States, unlike the federal government, cannot run deficits. So when tax revenues dropped during the Great Recession, state and local governments were required to downsize rapidly—cutting spending, reducing salaries, and laying off more than half a million public sector workers between late 2008 and 2012.
The American Recovery and Reinvestment Act (ARRA) of 2009 helped soften the blow, providing federal aid to states that helped close 30 percent to 40 percent of their budget gaps in 2010. According to the Department of Education, ARRA funding for state fiscal relief preserved or created more than 240,000 education jobs and about 44,000 other jobs during the fourth quarter of 2009. But because the Obama administration was ultimately unable to secure as large a stimulus as was needed, less than 30 percent of Recovery Act aid to states remained by the end of 2010. Public sector layoffs continued unabated through 2011 as stimulus funding dried up, creating a massive drag on the nascent economic recovery before leveling off in late 2012.
That trend is set to reverse in 2013, according to the Pew Center on the States. “Through a combination of downsizing, changes in tax policy and sometime[s] the luck of having energy and commodities, some states have weathered the recession better than others. Iowa is looking at an $800 million surplus. Florida’s is more than $400 million.” Even California, infamous for its budget shortfalls, is projecting a $1 billion surplus by 2014-2015.
The National Associating of State Budget Officers (NASBO) is also projecting a turnaround in the coming year, with state general fund revenues expected to grow 3.9 percent from fiscal 2012, surpassing pre-recession levels for the first time since 2008. According to their 2012 survey, nearly every state government expects they will need fewer budget-reduction strategies, like benefit cuts or layoffs, to fix budget gaps in 2013.
The shift from budget shortfalls to budget surpluses means the improving state and local fiscal outlook should be a net positive for overall economic growth in 2013, after years in which state-level austerity policies lowered both GDP and employment. Mark Zandi, chief economist at Moody’s Analytics, predicts state and local payrolls will expand by 220,000 in 2013, helping to offset the effect of federal tax increases and spending cuts, and keeping the current economic expansion on course.
Still, “states aren’t talking about new extravagant array[s] of new programs,” according to a senior fiscal analyst at the Council of State Governments quoted by the Pew Center on the States. “‘State Medicaid bills are continuing to surge, so whatever little surplus states might have generated will likely go back into that,’ as well as programs that were put on the backburner during the recession, such as their unemployment insurance trust funds, pensions and infrastructure.”
More worrisome is the prospect of a second “fiscal cliff.” Although state and local governments were granted a temporary reprieve when Congress delayed some $7.5 billion in planned spending cuts for education, health care, and other programs, they are unlikely to avoid both these and further cuts when budget negotiations resume next month.