State budgets will face severe stress as lockdowns constrict economic activity and tax revenues dry up. During the Great Recession, this drove massive state and local job losses that contributed to the economy’s negative spiral (state and local employees far outnumber the federal workforce). To prevent this, the Federal government should make large grants to the states proportional to population.
Recently some Republican politicians have expressed strong opposition to “bailouts” for state and local governments during the COVID-19 crisis, arguing that the states in need were irresponsible before the crisis. This may be true in some cases, but I expect almost all states will face substantial fiscal pressure by the end of 2020.
The Federal government should be the primary means by which we fund stimulus and stopgap measures during recessions. It has several advantages over the states, including (i) the ability to borrow at much lower interest rates, (ii) an enormous borrowing capacity, and, most importantly, (iii) the ability to self-fund its deficits as needed. Conversely, most state and local governments must balance their budgets, which may be fine during normal or boom times, but is extremely difficult during recessions, when tax revenue plummets and more people access unemployment insurance, food stamps, etc.
While the Federal government is the best way to fund anti-recession efforts, leaving the decision of what to do with the money up to the states is probably the best way to ensure broad political support. States with large public workforces could use the money to minimize layoffs, while other states may want to send the money directly to their residents or invest in infrastructure.
The money should be allocated on a per capita basis. While populous states would receive more cash in total, the lower cost of living in less populous states makes each dollar go further.
While Federal grants to states will be crucial to fight this crisis, the U.S. should also make this a permanent policy. A state and local budget crunch will happen in every recession and unnecessarily exacerbate economic pain.
Despite some initial rhetoric against “bailouts”, I am optimistic about this policy. So far it seems that having a Republican president in office has quieted most of the party’s debt doomsayers. Likewise, since their states generally have the most need, hopefully Democrats will resist the temptation to make the grants overly prescriptive, such as requiring the money be spent a certain way. Both parties are motivated – we should pass this while we can.