Note: This is a cross-post from my group blog, The Realignment Project, and part 2 in a series about how to bring Keynesian economic policy to the state level.

Introduction:

In this post, I'm returning to a theme I initially explored in June, back when California was grappling with its budget crisis.

Now, after nearly two months of additional struggle, we finally passed a bill that cut $26 billion and raised no new revenue, and now we learn that the governor has possibly illegally cut a further $500 million, taking the axe to children's welfare ($80 million), health care ($400 million), Cal Grants (cut in half), HIV/AIDS Prevention and Treatment ($52 million), and domestic violence shelters (cut by 80%). In addition to the moral insanity of attacking the most vulnerable of our citizens at a time when they are most in need of support one must add the economic insanity of believing that you can reduce government spending by $31 billion in the course of a single year (including both the February and July cuts)  and not effect the state's economic recovery.

Lest this be seen as merely a California problem, a recent report by the National Governors Association notes that the collective budget shortfalls of the fifty states comes to a collective $200 billion shortfall. Given that the total Federal economic stimulus for this year only comes to about $400 billion, we are forced to recognize that our system of state government budgeting and finance is creating a massive economic undertow, weakening the impact of Keynesian stimulus by cutting spending and raising taxes (although they've been doing a lot more of the former than the latter).

Background:

Why is it the case that America's state governments have become so strongly pro-cyclical? The basic reason is that all but one state in the Union (Vermont being the exception) have some form of a balanced budget or debt limitation requirement, which makes it impossible to deficit spend during recessions.

Many of these requirements date back over a hundred years, following the Panic of 1837, which caused nine states to default on their “internal improvement” (i.e, transportation infrastructure) related debts in 1842, which prompted a wave of anti-debt measures. The state of New York, for example, adopted a new constitution in 1846, which required a 2/3rds vote for appropriations bills and a 3/5ths vote for any bill that would raise taxes or incur debts. Illinois' 1848 constitution required a 2/3 vote for appropriations, a balanced budget requirement, and a $50,000 cap on state debts. Similar waves of constitutional redrafting tended to follow other major recessions in which states suddenly were unable to finance their debts, such as the Panics of 1857 and 1873 (triggered by the failure of banks that had over-speculated on railroads).

The question is why we allow a “hobgoblin of little minds” over a hundred and seventy years old to continue to rule over us? Why, when even a total economics amateur like myself can pick up Keynes and learn about the “paradox of thrift,” do we continue to allow the political cliche that “well, families have to balance their budgets, so the government should too” to be the conventional wisdom of the stump speech? (Incidentally, given the fact that most American families are horribly in debt and are relying on their credit cards to make ends meet, this couldn't be less accurate).

A 50-State Solution:

One of the things that's often puzzled me about the progressive movement is our lack of willingness to use the initiative process to our advantage in both achieving policy ends and mobilizing the electorate – consider the way in which the Republican Party used anti-gay marriage propositions in 2002 and 2004 to gin up their right-wing base, change the political debate from economic issues to their wedge issues, and attack the civil rights and civil liberties of queer Americans. In 2006, we saw a little bit of this strategy on the progressive side, using minimum wage initiatives to increase working class turnout in states like Ohio, but to the best of my knowledge it hasn't become a standard part of the Democratic Party political toolkit.

Hence, the first step in establishing “50-state Keynesianism” is to promote, state-by-state an “Anti-Recession Budget Reform Initiative.” (if anyone has a better name for it, I'm open to suggestions). This initiative should amend the state constitution's balanced budget requirement to allow the state, when the economy is in recession (i.e, two quarters of negative economic growth) to run a limited deficit (two years maximum) for the purposes of funding counter-cyclical stimulus programs (limited to say, 5-10% of state GDP).  We should begin our push in those areas which are deep blue states and which tend to have weaker balanced budget requirements – New England would be a good starting place, especially with Vermont as the lone non-balanced budget state sitting there as a model for how deficit spending won't destroy western civilization. The Rust Belt states that have been especially hit hard, like Michigan or Ohio, would probably be receptive to a message that it's better to spend money to create jobs than to balance a budget by throwing teachers and other state workers out of their jobs. As usual, the major prizes would be New York and California, given their size and political weight.

Second, in order to build state capacity for Keynesian economic policy, we should also push for the creation of State Reserve Banks.  Here, I really have to credit Ellen Brown over at the Huffington Post for promoting this idea and bringing it to my attention. This amazingly simple yet powerful idea takes its example from, of all places, the state of North Dakota, which has operated the Bank of North Dakota since 1919. It works like this – the state charters a public bank, and instead of placing its reserves, tax revenues, deeds for public lands, and so forth in a variety of state banks (as most states do), it puts all of them in the public bank to act as the bank's capital base. (Note: as long as the bank only circulates U.S dollars, it's perfectly constitutional, avoiding the Article I, Section 10 bar against states issuing coin or bills of credit) The bank then acts like a reserve bank, using the power of “fractional reserve lending” (i.e, that a bank can generate much more money in loans than it keeps in its vaults, thus multiplying many times over its actual reserves, as long as it keeps back a portion to redeem deposits) to generate loans, act as a local “lender of last resort” (thus buttressing the work of the Federal Reserve and FDIC during credit crises), and (this is the key bit) allowing the State to borrow money in order to deficit spend in a recession without relying on the ideologically-biased bond market and the credit agencies who've taken a hammer to state bond ratings while maintaining A ratings for AIG and Lehman Brothers. The State could then use these loans (which would be much cheaper than ordinary bonds, given that its essentially paying interest to itself) to maintain public services and fund public works and other stimulus measures in a recession.

Third, as I've suggested before, one of the best ways to fight a recession is to create jobs directly. Hence, with all this new fiscal and monetary muscle, we should set up a WPA-like system of State “Job Insurance.” While the Federal government is best suited to this task, in that it has superior powers to deficit spend and print money, state governments could run their own permanent job insurance systems, establishing State J.I Funds, contributions from workers and employers, and assistance from the general fund. The idea would be to create short-term jobs (say 6-month duration, with a right to re-apply after a job search at the end of 6 months) at $10 an hour – the number of jobs directed at reducing unemployment by whatever proportion (say, 50% in the example below) needed to keep unemployment at or below a specific level. As the economy turned around, these jobs could be gradually eliminated (at 1/2 the rate of job growth, for example) in order to not damage the recovery as happened when the WPA was suddenly downsized in 1937-8. In return for a monthly contribution, workers would have a right to one of these jobs, as allocated by some fair procedure (order of application, random lottery, etc.).

Let's take California as an example. The state has a normal workforce of 18.5 million people, of which 2.146 million are currently unemployed (a rate of 11.6%). The objective of a new job insurance system would be to create enough jobs to bring the rate down to an acceptable level – say, by 50% down to 5.8%. (Note, while I would consider 5.8% unemployment to be unnecessarily high, and while we may want to consider ultimately lowering the official “acceptable rate,” for the moment, let's consider simply meeting the immediate crisis). In order to create 1,073,000 jobs, the state would need to spend approximately $40 billion (taking into account wages, payroll taxes, and non-labor costs such as equipment, materials and land – although the state would probably require counties and localities to put up at least part of the latter two items).  Now, if we were simply to fund this off of Job Insurance contributions, you’re looking at $200 a month, which is quite high, although I imagine that it would be affordable for middle class folks and up. However, if you were to split the costs between contributions and State Reserve Bank lending (and/or general fund contributions), you could drop it to $100 a month (50-50), or $33 a month (say, 33/66 or, 33/33 and 33 from general fund).

Note that this is the cost if you have to do it all in one go – if we think about this a system to prevent the next recession, you can implement the Job Insurance system in economic good times, and build up a reserve, which would allow you to run the system on still lower job insurance premiums. Moreover, if you create a target for jobs to be created when unemployment grows to a certain level, the lower the level, the cheaper the program. If, for example, California had done this back in October 2008 when unemployment was only 8%, it would only have cost $29.6 billion to reduce the unemployment rate down to 4%, which would have buoyed consumer spending, forestalled foreclosures, and prevented further job losses in the private sector.

Now, I fully acknowledge that this would be a radical transformation of state economic policy, and that certain elements, especially the Anti-Recession Budget Reform Initiative, would be politically tricky to thread the needle on. But I would say that if you can't sell the public  job insurance that costs $33 or less a month, can't persuade people that freedom from economic uncertainty is within their grasp, can't tap into people's desperate desire to be free from the fear of destitution, you shouldn't be in politics.