Extending the State FiscalRelief Provisions of theAmerican Recovery andReinvestment Act (ARRA)

A Fiscal Policy Institute Reportwww.fiscalpolicy.org

June 2010

FPI

June 8, 2010

Extending the State Fiscal Relief Provisions of theAmerican Recovery and Reinvestment Act (ARRA)

During recessions the federal government tries to stimulate the economy (i.e., “prime thepump”) by increasing spending and cutting taxes. This requires deficit spending. Butstate governments have to balance their budgets in both good times and bad. So, tobalance their budgets during recessions, states almost always end up cutting spendingand/or increasing taxes, thus putting more drag on the economy rather than less.Since the federal government is responsible for overall macroeconomic management, itmakes sense for the federal government to provide fiscal relief to the states duringrecessions to reduce the amount of budget cutting and tax increasing necessary at thestate level. If the federal government doesn’t help the states during recessions, then statebudget-balancing actions will cancel out a greater portion of the positive impact of federal stimulus efforts.The “state fiscal relief” that was included in the American Recovery and ReinvestmentAct (ARRA) played a major role in allowing New York and the other states to balancetheir 2009-10 with fewer budget cuts and fewer tax increases than would have beennecessary otherwise.

This “state fiscal relief” should be extended so that its phase-out dovetails more closely with the recovery of the 50 states’ economies andfinances.

The two major forms of “state fiscal relief” included in the ARRA were a temporaryincrease in the federal share of state Medicaid costs (called the Federal MedicaidAssistance Percentage or FMAP) and the State Fiscal Stabilization Fund which providedfunds to avoid state and local layoffs particularly in the education. A 6-month extensionof the enhanced FMAP has been passed by the House of Representatives on severaloccasions in the past year and, on March 10, 2010, by the Senate. But to date, no singlebill with the 6-month extension of the enhanced FMAP has passed both houses of Congress. This week the Senate is considering a jobs and tax “extenders” bill in which itpreviously included the FMAP extension and has the opportunity to do so again.Using an economic impact model (IMPLAN), FPI estimates that if the lost federal fiscalrelief (from a failure to enact the 6-month FMAP extension) were absorbed over a 12-month period by state and local government layoffs, that the direct governmentemployment loss would be around 48,000 and that the indirect and induced employmenteffects, which would be mostly in the private sector, would be almost 29,000. FPI thusestimates that the total job reduction statewide (direct, indirect and induced) would beabout 77,000.

June 8, 2008

FPI

The federal government and state budgets during recessions generally

The federal government is responsible for the overall macroeconomic management of theU.S. economy. This is why, during recessions (which, by definition, are periods duringwhich consumer and business spending is low, thus slowing the economy and creating adownward economic spiral) the federal government works to stimulate the economy byincreasing spending and cutting taxes. This requires deficit spending, which the federalgovernment can, does and should engage in during recessions.State governments, on the other hand, have to balance their budgets in both good times andbad. To balance their budgets during recessions, states have to cut spending and/or increasetaxes, thus putting more drag on the economy. This means that states, left to their owndevices, have to do things during recessions that cancel out some of the positive effects of the actions that the federal government is taking to get the economy moving.Given that the federal government is responsible for overall macroeconomicmanagement, it makes sense for the federal government to provide greater fiscal relief tothe states during recessions than it provides during good times. By providing enhancedfiscal relief to the states during economic downturns, the federal government is able toreduce the amount of budget cutting and tax increasing that the states have to do tobalance their budgets. If the federal government doesn’t help the states duringrecessions, then state budget-balancing actions will cancel out a greater portion of thepositive impact of federal stimulus efforts than would otherwise be necessary.

The federal government and state budgets during the Great Recession

During the Great Recession that began in 2008, the American economy experienced thedeepest and most prolonged decline since the Great Depression. As part of this GreatRecession, state government revenues plummeted – literally falling off a cliff. This inturn has created large gaps between state revenues and expenditures.Fortunately, the federal government responded strongly and in a relatively timelyfashion. On February 17, 2009, less than a month after taking office, President Obamasigned the American Recovery and Reinvestment Act (ARRA) into law. The bulk of thispackage’s total estimated multi-year cost of $787 billion took the form of tax cuts (suchas the Making Work Pay Tax Credit) and transfer payment increases (like increased andextended Unemployment Insurance benefits) designed to increase aggregate demand andto kick start the economic recovery.The ARRA also included $135 billion that was explicitly for state fiscal relief. This aidcame in the form of two funding streams that were explicitly intended to help the states tomaintain essential public services in the face of sharply declining tax revenues:

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An estimated $87 billion in the form of a temporary increase (until December 31,2010) in the federal government’s share of state Medicaid costs (referred to as