The release of gross domestic product data on Friday highlighted how the contraction of state and local governments has been a drag on economic recovery since the end of the official recession. As Nicholas Johnson of the Center on Budget and Policy Priorities explains, 2011 was the third straight year that state and local government output has fallen, reaching -2.3% in 2011, the worst since 1944, as shown in the chart below.
Paul Krugman amplifies this point, noting that investment in physical capital by state and local governments has fallen from over $290 billion (constant 2005 dollars) in 2008 to a little over $250 billion today, well over 13%. He further emphasizes that a lot of the cuts on current spending by governments has fallen on education. State and local governments, constrained by balanced budget requirements, are not doing their part to "win the future." This is precisely what Krugman predicted in December 2008 when he said that "50 state governors who are slashing spending in a time of recession" would counteract the stimulus that would be enacted at the federal level in 2009.
As readers of this blog know, a big chunk of state and local deficits could be offset by cutting corporate subsidies rather than cutting programs. My estimate of these subsidies comes to as much as $70 billion per year, more than enough to pay for the 656,000 state and local jobs Johnson reports have been lost since their peak employment in 2008.
It's important to emphasize that from a national point of view, this spending actually creates very few new jobs. While a multi-hundred-million incentive may appear to attract a new automobile assembly plant in one state, this will be offset by reduced sales from existing plants, which eventually leads to one closing (James Rubenstein, in 1992, indeed found a one-to-one relationship of auto plants opening and closing in North America). Similarly, local governments in the St. Louis metropolitan area poured over $2 billion in subsidies to retail between 1990 and 2007, with the net increase in jobs, 5400 ($370,370 per job!) not exceeding the percentage increase in local income, according to a report by the regional planning organization, the East-West Gateway Council of Governments. In other words, no jobs were actually created by these incentives, as the growth in retail would have occurred anyway due to income growth.
While it would not offset the entire state/local budget deficit, cutting subsidies would go a long way toward that goal, allowing the "Fifty Herbert Hoovers" to rehire workers and cut less from their budgets. Moreover, it would reduce income inequality slightly by ending these transfers from average taxpayers to subsidy recipients who are richer on average.