When the Obama administration announced its federal stimulus package in 2009, it projected that unemployment would fall to 6 percent by the end of 2012. Instead, it’s at 7.9 percent. Despite that sluggish recovery, Americans reelected President Obama yesterday, accepting his argument, exit polls show, that the economy was so deeply distressed that this was perhaps the best he could accomplish.

One important feature of that 2009 stimulus was $200 billion in aid to state and local governments, intended to cushion the blow from falling municipal tax revenues. Like much of the rest of the stimulus, that money provided only a respite from our continued economic decline. Since then, states and cities have had to retrench rapidly, thanks to weak tax collections. Now, after an election in which voters seemed to accept a listless economic revival as inevitable, states and cities face their own “new normal”—an extended period of austerity that may affect Americans just as much as the flailing private economy has already done.

Tax collections at the state and municipal level lag below their 2008 peak, an unprecedented four-year stagnation that reflects the dismal recovery. Meanwhile, government expenditures have continued to rise, thanks to pressure to expand some programs (like unemployment insurance) during the downturn, as well as rising personnel costs—especially higher pension and health-insurance payments for government workers. These costs have produced a protracted squeeze on government budgets at the local level, where most citizens interact with government almost daily—trash pickup, public safety, education. We have now entered a period in which local taxpayers will pay more for municipal government and get less for it. Absent a major economic upswing, this won’t change soon.

Few cities and states have escaped budget cuts, which have continued in some cases for three or four years now. Last year, 72 percent of cities said that they reduced their workforces, up from 67 percent in 2009, according to a survey by the National League of Cities. Six in 10 cities said they were spending less on capital projects, only slightly lower than three years ago; 20 percent were cutting public-safety budgets, following similar levels of cuts in 2010 and 2009.

While some of this retrenchment was inevitable, given that cities and states expanded public employment and social programs during the boom years, the sustained nature of the reductions now has some places scrambling to provide adequate services to residents. Facing a fiscal emergency, for instance, the city of Stockton, California, began cutting personnel three years ago. So far, it has reduced its police force by 25 percent amid rising crime—and still the city had to file for bankruptcy earlier this year. Even healthier cities haven’t escaped unscathed. New York City has reduced its police force by some 5,000 officers, about a 15 percent decline.

Much of the problem is that states and cities are big employers and spend a significant portion of their budgets on personnel costs, which they’ve had difficulty controlling, except by cutting workers outright. In particular, states and cities face the burden of rising long-term pension debt, which has grown worse in recent years thanks to poor returns in the stock market. In the fiscal year that ended June 30, government pension funds averaged investment returns of just 1.1 percent, when most project an annual investment gain of between 7 percent and 8 percent. Those returns are crucial for pension funds, because states and cities rely on market gains to pay for about two-thirds of pension benefits. With the markets so weak for so long, the state and local pension problem continues to grow to historic proportions. American Enterprise Institute scholar Andrew Biggs recently estimated that pension liabilities have reached $4.6 trillion, up nearly $2 trillion since 2008.

Some state and local pension funds are now in such bad shape that it’s hard to see how they can be saved without steep tax increases or a bailout from the federal government. Illinois governor Pat Quinn recently provoked a controversy when he speculated, in budget documents, that the federal government might back a massive loan guarantee to bail out his state’s severely underfunded pension plan. President Obama’s reelection might make that kind of bailout more likely, though the Republican-controlled House of Representatives would almost certainly balk—as would elected officials in other states who have kept their pension systems in better shape.

Obama’s reelection also makes it likely that we will hear renewed calls for a second round of stimulus for states and localities. The president proposed something on that order in 2011 with his American Jobs Act, which aimed to provide funds to protect state- and local-government jobs. An emboldened Republican Party, fresh off significant victories in the 2010 midterm elections, blocked that aid. Now, however, the president, who promised during the campaign to provide funds to hire hundreds of thousands of new schoolteachers, might come back with a similar stimulus proposal, believing—probably correctly—that Republicans would feel pressure to vote for it. Any such spending, of course, would add to the already frightening federal deficit.

In the end, cities and states can really afford only one kind of “bailout”: a vigorous and sustained national economic rebound, accompanied by a robust stock-market revival, both replenishing local coffers. Otherwise, the “new normal” in state and local government will soon become the real norm.


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