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States Will Drag on Economic Growth and Job Recovery

State Deficits Will Continue Through 2009 and 2010

SOURCE: AP/Kelley McCall

A chart created on a large dry erase board to illustrate the budget troubles facing Missouri. The chart breaks down state funds by departments and compares monies available.

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State budgets are in trouble. State legislators, faced with declining tax receipts and a larger share of their populations requiring more government-provided services, have been forced to make deep cuts into their already stretched budgets. And this round of budget cuts will not be the last that states are forced to make as a result of the recession that began in December 2007. In fact, according to the Center of Budget and Policy Priorities, 48 states have either addressed or are now facing shortfalls in their budgets for the 2010 fiscal year, and 36 states are already anticipating shortfalls in fiscal year 2011. The situation may continue to worsen for many states, even if we are nearing the end of the recession.

Our analysis shows that state and local governments typically support the economy by increasing spending and employment levels during the first year of a recession when the private sector is declining. States have limited ability to modify the level of taxes and services for a fiscal year after they pass a budget, which means there is a lag between the decline in economic conditions and responses from the states. It also means that state and local governments tend to maintain their spending at pre-recession levels for the first year after a recession begins. State and local government employment levels therefore continue to rise during the first year of a recession, which moderates the intensity of the recession by providing the labor market with additional jobs.

State and local spending and employment have indeed helped prop up the currently weak economy. But the realities of state and local government budgets catch up during the second year of a recession as public sector employment growth slows and spending decreases. This is generally not a big problem because the private sector is usually already in full recovery mode, adding growth and jobs. Yet this recession is already in its second year and has lasted longer than any recession since 1933.

What’s more, the private sector is continuing to decline rather than expand; August’s loss of 216,00 jobs brings the grand total of jobs lost since the start of the recession to more than 6.9 million. And state and local governments are cutting spending and employment levels in the face of huge budgetary deficits, as is typically the case in the second year after a recession starts. These cuts will likely continue to deepen as the private sector struggles to recuperate, delaying the onset of a strong, sustainable recovery. Such a recovery will be more likely if state and local governments can continue to make a positive contribution to job growth in this comparatively severe and prolonged recession.

Table 1 shows the rate of job growth in state and local governments during the first and second year of each recession since 1957. Each year is counted from the start of the recession, as determined by the Business Cycle Dating Committee of the National Bureau of Economic Research. This table highlights the rise in state and local employment levels in the first year of a recession, which on average contributes an overwhelming 547,000 new jobs to the economy. The sustained levels of spending growth and job creation from state and local governments play a significant role in helping to reduce the sting of the economic downturn during the first year of a recession.

Job growth in state and local government

State and local governments generated 131,000 jobs in the first year of the current recession despite the high number of job losses in the private sector. This number is significantly lower than the average number of jobs created in the first year of prior recessions, but it demonstrates the resilience of state and local government employment, even in the worst recession since the Great Depression. It also reflects the fact that this is, by many accounts, the worst recession since the Great Depression and that state and local governments were forced to cut back more quickly on hiring earlier in the recession than has historically been the case.

Unfortunately, public sector job growth did not continue through the second year of prior recessions, and it appears that this recession will be no different. Many states are forced to adjust their spending during the second year of a recession to comply with their state constitution, which requires that they adopt balanced budgets. The growth of state and local government spending during the first year of the recession outpaces the growth of receipts due to reduced consumer spending and poor economic conditions. This results in expanding deficits (or shrinking surpluses).

Table 2 shows the average growth rate of states’ receipts and spending in both the first and second year of every recession since 1957. Spending grew by an average of 2.3 percentage points more than tax receipts during the first year of a recession. States typically reduce spending growth in the second year of a recession in order to align their budgets with their revised projected revenues. As Table 2 shows, the annual growth of state and local government spending slowed on average from 2.8 percent to 1.5 percent between the first and second year of a recession.

growth rate of real spending and taxes

State spending tends to grow more slowly than receipts in the second year of a recession due to states’ efforts to close their deficits. This occurs even though receipts grow faster during the second year than during the first year of the recession as the economy typically starts to recover during the second year. Employment growth for state and local governments is on average 1.2 percentage points lower during a recession’s second year than during the first year as a result of reduced spending growth.

State and local governments reduce the growth rate of employment for educational personnel—who comprise 52.9 percent of the state and local government workforce—by an average of 1.2 percentage points between the first and second year of a recession. Data is only available for the first eight months of the second year of the current recession, but educational employment has so far only fallen by 0.5 percentage points. Non-educational state and local government jobs have already declined by 0.4 percentage points.

This spending reduction by state and local governments may not have been very worrisome in previous recessions since the economy was generally recovering by the second year of the recession. Yet today we are arguably experiencing the most severe and long lasting recession since 1933. As this recession pushes through its second year, we can expect state deficits to continue to increase as tax receipts fall throughout 2009 and 2010.

Census data shows that state property tax receipts fell by only 4.9 percent in 2008, but these receipts plummeted by 33.2 percent in the first two quarters of 2009 alone. Local governments have also had problems collecting property taxes because the number of Americans not paying their taxes has increased dramatically and even doubled in some parts of the country. This drastic decrease in property tax receipts foretells larger declines in receipts for the remainder of 2009.

The Center on Budget and Policy Priorities estimates that state budget shortfalls will total $110 billion in 2009, $168 billion in 2010, and $180 billion in 2011. Almost two-thirds of the states have projected budget gaps for the 2011 fiscal year. States will have to make even more hard choices and severe spending cuts that will have serious ramifications for state and local employment and services. This comes at a time when workers, many of whom may have lost their jobs and health care insurance coverage, need extended unemployment insurance benefits, public health programs, and other state services more than ever.

The growth in state and local employment levels during previous recessions fell 1.2 percentage points on average during the second year of the recession (Table 1). If we conservatively assume that this recession is not more severe than the average recession, we can expect that state and local employment levels will fall by 1.2 percent during 2009. If this is correct, state and local employment growth rates will fall from a positive 0.7 in the first year of the current recession to negative 0.5 percent in the second year of the recession, causing a loss of roughly 99,000 jobs in 2009. More realistically, however, state and local employment will grow at a slower than average rate because of the broad reach of this recession and the large budget shortfalls facing the states.

If we therefore assume that the rate of employment growth falls by the same 2.6 percentage points that it fell during the 1980 recession, then state and local employment will shrink by 1.9 percent in the second year of the current recession for a staggering loss of approximately 375,000 jobs in 2009. This figure does not bode well for the economy’s recovery over the coming years.

State and local governments have thus far stimulated the lagging economy, but they have begun to reduce their employment levels. These reductions will likely persist longer than in the past, which will make it more difficult for the economy to recover.

Congress recognized the impending problem and contributed approximately $140 billion to the states through the American Recovery and Reinvestment Act, which passed in February 2009. Federal aid to the states is an effective stimulus because states can quickly transfer funds to workers and beneficiaries. This Act has already allowed a number of states to cut fewer jobs and services and has consequently limited the economic effect of the inevitable budget cuts. But the federal stimulus still only reduced 30 to 40 percent of the budget shortfalls that the states will face over the next two years.

Unless the federal government steps in again, states will still need to make significant spending cuts over the next two years, resulting in still further job losses and a slower economic recovery.

To speak with our experts on this topic, please contact:

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Print: Tom Caiazza (foreign policy, health care, energy and environment, LGBT issues, gun-violence prevention)
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Print: Chelsea Kiene (women's issues, Legal Progress, Half in Ten Education Fund)
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202.741.6258 or tarditi@americanprogress.org

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Radio: Chelsea Kiene
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