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State Spending Impacts National Economy
Subject State Government Spending
Topic Fiscal Policy
Key Words Fiscal Policy, Pro-cyclical Fiscal Policy, and Entitlement Programs
News Story

Unlike the federal government, many state governments face constitutional or legal mandates to balance their budgets. Because of these requirements, state and local fiscal policies tend to be pro-cyclical. Although California is running a budget deficit, the state is facing a necessary budget cut of about $8 billion. The cuts are most likely to come from education expenditures and programs that help the poor and disadvantaged. "We have been shifting a lot of spending for social services from the feds to the states,' said Robert M. Solow, a Nobel laureate in economics. "And that means the cuts that are taking place are hurting people at the bottom of the income distribution."

The situation could be worse were it not for most states ability to do some creative financing. Illinois has sold its large glass office building in downtown Chicago, pocketed the sales revenue and is now renting it back. Many states are resisting the need to lay off workers, instead opting to freeze hiring and wages and not fill vacancies as workers resign or retire. Minnesota has even stopped providing free public defenders; defendants must now pay at least $50 and sometimes more for the service.

In a period of only three years, state spending has gone form being a stabilizing force in the economy to a negative force. Early in the recession when private spending was slacking, state revenues remained strong and provided stimulus for the economy. Now, with most states having to cut budgets they have become an additional drag on the economic recovery. If it had not been for this reversal in the state contributions to the national economy, some economist say the national economy would probably be growing at an annual rate of more than 3 percent.

Nicholas Johnson, director of the State Fiscal Project at the Center on Budget and Policy Priorities in Washington, says, "It is reasonable to think that the response by the states to the fiscal crisis is taking at least half a percentage point out of the growth rate of the national economy."

(Updated August 27, 2003)

Questions
1.

Explain the notion of pro-cyclical fiscal policy as it relates to state government finance.

2. Is a balanced budget expansionary, contractionary, or stable?
3. How are state budgets affected by "fiscal federalism"?
4. What are entitlement programs?
Source Louis Uchitelle, "Red Ink in States Beginning to Hurt Economic Recovery," The New York Times on Line, July 28, 2003.

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