Note: this is a cross-post from my group blog, The Realignment Project. As California grapples with the Herculean task of trying to solve its budget crisis, there’s a sense of complete impasse on what to do – Republicans won’t vote for tax increases, there isn’t enough space in the budget to cut without eliminating some fo the basic functions of government, the governor won’t sign off on a majority budget. There’s been suggestions that the state could get some sort of financial backing from the Federal government, either in the form of a stimulative infusion to fill up the $24 billion gap, or in some form of a guarantee of California’s bonds so that the state can borrow money for routine cash needs without having to pay exorbitant interest rates, and hopefully so that the state can re-start its stalled public works projects (including the High Speed Rail line that was voted in back in 2008). Politicians, pundits, and the public from other states have reacted negatively to this trial balloon, arguing that California is responsible for its own fiscal crisis and that it would be wrong to help one state and not the other. In essence, the reaction is “this isn’t our problem, we shouldn’t have to pay to fix it.”

However, I’m going to argue that it actually is all of our problems, that we are all in the same boat, and that there’s a way to fix it.

To begin with, it’s important to recognize that California isn’t alone; other states are in a similar predicament. As Robert Cruickshank over at Calitics notes, most other states have experienced the same fiscal shock we’ve encountered. Personal income tax revenues are down in 37 states, corporate income tax revenues are also down in 37 states (although it’s not always the same 37 states), sales taxes are down in 29 states. This doesn’t even include property tax revenues, which have been badly battered by the collapse in housing prices. 29 states saw declines in all three areas. While California, by virtue of its size, is in the deepest hole in dollar terms – many other states are in similar trouble. New York’s income tax revenues have fallen by virtually 50% and has been dealing with a $17.7 billion deficit, and Alaska and Nevada are facing a 30% budget gap between revenues and budgetary requirements. This is not a state-level phenomena, it’s national – and if you look at it all together, it’s a $120 billion dollar deficit that we have to fill.

The larger problem is that we’re in a recession and state governments can’t print money to pay their bills, can’t deficit spend due to state laws (usually constitutions), and the bond markets aren’t really snapping up state debt and are charging an arm and a leg to do so. This means that while the Federal government is trying to push a stimulative policy and get the money pumping, the state governments are going to undercut recovery efforts – the Federal stimulus package is about $350 billion/year, and that $150 deficit will cut the effect nearly in half. This policy problem is being compounded by a political problem – bond rating agencies and the bonds markets are ideologically going after public credit ratings. As John Quiggan notes, agencies like Moody’s, Standard & Poor’s, and Fitch which were up to their necks in the current financial crisis, who looked the other way and stamped AAA ratings on garbage CDOs and asset-backed-securities and credit swaps and other financial snake-oils are now aggressively targeting the bond ratings of government entities. While Quiggan’s examples are mostly Australian, you can see the same thing happening in the U.S as states and even the Federal government (all of whom maintain the power of taxation as a guard against permanent insolvency) are being warned or downgraded for actions that are vitally necessary to save our economy. By itself, by shifting state spending away from stimulative spending towards financing higher interest rates and by forestalling the potential for Keynesian borrow-and-spend policies, these agencies are making the crisis worse. Moreover, by pushing the ideological line that balanced budgets are better than increasing spending, they are complicit in the shock doctrine proselytizing going on in state governments (such as in California, where Swartzenegger used the budget crisis to push for the elimination of the state’s SCHIP program, the Calgrants college aid program, and the Calworks welfare program).

So how do we, and by we I am referring to the national progressive movement and our political allies in government, prevent this crisis being used to gut government and exacerbate the recession? I think the solution is that the Federal government needs to either buy or guarantee economic recovery bonds, which would be specifically targeted at rehiring fired public workers and paying existing salaries, for maintaining/expanding funding levels for social services, and for public works. In a sense, this would be Stimulus 2.0, allowing President Obama and his team to accelerate recovery by turning the states from a pro- to counter-cyclical force. More importantly, by creating a new policy mechanism for preventing pro-cyclical spending cuts and tax increases, this would provide a policy tool for future generations, turning the states from a lead weight on the economy in recessions into local engines for Keynesian recovery.