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Most American states have been reeling in this great recession, cutting not just meat out of their budgets, but bone. In some states that means cruel, draconian measure. That would include Arizona, which decided to impose new death panels by slashing Medicaid funding for life-saving transplants. But states are having to take drastic measures, like closing firehouses, cutting cops, and laying off teachers.

Congress has been able to make some bad deals to keep aid flowing, like last summer's deal to cut food assistance programs in order to extend critical funding for Medicaid and other state aid. Apparently we're at a place in America where you have to make choices--keeping people employed and with basics of health care, or helping them buy food.

Almost all of the states have constitutionally mandated balanced budgets, unable to run deficits. In recessions, declining revenues mean states have to make cuts--they can't borrow against the future. Recessions and high unemployment also bring greater demand, particularly more people being forced on to Medicaid because of job loss. So the states lay off state workers, demand decreases because these people have less to spend, and more private sector lay-offs result.

It's a vicious cycle that isn't going to stop any time soon, apparently. With continuation state aid missing from the tax cut deal, states are bracing for the end of any kind of help.

And the situation at the state level is about to get worse. "We think that states may be facing their most difficult year yet in 2012," said Phil Oliff, a policy analyst for CBPP. That is because nearly all the aid authorized by Congress will have run out by June 2011, when states are setting their fiscal 2012 budgets. Meanwhile, state revenues have started to recover modestly, but remain well below 2008 levels. Projections are tentative at this point, but CBPP foresees a total shortfall of about $140 billion at the state level in 2012.

With federal aid running out, reserves fully tapped, and many revenue-boosting options already explored, public sector job losses are likely not just to continue but to "accelerate," said Chris Whatley, deputy executive director of The Council of State Governments. "You’re going to see states cutting to the bone."

Further federal aid to states could soften those cuts. It would also, according to leading economic models, be among the most stimulative ways for the federal government to spend money: the Congressional Budget Office recently concluded that compared to other parts of the Recovery Act, non-infrastructure aid to states did almost as much to boost the overall economy as payments to individuals like unemployment insurance, and more than any class of tax cuts.

"We’re talking about how many jobs this creates, and what the economic impact is, but for whatever reason, we’ve decided to leave the most effective arrows in our quiver," said Michael Linden, associate director for tax and budget policy at the Center for American Progress.

Despite the logic of further state aid, and the apparent opportunity created by the tax cut talks, the topic seems to have been nearly absent from the recent negotiations. Representatives for state governments said leaders in Congress had already made it clear that they had no appetite for extending the major spending provisions of the Recovery Act — and that states, having gotten the message, had mostly stopped asking.

"The prospects of getting any more [Medicaid] or education jobs funding is about nil," said Whatley. "There is a clear aversion ... to fund anything that squawks like the stimulus." Michael Bird, federal affairs counsel for the National Conference of State Legislatures, said he had received the same message. After the August jobs bill, "we were told, this is going to be it," he said....

If further spending is out, one of the tax measures in the deal may actually worsen the revenue situation for some states. The package includes a provision, first sought by the White House in September, that will allow businesses to deduct 100 percent of the cost of new investments from their tax liabilities upfront, rather than depreciating them over their lifespan....

But it could hurt state budgets now, too. That’s because in about half the country, taxable income for state purposes is defined as whatever way the federal government defines it; a federal deduction automatically becomes a state deduction. In much of the rest of the country, that conformity isn’t automatic, but it is routine. A CBPP paper last month warned that because of these linkages, a similar proposal could cost states $20 billion in revenue between 2011 and 2013 — and while states would also recoup most of those funds over the next decade, unlike the federal government, states cannot run deficits in the meantime.

"The additional state revenue losses resulting from the proposal would make it necessary for states to enact additional budget cuts or tax increases, which would reduce the proposal’s overall stimulative effect," the organization wrote.

Economists all over the map agree that tax cut stimulus doesn't stack up with direct spending stimulus in terms of bang for the buck. There will be some stimulative effect from this tax deal, largely from the extension of unemployment benefits, but the deal is largely the less effective tax-cut stimulus.

There's serious question as to whether that stimulus be enough to offset the trade-offs. One of the most critical--and worst--trade-offs is tax-cut stimulus now in exchange for any kind of direct spending stimulus in the near future, when budgets will be slashed at the federal level because of deficit concerns. That axe will fall on the states, and with it more jobs.

Originally posted to Daily Kos on Fri Dec 10, 2010 at 02:20 PM PST.

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