Federal Bailout: Potion or Poison?

By: - March 5, 2003 12:00 am

With most states in dire fiscal straits, governors are asking the federal government for more financial aid. But a study prepared for a conservative political group concludes that if Uncle Sam were to fill the states’ tin cup, it would just encourage more spending and worsen the deficit problem.

The study, which was prepared for the American Legislative Exchange Council (ALEC), found that every dollar of federal assistance deepens state budget deficits by more than 62 cents.

ALEC describes itself as a bipartisan membership association for conservative state lawmakers who shared a common belief in limited government, free markets, federalism, and individual liberty. It claims a membership of 2,400 state legislators, or about a third of the total.

“If the federal government steps in and bails them out, then it will lead to higher state spending. You can’t keep printing money and giving it to the states, particularly when states have increased their expenditures quite heftily over the past 10 years,” said Chris Atkins, director of tax and fiscal policy for ALEC.

After a partisan rift, Republican and Democratic governors joined forces at last month’s National Governors’ Association meeting to ask for more federal money for homeland security, special education and President Bush’s own education program, “Leave No Child Behind.”

But Republicans didn’t want to send the message that a blank check is the only way to solve the states’ problems. They agreed on a statement that said Washington was not providing enough money for homeland security and education but did not include specific dollar requests.

Chris Edwards, director of fiscal policy at the libertarian Cato Institute, sided with ALEC’s study, saying a federal bailout doesn’t make sense because states’ current budget woes are the result of overspending, not revenue shortfalls.

“News headlines are overplaying how bad it is,” Edwards said. “I don’t think it’s a huge crisis.”

A Cato Institute study shows that if all states had restrained spending to the rate of inflation plus population growth over the past 12 years, they would have a combined surplus of close to billion.

The views of ALEC and the Cato Institute dovetail with those of the Bush administration, which has ignored state pleas for an emergency infusion of federal dollars.

The ALEC study, which was conducted by Ohio University economics professor Richard Vedder, looked at how much deficits have been reduced for every dollar of increased federal aid to state governments. Vedder’s answer: Zero.

“The strings attached to federal aid lead to greater state spending — meaning that state deficits are encouraged, not helped, by federal assistance,” he said.

But economists such as William Gale, a senior fellow at the Brookings Institution, and Robert Solow, emeritus professor of economics at MIT and winner of the 1987 Nobel Prize for Economics, defend the value of federal fiscal relief.

They contend that budget cuts in basic state services — forced by constitutional requirements to balance the budget — weaken the overall economy.

Iris Lav, deputy director of the Center on Budget and Policy Priorities, said spending cuts victimize low-income groups.

“It makes sense for the federal government, which can run deficits, to use some of that power to provide temporary revenues to states so they don’t have to cut the services that are needed most during an economic downturn. It strains credulity to say that a one-year infusion of money to allow states to balance their budget and finance their normal level of spending will make deficits deeper. That’s just ridiculous,” Lav said. 

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