Federal Aid Could Be Harder to Come by in the Next Recession

State and local leaders planning for the next recession would be wise to consider the nation’s growing budget deficits and debt, based on the views of economics and finance experts.

The daunting math and sensitive politics that surround federal borrowing threaten to restrict how much latitude lawmakers will have to enact stimulus legislation in the event of a downturn. This has implications for states and local governments, who saw copious federal grants and other aid flow when the Great Recession rocked the nation’s economy about a decade ago.

“There's no question that the sheer amount that we've added to the debt, plus the pressure we’ve put on policy makers to add more to the debt, is going to limit our fiscal space and ability to respond to the next crisis, relative to what it otherwise would have been,” said Marc Goldwein, senior vice president and senior policy director for the Committee for a Responsible Federal Budget, a watchdog group.

“Some of these limits may be economic,” he added. “Many of them may simply be political.”

Dan White, director of public finance research at Moody’s Analytics, said when it comes to federal assistance to states in the next recession, “I don't think they can count on getting as much as aid as they have in the past.” If this proves to be true, it will be even more important for states and local governments to plan and prepare for gloomier economic times.

“If they don't have rainy day reserve funds, enough to get them through the next recession, at this point, then they're already too late,” White added. “But any little bit can help.”

There’s not universal concern the federal government will crimp stimulus spending in a recession. “I’m in the camp that it just remains to be seen,” John Hicks, executive director of the National Association of State Budget Officers, said by email.

Hicks pointed to recently passed budget and tax legislation as evidence that Congress is not shy about advancing legislation that adds to the nation’s deficits. He also noted that states haven’t always received federal assistance during recessionary periods.

Economics vs. Political Realities

There’s no precise measure of when the nation’s debt, or annual budget deficits, would slip into truly dangerous territory, which would hobble the federal response to a recession.

But, putting that aside, there are political realities that come into play. The stimulus package then-President Barack Obama shepherded into law in 2009, in the early days of the Great Recession, was met with strong Republican opposition in Congress.

“I think this can only be described as generational theft,” Sen. John McCain, Republican of Arizona, said at the time. "We are going to amass the largest debt in the history of this country and we are going to ask our kids and grandkids to pay for it."

Around the time McCain took this stance, the amount of government debt held by the public was about 40 percent of gross domestic product, according to the Congressional Budget Office. When fiscal year 2017 ended last September, it was about 76 percent of GDP.

And federal debt is set to exceed the size of the economy under current law, within a decade, even without a recession, based on projections from the Committee for a Responsible Federal Budget.

The group’s estimates show trillion-dollar deficits will return permanently by next year. Its baseline projections indicate that the nation’s debt will be 101 percent of GDP by 2028, reaching about $29.4 trillion—compared to about $14.7 trillion last year.

Jason Furman served eight years as a top economic adviser to Obama and is now a professor at Harvard’s John F. Kennedy School of Government. He argues that if there were to be another recession, stimulus policies would be warranted and effective, even if the U.S. has a very high debt-to-GDP ratio.

“The most important thing to do for debt is to get growth up. And fiscal stimulus can really help with that,” Furman said. “I'm very worried though that if our debt was, you know, a hundred percent of GDP and our deficits are over a trillion dollars a year, that many politicians would be resistant to using fiscal stimulus.”

“My worry is not about the economic space for fiscal stimulus,” he added. “I think we will have that no matter what. It’s whether there will be the political space to take advantage of it.”

Goldwein, with Committee for a Responsible Federal Budget, offered a similar perspective.

“My one worry is that we’re not going to grow up and realize that we are spending far more than we are bringing in in revenue and we need to bring those numbers in line,” he said. “And my other worry is that we’re going to panic about this at the wrong time and we’re going to forgo needed spending increases, for example, in a recession.”

‘It’s Easy to Spend Money’

Congressional lawmakers agreed in February to a deal that relaxed strict budget caps, clearing the way for about $300 billion in added spending over two years.

President Trump in late March signed a $1.3 trillion spending bill that was crafted under this broader budget framework.

The legislation plusses-up both defense and non-military spending, and includes extra money for a raft of programs that will help state and local governments cover costs ranging from highway and transit projects to upgrading their voting systems.

Meanwhile, Republicans pushed through a tax overhaul last year that features rate cuts for corporations and individuals, along with other changes to the tax code, that are expected to erode upwards of $1 trillion of federal revenue over the coming decade.

The spending bill and the tax law amount to what is effectively a federal stimulus package. But, as opposed to putting these policies in place to boost the nation’s economy in a financial downturn, they’ve been enacted late in an economic growth cycle.

Although the two-year budget framework and the tax law are both sweeping in their scope, Paul Van de Water, a senior fellow at the Center on Budget and Policy Priorities, cautioned against thinking about the fiscal ramifications they will have on the same plane.

“The effect of the tax cut law is much larger than the effect of the spending increases,” he said.

As he discussed the tax law, Van de Water added: “The problem, in my view, is that basically this is going in exactly the wrong direction. We need a revenue base which is sufficient to fund the programs which Americans have pretty clearly indicated they want.”

Tom Coburn, a former Republican U.S. senator from Oklahoma who retired from office in 2014, put it another way.

“It’s just easy to spend money, easy to cut taxes. It’s hard to do the other stuff,” he said. Coburn added: “It’s not about parties. It's about career politicians thinking short term, not doing what’s best long term for the country and willing to spend money like crazy.”

Coburn is now an adviser to The Convention of States Project, a group pushing for a convention of states under Article V of the U.S. Constitution, to allow for amendments to be proposed. The group is interested in discussing amendments to “limit the power and jurisdiction of the federal government, impose fiscal restraints” and place term limits on federal officials.

Looking beyond the budget deal and the tax law, an aging population with more and more “baby boomers” transitioning into retirement promises to drive costs for two of the U.S. government’s largest programs, Social Security and Medicare—a health insurance program that covers people who are 65 and older, as well as others.

Combined expenses for Social Security, Medicare and Medicaid, which covers low-income Americans, accounted for nearly half of the $4 trillion in federal spending for fiscal 2017.

“The dominant number, long-run, is this huge growth in health and retirement spending,” said Eugene Steuerle, a fellow at the Urban Institute. He highlighted an analysis he did last year that found about 150 percent of the nation’s revenue growth over the coming decade had already been committed to cover health care programs, including Medicare and Medicaid, Social Security and interest on the debt.

“That’s the situation we were in even before you add on this tax bill and you add on this new spending splurge,” Steuerle said.

Interest Rates

Another twist in the nation’s finances is that interest rates are creeping upwards. This means that the federal government is poised to pay more to borrow. The Federal Reserve upped rates by a quarter of a point in March, to a range of 1.5 percent to 1.75 percent. The Fed has indicated that additional, gradual rate hikes are on the horizon.

“Long story short, it becomes a larger percent of the budget to cover all the borrowing that’s being done,” said Natalie Cohen, managing director of municipal research with Wells Fargo Securities. “There's definitely a crowding out for other purposes.”

On the other hand, interest rates are down compared to just before the Great Recession. In 2007, for instance, Federal Reserve rates were between 4 percent and 5 percent. Lowering rates is a tool that the Fed can use to help stimulate the economy. Today’s low rates limit that option.

There’s another aspect to rising interest rates: They will also affect the finances of state and local governments, who commonly borrow to build infrastructure projects like roads and schools.

“Unlike the federal government, when you issue debt, you have to pay for it,” Frank Shafroth, director of the Center for State and Local Government Leadership at George Mason University,  said of state and local borrowers. “If the interest rates are higher, it costs a lot more.”

"So you either don’t do as much or you don’t do it all,” he added. “Or you raise taxes.”

‘It Was Bad’

The 2009 stimulus package, known as the American Recovery and Reinvestment Act, cost the federal government about $836 billion over a decade, according to estimates from the Congressional Budget Office. The legislation included increases in safety net spending, financial aid to states, money for infrastructure projects and tax cuts.

Michael Nutter was elected as mayor of Philadelphia around the time the Great Recession struck and recalls the harsh blows the downturn dealt to his city. “People losing jobs, losing their homes,” he said. “Companies going out of business, tax revenues down.”

“It was bad,” he added.

Debate continues about the merits of the stimulus. But Nutter described the package as invaluable for helping his city.

Some of the money that flowed there was a $15 million grant that went toward a $55 million project to make over Dilworth Plaza in Philadelphia’s Center City. In addition to creating a new public space, the project reworked access to a transit hub underneath City Hall.

“It put a thousand people to work over the course of a 27-month project,” Nutter said. By 2010, Philadelphia’s unemployment rate had shot up to around 10 percent, from 6 percent in 2007. 

“At that time, putting a thousand people to work on a project, I mean, it was incredible,” the former mayor added.

‘About as Good as It Gets’

It’s unknown when exactly another economic downturn will hit or how bad it will be. The U.S. economy has been growing for more than eight years, albeit at a somewhat slow pace.

“When we're talking to clients and looking ahead to the next two to five years, from a state and local and a federal budgeting perspective, the next two years are going to be about as good as it gets in terms of underlying economic conditions,” said White, with Moody’s Analytics.

“Beyond two years, we will be in the single longest period of expansion in modern American history if we can make it beyond mid-2019 without going into another recession,” he added. “So it’s very likely that beyond 2020 that next recession will be knocking on our door.”