State and local governments reaction to recession

In this article we examine the behavior of the state and local sector during the business cycle, paying particular attention to those discretionary actions such as tax hikes and spending cuts that are typically taken by state and local government to maintain fiscal balance in response to business contractions. In particular, we focus on the discretionary fiscal actions of the five Seventh District states (Illinois, Indiana, Iowa, Michigan, and Wisconsin). No two business cycle episodes are identical, especially for the state and local sector which must cope with sharp changes in the direction of federal grant-in-aid programs. This time around, state and local fiscal pressures are arising from spending pressures as much as from lagging revenues. In response, solutions to budgetary stress are likely to focus on spending cuts as well.