The growth of federal debt is exceeding GDP growth

May 9, 2012

As the U.S. economy continues to move at near-stall speed, there seems to be a swelling chorus arguing that a lot of the weakness can be traced to state and local government job losses. Mark Thoma, a professor of economics at the University of Oregon, wrote this today:

One of the biggest policy mistakes that has been made during this recession is allowing government employment to fall by this magnitude. Stabilization policy calls for the opposite, a temporary increase in employment to provide employment for people who cannot find private sector jobs, and at the very least we should have kept government employment stable.

Because muniland cannot fund continuing operations by issuing debt, maintaining state and local employment would have required another round of fiscal stimulus, meaning that the Treasury would have to issue additional debt over and above what is currently funding the federal deficit. As the chart above shows, new federal debt is approximately equivalent to the amount of growth the economy is experiencing. Basically, debt-financed deficit spending has been what is keeping the economy afloat, but in each of the last three quarters of 2011, the growth rate in federal debt issuance surpassed the growth rate of the U.S. economy.

I have argued in the past that it’s unwise to use state and local governments as a jobs programs:

What [Paul] Krugman’s analysis overlooks is that government at the state and local levels has been ballooning for decades and that a contraction may be necessary to purge the system of bureaucracy and outdated programs. Krugman’s borrowing plan would simply freeze budgets which, on their own, are basically unsustainable for state and local governments. As their costs increase, there is no more “fiscal space” in many state and local budgets to maintain the status quo without large tax increases. So after Krugman’s proposed federal stimulus expired, states and municipalities would likely have to raise revenues to support their expanded size.

Hoping that state and local government can provide a large number of jobs is unwise policy, since government employees have substantial attendant costs, notably generous pensions. Unlike private corporations, government cannot quickly add and reduce jobs as public budgets must go through the legislative process, which is infinitely more complex than corporate planning.

That said, it is necessary for the federal government to provide a minimum guaranteed income for those who have been displaced due to municipal downsizing. This can be done through the unemployment benefit system, and additional funds to extend the term on those benefits would be very helpful.

Although economic distress was and is concentrated among a small percentage of municipalities, federal stimulus spending was quite diffuse. The map above was prepared by Edward Tufte, an adviser to President Obama’s Recovery Accountability and Transparency Board, and depicts the distribution of grants and loans awarded by the Recovery Act. When I zoom down into my own community of Rhinebeck, New York, I find that the grants it received are approximately twice the amount of the local budget, excluding what it spends on public schools. It’s really questionable whether an affluent community should receive federal stimulus dollars, but because the program’s intent was to disperse funds as quickly as possible, Rhinebeck got a windfall.

The shrinkage in state and local government employment has been mainly driven by the collapse in the value of housing and property taxes that underpin local government revenues. Substituting federal debt issuance for that will buy a short reprieve, but it’s unlikely that governments could maintain these jobs without a permanent federal stimulus. We must help with economic suffering, but propping up governments in perpetuity is unsustainable.

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