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Let Treasury rescue the states

Chris Edley, professor, UC Berkeley School of Law | July 8, 2010

Here in California, where people tiresomely boast that the state’s gross domestic product exceeds that of all but seven nations, I keep expecting a ballot initiative demanding admission to the Group of 8 industrialized nations. I’d consider voting for it, too; then maybe Washington would work as hard to synchronize its economic policy with Sacramento as it does with Tokyo and Berlin. The lack of coordination within the United States — and, equally important, the failure to recognize the states as macroeconomic players — helps explain our sluggish recovery.

To make matters worse, several states have country-sized G.D.P.’s, but none has the macroeconomic tools of an independent country. Every state except Vermont has some sort of balanced budget requirement that prevents it from weathering a recession by running up big deficits to keep teachers employed, students in college, welfare payments flowing and construction humming. Nor can New York and California stimulate their economies by, say, printing more currency. Instead, states are managing huge budget crises with the only tools they have, cutting spending and raising taxes — both of which undermine the federal stimulus.

That’s why the best booster shot for this recovery and the next would be to allow states to borrow from the Treasury during recessions. We did this for Wall Street and Detroit, fending off disaster. It’s even more important for states.

Here’s how this would work. States already receive regular federal matching grants to help pay for Medicaid, welfare, highway construction programs and more. For instance, the federal government pays a share of state Medicaid costs, from 50 percent to more than 75 percent, depending on a state’s wealth. The matching rates were temporarily sweetened by last year’s stimulus.

But Congress should pass legislation that would allow a state to simply get an “advance” on these future federal dollars expected from entitlement programs. The advance could then be used for regional stimulus, to continue state services and to hasten our recovery.

The Treasury Department, which writes the checks to the states, could be assured of repayment (with interest) by simply cutting the federal matching rate by the needed amount over, say, five years. Of course, when Treasury eventually collected what it was owed, the state would have to cut spending or find new revenue sources. But that would happen after the recession, when both tasks would likely prove easier economically and politically.

What would this cost the federal government? Nothing. There would be zero risk of default, and a guarantee of full repayment plus interest equal to what Treasury pays in the bond markets to borrow. Congress would need only to appropriate the administrative costs of this program, which would be minimal.

It seems clearer every day that there isn’t the political will for another traditional federal stimulus package large enough to be effective in a $14 trillion economy. This proposal, however, would merely shift the timing of federal payments to states to help offset economic swings. It would have the additional merit of finally forging the federal-state partnership that has been missing since 1787, when the Constitution created a federal government with sufficient legislative authority to shape a nationwide economy out of separate state economies.

Indeed, our best shot at devising United States economic policy may be to give the states the role of creating and carrying out the economic stimulus we so desperately need.

This article was originally published as a New York Times op-ed.

Comments to “Let Treasury rescue the states

  1. Wait a minute! Is this the same Christopher Edley who complained because the University of California might cap retirement contributions for its highest paid employees–including Edley? See “Cornered in California,” by Jack Stripling in the January 5th issue of Inside Higher Education.

    If Christopher Edley wants to make a contribution to fiscal sanity in California, he might accept the proposal that his employer only pay retirement contributions based on a percentage of the first $245,000 of his salary.

  2. Law School Dean Pretends to Be Economist and Goes Wild
    Here is the best proof yet that some college educators don’t have a clue about basic economics and the ramifications of their proposals. Jeffrey Miron writes:

    Christopher Edley, currently dean of UC Berkeley’s law school and formerly an important advisor to Bill Clinton, is concerned that states cannot run their own macroeconomic policies. So he proposes the following:

    The best booster shot for this recovery and the next would be to allow states to borrow from the Treasury during recessions. We did this for Wall Street and Detroit, fending off disaster. It’s even more important for states.

    The potential for this plan to unleash catastrophic increases in state debt, analogously to what happened with Greece once it joined the Euro zone, should be obvious.

    Miron is understating the magnitude of this insane idea by the power of , at least,10,000.

    It would certainly eliminate the need for responsible fiscal policies by the states, but the further question has to be, “Where would the federal government get the money for such a program?” They would obviously have to increase the debt, which suggests eventual money printing by the Fed.

    This is not analogous to Greece, since most of the EU is only offering minimal support of Greece–and dragging their feet at that. It is more analogous to the EU saying, “Hey, Greece spend whatever you want. We’ll loan you the money.”

    Posted by Robert Wenzel at 1:04 PM

  3. I just successfully defended my dissertation on the sustainability of public debt which focused on the States as one sector. Mr. Edley’s suggestion is an appropriate short-term solution to the immediate economic situation we currently find our self facing. The Obama Administration’s stimulus plan had effectively been voided by states and local governments having to retrench in their spending. This then brings us to a long term solution where the federal-state fiscal relationship has to be modernized.

    After explaining my dissertation topic someone from Vermont pointed out that if you pronounce Vermont with a silent t, you are then probably aware that it was not all clear whether Vermont was going to join the Union or Canada and thus it was the sole state not to include some language in its Constitution recognizing the Federal government as the sole creator of money, i.e. debt. Because of the limitation of states borrowing only for capital expenditures and not current expenditures, states can not implement long-term budgeting plans and thus there is an inability for federal-state coordination on fiscal matters.

    Ted — let me see, just because we’ve loosened up regulations governing private employers contributions to pension plans and the result is that most people retiring from the private sector will not have enough savings to last them through out retirement life, you want to subject public employees to the same vagaries although state employees make far less than their counter-parts in the private sector? Hmm

  4. Nowhere in that column is there any mention of the mounting resentment out here when the rest of us feel when we see the out-sized pay, job security, and retirement benefits that state government workers get. If Washington bails out the states, the states will be under even less pressure to consider the rest of us when negotiating with state workers’ unions or dealing with massive unfunded retirement obligations.

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