Q: What with the much benighted Washington debate, what can the states do to improve the economy – or more specifically, fight unemployment?

A: The states can’t do much at all. To the contrary, because they have to balance their budgets, when their revenues come in under their spending in a given fiscal year, they have to close those gaps in that year. That means service cuts and/or tax increases, or in econo-jargon, their policy stance has to be procyclical when we need it be countercyclical.

My CBPP colleagues have tracked this problem throughout the recession (this is their most recent review). The figure shows the magnitude of the gaps summed across all the states, compared to the last downturn.

A few points are instructive:

–clearly, this downturn has been much tougher on state budgets (as well as the federal budget) than the last one.

–things are improving; the recovery in GDP that began in mid-2009 has begun to show up in higher state revenues, and states expect their 2013 shortfall to be half as large as their 2012 gap.

–but the hole is deep and the damage severe; over the past three years, state and local governments have shed over half-a-million jobs.

There’s a very important Keynesian punchline here: since states cannot offset their budget gaps with deficit spending, the only countercyclical game in town is the federal gov’t. The state fiscal relief in the Recovery Act was fast-acting, effective stimulus, helping to retain needed jobs in communities, like teachers, cops, firefighters, sanitation workers, etc. As the stimulus has faded, layoffs have accelerated.

Q: What’s wrong with the “unfunded liabilities” stories that conservatives tell about Social Security and Medicare? This is where they make the case that over some very long time horizon, these programs are supposed to pay out tens of trillions more than they’re scheduled to take in.

A: These are mostly scare tactics, designed to mislead. That said, there’s a useful point embedded in there: both programs need to undergo changes to meet their obligations. But at least some of the folks who make the “trillions in unfunded liabilities” argument do so to make it seem like we can’t afford social insurance, which is nonsense.

There are two misleading tactics the UL types make.

First, yelling “trillions” in a crowded theater. That is, failing to scale the liabilities by the size of the economy. The net present value of the Social Security and Medicare shortfalls over the 75-year horizon are in the trillions, but as the share of the economy, which also grows over all these years, they’re around one percent.

Take a look, for example, at the table on page 83 of this doc (it’s the trustees’ report on Medicare). It refers to the expected 75 year shortfall in the Hospital Insurance trust fund, which is $3.1 trillion! Oh no! But the next line shows that taxable payroll over this horizon is expected to be $400 trillion, so the shortfall is less than one percent.

The other thing the UL’ers do is calculate the shortfall over an infinite time horizon. That’s just bad policy analysis. Again, if you do the math relative to GDP or payrolls as you should, the shortfall amount is fractional, much like the 75-year results (see the tables a few page later in the trustees’ report). But a moment’s reflection should lead you to wholly discount forecasts out to infinity. Who knows what growth, productivity, and population trends will be that far out in the future?

We know that if we want these programs to last, we need to raise revenues or reduce benefits. The fixes for Social Security are known and not deeply burdensome. Lowering the growth rate of health costs is harder because we’re not sure how to do it. But we know we must, both in the private and public sector, or else health spending will eat up far too much of our national income in the future (from about 17% of GDP today to twice that twenty years hence). The ACA (health care reform) makes a strong stab at just that, though we won’t know how well it works until the Independent Payment Advisory Board—ACA’s main cost control mechanism—is up and running.

Most everything else is just noise.

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