State and local governments are working hard to persuade Congress that they desperately need and deserve a second round of fiscal stimulus. That is the way, they argue, to ensure that the nation's sluggish economic recovery does not stall out. As most readers know, the financial condition of many state and local government budgets this year is even worse this year than last because tax receipts lag the economy and many have exhausted their reserves. Layoffs are deepening in many jurisdictions. So there is a clear need for timely additional counter-cyclical assistance to avert even deeper layoffs of teachers, police and firefighters along with other public servants. The National League of Cities has promoted a "Jobs for America" bill that would help avoid more layoffs. The teachers' and schools' lobbies have a similar effort underway, with the Secretary of Education advocating their cause. But the mood in Washington may not be friendly enough to clear a bill in time to make a worthwhile difference.
Advocates of additional aid to states and localities face two hurdles: timing and anti-deficit/anti-bailout fever. The timing problem is that the longer it takes to clear a bill through Congress, the less it's really needed. Our American economy is starting to recover in the private sector, which reduces the sense of urgency for retaining public-sector jobs. Last week's labor report was downright encouraging. Any public-sector job retention beyond Halloween 2011 will run the risk of squeezing out private employment growth and wasting federal taxpayer dollars.
Further, the public has developed a real antipathy toward measures that increase the federal deficit through bailouts. Even though governors, mayors and school superintendents can show that they didn't cause the problem — as many feel Wall Street did — the image of handing out pork-barrel money from a government printing press is clearly out of favor. In essence, the local lobbyists are now asking for "deficit-sharing" money, not "revenue sharing," but without taking any responsibility for repaying the additional deficit. Essentially, they want divine intervention to avert layoffs.
What if some frugal strings are attached? From a public-policy as well as a public-relations standpoint, the governors, mayors and school officials would be wise to tweak their requests to convince Congress and the populace that additional federal aid should also be an investment in better fiscal management in the future. Here's a strategy that would make it hard to turn down their request for countercyclical financial assistance now:
• Make this aid a loan, unless two conditions are met. Congress can require that a second round of assistance to the states and localities be treated as a loan to be repaid when the economy recovers, unless the recipient has installed financial reforms that will help prevent financial crises in the future. Governments that accept the funds would face the choice of returning Uncle Sam's money over a three-year repayment period, or taking two simple steps to bolster their financial condition to weather the next economic storm. If they satisfy those terms, the federal loan is forgiven.
• Require a rainy-day fund. I continue to advocate the need for municipalities and states to manage their cyclical finances with a budget stabilization fund or sufficient reserves to weather a normal economic recession. When times are good, politicians must be disciplined to sock away some money for the lean times, rather than spending every last dime they collect and making ongoing commitments to programs and employees that cannot be sustained over the full business cycle. For example, when revenues have recovered to surpass 2008 levels, the aid-recipient's budget should automatically allocate some of the new receipts to a rainy-day fund. If local policy-makers face the choice of repaying the U.S. Treasury for 2010 financial assistance, or socking away some reserves, the prudent fiscal decision will be far easier. In a way, this strategy reverses the now-familiar "kick the can" approach to financial management that short-sighted politicians have come to practice.
• Require proper funding of employee benefits. Most states and localities have failed to properly fund their retirement benefits plans. Nationwide, the unfunded liabilities now exceed $2 trillion. Even those who are paying for their annual pension contributions on a regular basis are often negligent with their retiree medical benefits (so-called OPEB, for "other post-employment benefits"). Borrowing a presidential phrase, they just keep kicking the can down the street. And that means their annual costs will escalate dramatically in the next decade because they are failing to fund actuarially. A reasonable requirement would be that recipients of 2010 intergovernmental aid should ramp up their retirement plan contributions toward full funding over a three-year period beginning once their revenues have increased by 10 to 20 percent from current depressed levels. As with the rainy-day requirement, failure to fund benefits actuarially would trigger a loan repayment requirement. Even more importantly, a failure by local governments to begin funding actuarially will only mean that the deficits they run in the next recession will be that much larger. Uncle Sam — the lender — needs to stop reinforcing bad behavior.
State and local politicians and advocacy groups may object that they don't like federal strings, but these are reasonable financial practices that they should be observing on their own. As the nation witnesses the return of TARP funds from the private sector, it is only fair to expect something in return for Uncle Sam's help to balance the localities' books in fiscal 2011. Those who don't like these terms can decline the assistance and fend for themselves. This will separate the fiscally responsible good-government crowd from the whiners and the spendthrifts. For members of Congress, it would be far easier to explain to their constituents that this time, the deficit-financed financial aid they send back home will compel local politicians and policymakers to watch out for all the taxpayers' interests, and get their act together as financial managers.