Thursday, July 23, 2009

States and the Financial Crisis




James Surrowieki has an interesting article in the New Yorker
about the financial crisis and how it's affecting the
states.

I think Surrowieki is right in noting that states could
retard the process of recovery. Most states are required by
law to balance the budget.

The bad economy means more people out of work and less tax
revenue. That leaves states two bad options. They can cut
back on important social programs which will make the
downturn even harder on the poor. These cuts could
eventually compromise the quality of public schools, or
force states to cut financial aid for poor students. That
will make it even harder to climb the economic ladder for
poor kids.

Alternatively, states can raise taxes. But given the depth of
their budget gaps and the number out of work, taxes would
have to rise a lot on those with jobs. That could depress
consumer spending which would prevent the economy from
recovering. States with high income taxes like California
and New York will have to worry about whether their rates
will cause the wealthy and entrepreneurs to leave, which
could leave the tax base even smaller.

My hunch is that some mix will happen. Taxes will rise, and
services will be cut at precisely the worst time for such a
thing to happen.

In the short term, the federal government can step in and
help states by providing aid as the stimulus package has
done. But all that does is increase the federal debt, which
means income taxes might have to rise eventually. Still
since the feds have a bigger borrowing capacity than the
states, this is a realistic option.

Would it be a good idea for the states to nix heir balanced
budget requirements? In this crisis, sure. But I do see the
value of having such an amendment to restrain politicians
from borrowing endlessly. In most good years then, the
requirement is a good thing. But perhaps there can be an
exception made for times of crisis like this.

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