Economic Snapshot for January 21, 2009

In recessions, federal grants are key to recovery for states

by Kathryn Edwards

Virtually all states are required by law to have a balanced budget, meaning that each year a state can only spend as much as it receives in taxes. Because of the current recession, revenue from taxes is very low and most states now face troubling budget shortfalls.

The chart shows how badly state budgets were affected by the 2001 recession, clearly illustrating how, after the nation slides into recession, it can take years to climb out of the deep fiscal hole.

Such recessionary shortfalls force states to either raise taxes (to increase revenue) or cut expenditures, usually by eliminating or gutting valuable public services in areas like health care or education. But cutting expenses and raising taxes only exacerbate the recession’s effect because both further reduce demand in the state’s already weakened economy. That is why federal grants to the states are so crucial: they help states maintain needed public service levels, combat the recession, and provide a fighting chance at eventually building up reserves to weather the next downturn.