25 September 2015

State and Local Spending Finally a Boost to - Rather than a Brake on - Economy

We are finally at the point in the recovery when spending at the state and local level can be a boon to the boom.

The Commerce Department revised its final estimate of second quarter GDP growth upwards today. In current dollars, GDP is up 3.9%. In current dollar GDP is up by 6.1%, an increase of $264.4 billion, which brings GDP to $17.9 trillion.

Why is it up? In large part because personal consumption, exports and home construction are up. New home sales are at their highest since before the Great Recession. The revised numbers for July report that new home sales were up 12%, a fairly stunning leap. Sluggish home construction and home sales have been a brake on the economy until recently. The same could be said of government spending.

Federal spending has gone down in each of the last 3 years. During 2012 - 2014, on average, federal spending dropped by 3.3%. State and local spending dropped by nearly 1%  per year on average. Now, in the most recent quarter, federal spending was unchanged and state and local spending rose a remarkable 4.3%. This trajectory could continue, helping to prime local economies.

Most of the states mandate balanced budgets. Taxpayers have this naive notion that this makes for sound policy, arguing that households have to balance their budgets and so should government. This is absurd, of course. What it means in practice is that during a recession, states are a huge drag on the economy and during a boom, their spending is likely to overheat the economy. During a recession, states have to layoff employees, adding to the employment carnage. They might also raise taxes to help fund services like, say, third grade classrooms; this adds to the pressure on households to cut back on spending, further exacerbating the recession. During a recovery, this amplification process is reverses. States spend more because they have more, and that adds to the boom. Even if they "given the money back to taxpayers" through tax cuts, they stimulate the economy because now households have more money to spend. Mandated balance budgets is a farce fueled by confusion. And at least for now, it is going to work in our favor.

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