State and Local Spending Cuts Dampen the Recovery

On Friday, the Bureau of Economic Analysis released its first look at Gross Domestic Product and its components for the second quarter of the year plus revisions going back to 2009. Those data confirmed that weak government spending continues to hamper the economy.  In the second quarter, government spending declines subtracted more than a quarter point from GDP growth, almost exclusively from the state and local government sector.

State and local spending cuts also dragged the economy down in 2010 and 2011. In 2011, the state and local sector contracted 3.4 percent, the largest decline since World War II.

In 2009, real GDP fell 3.1 percent, the largest contraction since 1946, and would have contracted even more without government spending. That decline is smaller than previously reported because of an upward revision in state and local spending. Most of the revision was to the final quarters of 2009 which was the same time as the American Reinvestment and Recovery Act (ARRA) began distributing funds.

The level of state and local spending in 2010 was revised up by a similar amount, so the rate of decline from 2009 to 2010 remained the same at 1.8 percent. The pace of decline in 2011, however, increased by over one percentage point.  Instead of state and local government spending contracting by 2.2 percent it turns out the contraction was 3.4 percent.  By late 2010 and 2011, the ARRA money was mostly spent, revenues were still well below the peak and states began cutting expenditures in earnest.  Many of the cuts in spending were not done as part of the normal budget process.  The National Association of State Budget Officers reported in its Spring 2012 Fiscal Survey of States that in fiscal year 2010, 39 states made mid-year budget cuts and 19 made mid-year cuts in FY 2011.  Given the urgent nature of the changes required over the last four years, it is likely that the accounting for the crisis is not yet complete.