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State economist addresses states' pain

January 2009

Pro-cyclical pain afflicts the states

TomPotiowsky By Tom Potiowsky

I’ve been thinking about the movie Independence Day. It starred Will Smith and Jeff Goldblum and an alien attack on earth. Toward the end of the movie, the entire world coordinates efforts to launch an offensive attack against the alien invasion. This is the first time the governments of the world have joined forces. President Whitmore (Bill Pullman) addresses the ragged group of pilots: “We are reminded not of our petty differences but of our common interests.” When the world is in danger, you put aside politics and pull out all the stops to survive.

The global effort to save the world financial system has the same feel as this movie. The toxic assets held by our financial institutions were surely devised by some evil alien scientists from another solar system. Governments around the world are devising bailout packages, lowering interest rates, guaranteeing assets and infusing financial institutions with needed capital —a worldwide effort to save the planet (maybe that’s a bit over the top, but the world financial system is pretty darn important).

Since the national governments are all moving in the same direction to assist the financial system and alleviate a global recession, most certainly state and local governments in the U.S. are doing the same thing. But we have heard very little about state stimulus packages or state tax-rebate programs. What are state and local governments doing to counter the ill effects of the housing collapse and financial market meltdown?

Recessions impact state government budgets and federal budgets in the same ways. Tax revenues decline while the demand for government services rises as unemployment increases. Whereas the federal government can deficit- spend, states have to balance their budgets. So while the federal government is racking up an estimated $1 trillion deficit to undertake all its rescue measures, state governments have to close their budget holes with combinations of drawing down reserves, spending cuts and tax increases. The rest of the world is undertaking measures to help economies and state governments are forced to take actions that are detrimental to economies.

For fiscal year 2009 (July 2008 to June 2009), the Center on Budget and Policy Priorities estimates the budget shortfall for all states to be $71.9 billion, or about 12.2% of total general fund resources. This number is most likely higher today given that Oregon (and other states) is not on the list of states with budget shortfalls and faces a deficit of $142 million. And as the recession drags on, this shortfall will likely spill into fiscal year 2010. Projection for the Oregon budget shortfall for the 2009-2011 biennium is around $1.2 billion.

The Oregon budget for this biennium and next will be pro-cyclical — meaning that the state must undertake action that will make the recession worse. Projected spending this biennium and next must be reduced. In 2009-2011, a number of measures are proposed to close the budget hole. A sampling of these measures includes a 2-cent gas tax increase, raising minimum corporate taxes, a cigarette tax increase, work furloughs and no cost-of-living wage increases for state employees, and reducing the size of various government programs.

The state cannot avoid the pro-cyclical impact on the economy but can be prudent in how to close the budget hole. To avoid the impression that this article is taking a partisan stance, let me simply say that the governor’s budget takes a look to the future in balancing the budget.

A good deal of this pro-cyclical pain can be avoided with federal government assistance. Back in 2003, the federal government provided about $20 billion in the form of Medicaid assistance and general block grants to the states. A similar and somewhat larger package is needed today. Federal grants to states could assist with the growing need for social services and fund capital infrastructure from roads to buildings. Oregon has a number of public infrastructure needs: bridges, roads, public transit, earthquake retrofit for buildings and huge deferred capital maintenance, especially at our public community colleges and universities. This would be a great opportunity to retrofit buildings to meet sustainability and “green” standards, and what better place than Oregon to lead the way.

If Congress sees rescue packages to investment banks, insurance companies, commercial banks, homeowners and car manufacturers as needed medicine to keep this economy afloat, then surely the states are equally important in this game plan.

Short of this, I recommend the state of Oregon start the application process to become a commercial bank before all the TARP money is spent.

Tom Potiowsky is Oregon’s state economist.

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