Mr. Reich, perhaps you could consider the idea that blowing wads of money to non-stimulative purposes actually retards the economy?
There was a $300B highway bill signed in 2005. Any idea as to the stimulating effect of that particular pile? Did anything actually get built? I don't know. How about you?
Maybe you'd like to explain how social services push along investment in hardware or new building?
April 9, 2009 5:51 PM | Reply | Permalink
Most every nickel that goes to poor people gets spent. People spending money is what powers the economy. Most of the money that goes to rich individuals does not get spent, as Mr. Bush and the conservative Congress demonstrated for six years.
April 9, 2009 10:19 PM | Reply | Permalink
Presumably you don't build new stuff unless there's a need. So a population that's more stable and therefore able to spend a few bucks might push the creation of new building and infrastructure.
On a slightly related note, government committees that look at debt-financed capital project requests will be very sensitive to both issues of need and availability of operating funds for the future. Nobody wants to get stuck with approving a nice new building if it doesn't seem there will be money to operate it in future. So in this sense Reich is correct about the chilling effect of state and local budget cuts.
April 10, 2009 12:28 AM | Reply | Permalink
Mr. Reich, thanks for bringing this up. The states and cities are where the rubber meets the road in terms of keeping peoples' lives from slipping into chaos.
As examples for those like shooter who question this sort of thing: someone buys an investment property in a neighborhood that's getting better. The state cuts the city's budget, and the city responds by cutting a lot of programs, including cutting the police budget by 20%. Almost immediately, crime skyrockets in the investor's neighborhood, it's impossible to get paying tenants, and the place drops into foreclosure. People need consistency in order to lead their lives and do business. Cuts in services do have negative effects.
As for kindergartens and homeless programs, first of all they are staffed with people who will have no jobs if the programs are cut. Second, sudden changes in childcare availability lead to sudden changes in peoples' jobs. And less help for growing numbers of homeless people means more people breaking into empty homes, and more people roaming the streets.
April 9, 2009 7:04 PM | Reply | Permalink
. . . bank bailouts [won't] stimulate much of anything . . . until Americans . . . borrow [again]. Robert Reich
I suspect most of us, here, agree with this claim and find it uncontroversial.
It should, then, surprise us to learn that Bernanke, Summers and Geithner, all of whom are bound and determine to pump up bank capital, disagree. They are confident that handing the banks money will,. all by itself, increase lending (and crucially, increase the money supply). Why do they think that? And why are they wrong?
Being slaves to conventional economic theory they believe that the Federal Reserve Bank, through the magic of fractional banking, controls the production of credit (the increase/decrease of the money supply) by setting
1) manipulating interest rates or
2) altering reserve ratios or
3) creating bank reseves (printing money) or a combination of all three.
But banks and not the FRB control the production of credit. They advance loans when they think they'll make money (3Cs) and can find people and more importantly, firms who are willing to borrow. Only after they've made the loans (typically, lines of credit to firms) do the banks go looking for capital from the market place or cash from the Fed to meet their reserve requirements.
If the conventional theory subscribed to by B,S & G were correct, when coming out of a recession we should expect to see M0 or M1 expand ahead of the expansion of GDP as lowered rates and pumping by the FRB gets the ball rolling. Do we? We don't.
Professors Kydland and Prescott looked at the real world and having gathered the statistics showed that pro-cyclical changes in GDP lead changes in M1 -- up and down.
Conclusion: Bernanke, Summers and Geithner are not just throwing taxpayer money at undeserving banks; they're throwing it away -- just as Bob Reich implies, above.
April 9, 2009 9:00 PM | Reply | Permalink
:( but good comment.
Pumping up bank capital seems to be looking at only the wrong slice of the pie, instead of all the slices together as a pie.
Given that I've pointed out a [weak] case for treason at the Treasury, it might surprise a reader that I hope that I'm wrong about the pie. If I'm right, we're screwed. If I'm wrong, we the public here are the ones who are not seeing the whole picture. Geithner is acting weird not because he's lost or blind (or criminal) but because the larger picture is more complicated. But in that case it seems the whole picture must be pretty terrible, in which case it seems we're screwed anyway.
Roubini has been saying $1.8T realized "bank" losses for some time now. Is there a [good] reason Geithner is not saying anything along these lines, even if subtly (maybe I've missed them)? I read somewhere that bank write downs have passed $800B so far.
April 9, 2009 11:57 PM | Reply | Permalink
Ellen, I am trying to understand what you are geting at. It seems you and Reich agree that people need to borrow again. It also seems that you are saying that by throwing money at the banks we are priming the pump at the wrong end.
Adding to the picture your focus on savings as the solution to depression, I have the sense that you consider the bank customers, (whom I will call consumers but it includes firms) to be the key, and the steps would be:
1) Tapped-out consumers realize they have overborrowed and cut expenses (or just stop buying because they have no credit).
2) Economy slows down.
3) Consumers continue to cut expenses, get on an even keel. (Pay down debt, etc.)
4) Consumers begin to save.
5) At some point after the saving, consumers are freed up to spend. They do so, and feel confident enough to even borrow again, and prosperity returns. (This is where your view meets up with Reich's.)
I'm sorry I don't understand your numbers, but if this is the gist of what you are saying, then it seems we ought to be helping consumers (individuals and small firms) get sorted out, or at least stand back while they do so, and not load the banks up with money they can't in good conscience loan out.
Is this where you are going? The last big depression took about 10 years and a few years with govt as a huge employer and nothing to spend money on during the war, in order to get the public to save enough for a return to prosperity. What's the time frame on this thing?
Mr. Reich, I hope you can comment on this--I am always impressed when you and Ellen find a point of agreement.
April 10, 2009 12:51 AM | Reply | Permalink
more
3a) "Consumers continue to cut expenses, get on an even keel. (Pay down debt, etc.)"
3b) Producers cut back, materials and labor
3c) Unemployment payments keep some consumers from doubling down on #3a
3d) Materials suppliers cut back...
3e) Some unemployed start falling off insurance and thus double down on #3a
If this goes too long or too far, tax revenues are hit badly while government spending is already up, thus larger deficits.
April 10, 2009 1:40 AM | Reply | Permalink
Let us presume that the ongoing crisis is a "balance sheet recession"* -- a post-asset bubble attempt of firms and consumers to repair their balance sheets by reducing debt.
Do the economic and financial theories that B, S & G are wedded to provide a solution? Today, Krugman reminds us that Raghuram Rajan, back in 2005 at the annual Jackson Hole conference, warned** "this supercharged financial system might come to a bad end."
Krugman's purpose for raising the point is to foreground Larry Summers' reaction. According to Krugman (and Justin Lahart at WSJ), Summers "ridiculed Mr. Rajan’s concerns."
As Dean Baker likes to ask, should people who chose not to see or were incapable of seeing the coming crisis be put in charge of crafting solutions when the crisis arrives. Or as Krugman implies, do their preconceptions explain why they failed to see the looming disaster and make them incapable of designing repairs to a system that they continue top believe is, basically, sound?
Summers and Geithner must go!
* See below for links
April 10, 2009 9:31 AM | Reply | Permalink
* a balance sheet recession
** warned
April 10, 2009 9:32 AM | Reply | Permalink
As I read the Jackson Hole thing, the anti-Summers crowd has spun it out of all proportion. I looked at it months ago, so maybe my memory is faulty, but I think if you look at what Summers actually said in context, and what he was addressing, it's not what's being made of it.
That said, "repair their balance sheets by reducing debt" seems to fly in the face of "getting banks lending again" aka "get debt growing again". But it might not be that simple. It could for instance be that the people who could make good productive use of debt are not getting it, while others who were overleveraged need to continue to deleverage and reduce debt.
But Finance Sector debt strikes me as non-productive debt. Lending people money to speculate on the stock market is pretty far from lending money to producers of real value (aka "value investing"). And a similar but slightly different problem applies to speculation in the housing market.
One part of the problem is that general expectations for future returns and future wealth were inflated by this speculation, across a very large part of the population. So people are now dealing with disillusionment, and some people who rely now on the sale of stock investments to survive or maintain an above poverty lifestyle may be hurting now (selling off assets to live on, their effective incomes might be down 50% from 2 years ago).
April 10, 2009 1:06 PM | Reply | Permalink
I'll admit I wasn't aware of the January "pro and anti" debate over what Summers said or what his tone of voice was.
Who defended Summers? Any links?
April 10, 2009 8:01 PM | Reply | Permalink
It would have been me questioning the anti-Summers crowd, for one, and it might have been in late 2008. I don't believe I ever did my own blog on it, I just couldn't figure out the brazen and unexplained antipathy from the likes of Baker and Reich (to mention two TPMers I believe were anti-Summers). It was like "if you don't know, you're not worth dealing with".
It might turn out that Summers is screwing us over, but so far the arguments against him have not made sense to my naive born-again moralist way of approaching politics (except as signs of personal grudges or the like) -- with the exception that despite being really smart on this stuff he's maybe got a blind spot which is not being confronted well. I really don't get him as a criminal type, more a shadow government hack, the economic equivalent for Obama of the politics role Rove played for Bush or Cheney for Bush in general.
I'm more concerned with specific initiatives such as PPIP, than with the people behind them. And the lack of information and meaningful public debate, of course...
April 10, 2009 8:46 PM | Reply | Permalink
Of course there's a third way, which is to simply cut services. That's the scenario playing out here in South Carolina, where unemployment is endemic and plunging per capita income has been a fact of life for years. Whenever the legislature begins to show some spine their attention is miraculously diverted by one of the issues that really matters in these parts, like putting religious slogans on license plates.
I guess when you got nothin', you got nothin' to lose.
April 9, 2009 10:07 PM | Reply | Permalink
I don't agree about which services are vital, and we do need to make choices at some point, not all services are necessary and not all services are "stimulative".
You kind of bury your point the way you present it. Your point is that Congress needs to get more aid ready for states ASAP. But the title and the first parts hide that.
"Why It Makes No Sense for States to Cut Services and Raise Taxes Now"
It's NECESSARY to make cuts and adjustments. You believe that Federal borrowing should be used to buffer this. If Federal borrowing is cheap, and the money is used wisely, I'm okay with that. But those are two big "ifs" and I believe it's important to at least make adjustments if not radical cuts. State and local governments have in many cases been LEADING the over-spending binge which consumers took part in. Government is not a sacred cow. We must be prepared to "thin the herd" while aiming to keep important social services and vital economic functions running well enough.
BTW, your recent blogs have doubled up on the last paragraphs as though the TPM software isn't quite working (or being used) right.
April 10, 2009 1:51 AM | Reply | Permalink
"states are raising taxes...This is nuts -- exactly the opposite of what government needs to be doing."
This is the part I have trouble with. Raising taxes in an economic downturn is not "nuts", especially if they are raised on high income residents. Reich's article seems to fly in the face of Orzag and Stiglitz's assertion that:
“Tax increases on higher income families are the least damaging mechanism for closing state fiscal deficits in the short run. In a weak economy, it is particularly important to minimize reductions in overall spending. And reductions in government spending on goods and services, or reductions in transfer payments to lower‐income families, would result in relatively large declines in total expenditures in the state. But tax increases on higher‐income families tend to reduce saving, not spending, since such families save a large portion of their income.
Furthermore, consider a little recent history: The increases in federal taxes on upper‐income Americans in 1993, which were used to close the yawning budget gap at that time, preceded the strongest boom the US economy has had in more than a generation. There is no evidence that these tax increases harmed the economy—and considerable evidence that the deficit reduction that they helped finance was beneficial."
April 10, 2009 9:18 AM | Reply | Permalink
I have to agree with this one -- taxing households that are not consumption-constrained seems like a pretty good idea. It basically gets money back into rapid circulation without affecting consumer spending significantly.
Figuring out how to target such taxes is difficult, especially because states will potentially be working against one another, with some hoping to attract the mobile rich by having lower tax rates.
April 10, 2009 1:36 PM | Reply | Permalink
If it's Federal and over $500K, how would that be problematic? It would take money which would be spent on luxury items or services, or would be invested, and invest or spend it elsewhere on nominally better things.
April 10, 2009 2:11 PM | Reply | Permalink