Why State and Local Governments Need More Stimulus Funds

Several days ago, Aaron Pacitti, an assistant professor at Siena College in NY, emailed this attempt to strengthen the case for providing more stimulus funds to state and local governments. A key part of the argument is the claim that “state and local government employment lags that of the private sector by approximately one year.” I wasn’t fully convinced by the evidence given for why there was a one year lag (the case for more help can be made in other ways and is relatively strong even if this doesn’t hold), so I emailed back asking if there was any way he could strengthen his case by providing additional evidence on this point. He responded with the amended version below, and while I’m still not sure this link in the argument has been securely nailed down, I thought I’d let you decide for yourselves: 

Why State and Local Governments Need More Stimulus Funds, by Aaron Pacitti: Casey Mulligan disputes the idea that stimulus funds should be directed toward state and local governments because they are not shedding jobs as rapidly as the private sector.  His analysis is generally correct—state and local government employment has not fallen as precipitously as private employment. This can be seen in Figure 1, which shows the year-over-year change in private, and state and local government employment from January 2007 to September 2009.

Figure 1: Year-over-Year Change in Employment


However, there is one major problem with Mulligan’s claim, and thus his conclusion regarding the use of stimulus funds. A close inspection of Figure 1 indicates that the year-over-year percent change in state and local government employment lags that of the private sector by approximately one year. This makes intuitive sense: state and local government revenues—from which they pay their employees—is largely derived from income and sales tax revenue, which is directly related to changes private employment and aggregate economic conditions.  As private payrolls decline, so too will state and local governments tax revenue, and thus state and local employment, but not instantaneously: the decline in tax revenue won’t be realized until approximately one year and thus changes in government employment will not manifest themselves for one year.

The recent State Revenue Report by the Rockefeller Institute of Government confirms this hypothesis. In the second quarter of 2009, income and sales taxes—the two primary sources of state and local tax revenues, which are directly related to changes in private employment and aggregate economic conditions—have fallen for the third consecutive quarter (State Revenue Report, p. 1). More related the analysis of employment changes is that state and local tax revenues registered their first year-over-year decline since the start of the recession in the fourth quarter of 2008—the period at which state and local government employment begins its sustained fall (State Revenue Report, see Table 1, p. 3). Additionally, the drop off in state and local tax revenues has been accelerating since then and has decreased 16.6% since this time last year. Further, the June 2009 Fiscal Survey of States puts the one-year lag hypothesis into historical perspective. During the 2001 recession, “the peak years of reductions to enacted budgets occurred in fiscal [year] 2002 and fiscal [year] 2003…These years of peak cuts occurred after the national economic downturn ended in 2001” (Executive Summary, emphasis added).

This analysis suggests that the overall fiscal health of state and local governments—and thus employment changes—responds to economic conditions with approximately a one-year lag. When one accounts for this lag, as in Figure 2, an entirely different picture of the likely future growth path of state and local government employment emerges.

Figure 2: Year-over-Year Change in Employment with One-Year Lag


Thus, the future magnitude and direction of state and local government employment appears ominous. However, this is not to say that state and local government employment will fall an additional five percent over the next twelve months. Indeed, there is a lower bound to how far governments can trim their workforce and no shortage of accounting legerdemain that can preserve a few jobs here and there. But there is clear evidence that, absent stimulus funds, the rate of employment losses in state and local government will accelerate from its current pace.

The conclusion that stimulus money should not continue to flow to state and local governments seems misguided. Although these sectors are not engines of sustained job growth, government jobs can easily be preserved through additional stimulus funds. Increased federal funding to state and local governments would at worst mitigate the fall in employment and at best prevent additional job losses. [[email protected]]

Originally published at Economist’s View and reproduced here with the author’s permission. Opinions and comments on RGE EconoMonitors do not necessarily reflect the views of Roubini Global Economics, LLC, which encourages a free-ranging debate among its own analysts and our EconoMonitor community. RGE takes no responsibility for verifying the accuracy of any opinions expressed by outside contributors. We encourage cross-linking but must insist that no forwarding, reprinting, republication or any other redistribution of RGE content is permissible without expressed consent of RGE.