Former president Barack Obama is not typically associated with smaller government, but his two terms in the White House produced remarkable fiscal austerity—in the states. The country’s economic performance during the Obama years, encompassing one of the worst recoveries on record, has had such a dampening effect on state tax collections that it took until the final year of the president’s second term for state spending, adjusted for inflation, to recover to 2008 levels, according to the National Association of State Budget Officers (NASBO). Now, with the end of the Obama era, states are scrambling to balance their budgets amid a new slowdown in revenues, while the cost of items like Medicaid and worker benefits soars. Presidents cutting federal aid to localities are sometimes accused of “starving the states,” but Obama showed, if unintentionally, that there’s more than one way to put local government on a diet.
The states’ fiscal predicament should be an object lesson to President Donald Trump—if he needs one—that an Obama-like agenda of higher federal taxes, more regulation of businesses, and pricey stimulus programs that send taxpayer dollars directly to local governments ultimately produces austerity, not prosperity. State budgets will likely fare better when Washington provides targeted tax cuts (especially for businesses), reduces burdens on firms from federal programs like Obamacare, and lifts constraints on revenue-producing industries like energy. Trump has targeted a goal of economic growth between 3.5 percent and 4 percent annually. If he hits that mark, state budgets will improve significantly. But he’ll need to move quickly to head off another downturn in state revenues that’s already in progress.
For many states, the weak Obama recovery meant a constant struggle to balance budgets. One indication is the almost annual effort by states to reduce spending in the middle of a budget year because economic growth, and hence tax revenues, failed to live up to projections. In any given year during Obama’s two terms, at least eight states, and frequently more, had to scramble to plug midyear budget holes, even during the peak of the recovery, according to the NASBO study. That’s far more than during the best years of previous recoveries. Revenues from economically sensitive income and sales taxes, which provide states with 70 percent of the money in their general funds, proved especially disappointing during the Obama years. State sales-tax collections have seen average annual growth of just 2.3 percent since 2008, while income-tax collections have, on average, increased just 3 percent a year.
By contrast, after previous deep recessions, state revenues rebounded robustly. Despite a recession early in Ronald Reagan’s presidency, state tax collections rose by an accumulated total of 92 percent during his two terms, thanks to a strong economy. State tax receipts have enjoyed a mere 16 percent collective growth during Obama’s two terms. Even adjusting for higher levels of inflation in the 1980s, the differences are stark: a 34 percent net after-inflation gain for states during the 1980s recovery, compared with an anemic 3 percent inflation-adjusted total gain in the current rebound.
States are in a weak position to endure a new slowdown, but that’s what they fear is coming. Tax receipts declined by 4.5 percent in the second quarter of 2016, compared with the same period in 2015; the momentum continued in the wrong direction during the summer months (the latest data available) for the majority of states. Already, governors are preparing for new midyear budget woes (most states’ fiscal years start on July 1, so midyear adjustments typically begin in the fall or early winter). Virginia governor Terry McAuliffe began laying off state workers in October as part of plans to close a budget gap of more than $1 billion over the next year. Republicans and Democrats in Connecticut squabbled throughout the fall over how much they’ll have to cut to close a deficit that could top $100 million in the current fiscal year, after battling in the prior fiscal year to close a $300 million gap. Massachusetts is staring at a midyear $100 million shortfall after the state’s legislature overrode some $230 million in budget cuts that Governor Charlie Baker tried to enact in June.
Budgets are getting squeezed in a few key areas—especially expenditures on Medicaid, the bill for which states share with the federal government. Medicaid costs have increased by about one-third, or $52 billion, since 2008. In 2017, states will be even more on the hook for this program, as Washington’s contribution to the cost of adding new Medicaid recipients under the Affordable Care Act begins to shrink.
Among the biggest losers in the Obama-imposed local-government austerity have been public employees, whose union leaders ardently supported the president in both his presidential bids and strongly opposed Trump in 2016. As Obama leaves office, some 400,000 fewer local-government jobs exist than when he took the oath. Membership in public-sector unions, which peaked in 2009, was down by some 662,000 members as of the end of 2015.
Most of the money that states spend comes from their own tax collections—not federal aid. That’s why state officials should demand that Washington focus on policies that will encourage economic growth. Obama’s tenure demonstrates the consequences when that doesn’t happen. And their pain isn’t over. President Trump must deliver rapidly on his promises of regulatory reform and targeted tax relief if he’s to rescue state budgets from further troubles.
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