As the coronavirus pandemic — and Congress’s undersize response — wreaks havoc throughout the economy, tax receipts are cratering. This means that state and local governments are facing enormous revenue shortfalls at the exact time they are dealing with large additional demands. So far, states and localities have responded by slashing spending and jobs, with 1.5 million public-sector workers laid off by the end of June.
The federal government, which unlike most states does not have to balance its budget every year, could solve the problem tomorrow by providing fiscal relief to states and localities, like the $1 trillion provided by the HEROES Act that passed the House in May.
But regardless of whether Congress acts, states and localities can bolster their local economies and support their residents by raising taxes on those who have not been hard hit by the recession. This is not only the right thing to do from a humanitarian standpoint, it is sound economics.
Spending cuts are enormously harmful to the people who rely on government services and the public workers who lose their jobs. In a recession, cuts also damage the broader economy, causing layoffs to ripple through the community.
When you fire a teacher, you harm her family and her. But you also harm the local grocery store where she shops, and all the other people and businesses she gives money to.
Using conservative estimates, these ripple effects mean that each dollar of spending the state cuts leads to a drop of at least $1.50 in the gross domestic product, and there are reasons to believe that the drop is as much as $2.50. With state budget shortfalls forecast to approach $300 billion this fiscal year, a spending-cut-only approach to balancing state budgets will cause at least a $450 billion reduction in G.D.P.— more than 2 percent.
Tax increases, especially on high-income people who aren’t living paycheck to paycheck, are much less economically damaging, costing the economy only around 35 cents for every dollar raised. States and localities that raise taxes on the rich to increase spending will create at least $1.15 of economic activity for every dollar raised, and most likely closer to $2.15 or more. [Continue reading…]