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August, No. 265

Like the economy in general, individual state economies are struggling in this recession. State governments face significant constraints in raising additional revenues. Most states are required to balance their budgets regardless of the economic environment. This article considers the role of the federal government in helping the states to manage their finances.

Last Updated: 07/15/2009

Should the Federal Government Bail Out the States? Lessons from Past Recessions

Rick Mattoon

State government budget woes have been much in the news. Recently, California projected a $21 billion deficit after failing to get voter approval for a series of budget balancing fiscal measures. In January of this year, five prominent Democratic governors suggested that the federal government should commit $1 trillion in aid to the states over the next two years. The rationale for such financial support is that states (which are generally prohibited from running deficits) need the money to maintain key programs, such as Medicaid, unemployment insurance and workforce training, for which demand rises during a recession. Also, this aid might help states avoid enacting spending cuts or tax increases that could deepen or prolong the economic downturn.