For the first time ever, state and local governments' contribution to national gross domestic product is still negative three years after a recession has passed its low point, the Tax Policy Center found in a report.
The report, "State and Local Governments in Economic Recoveries: This Recovery Is Different," written by Benjamin Harris and Yuri Shadunsky of the Tax Policy Center, examined state and local government finances in recent economic recoveries.
Traditionally, state and local government spending provides a constant source of growth and has served to offset steep contractions in federal contributions to GDP.
However, this trend was reversed in the most recent recovery, when state and local contributions to GDP declined substantially and ultimately became a drag on the national recovery, the report said.
As a consequence of reduced spending, state and local payrolls shrank rapidly, adding further pressure on the national labor market.
"This declining trend in state and local tax revenue was also atypical," the report said. "In particular, property tax revenue - driven by steep declines in the housing market - was cumulatively about 1% less three years into the recovery. On average, this revenue source has been about 10% higher three years following a recession's trough."
Instead, in this latest recession state and local governments cut expenditures in order to fill budget holes. As a result, those budget cuts dragged down the recession even further, the report said.
In 2009, when the Great Recession officially ended, state and local government consumption and investment stagnated and by June 2012, 12 quarters after the trough, it had shrunk by about 4%. This compares with prior recoveries where state and local real consumption and gross investment spending usually grew steadily, with cumulative growth averaging about 6% three years after the trough.
The U.S. has gone through six recessions since 1970 with three of them relatively short, lasting eight months or less.
The report highlighted several aspects of this recession that were unique: it was driven by an unprecedented housing crisis with home values falling sharply nationwide, it was longer and deeper than any recession in the past four decades, and the 2009 American Recovery and Reinvestment Act mitigated the need for state and local governments to immediately respond to the economic downturn.
ARRA transferred over to states about $40 billion for infrastructure and $200 for non-infrastructure spending.
"This outlay postponed the impact of the recession on state and local budgets," the report said.
Also, state and local governments were reluctant to sufficiently raise taxes to cover the decline in revenue. Some states did raise taxes through higher tax rates or base broadening, but it only replaced a small fraction of the total lost revenue from the recession.
"The lackluster performance of state and local government sector raises questions about the sector's role in future (and inevitable) downturns in the business cycle," the report said. "This downturn warrants future attention to the fiscal tools available to policymakers directing subnational government policy."
