The Nexus and the Fiscal Crisis

Harry Moroz

The Nexus and the Fiscal Crisis

The Obama administration's "mid-session review," an adjustment of economic predictions made earlier in the year, confirms the already accepted wisdom that unemployment will breach the 10% mark before improving in 2010. While Ben Bernanke's re-nomination as Fed chief has stimulated talk of how best to unwind the Fed's robust involvement in the economy, this prediction of continued high unemployment should refocus our energies on what remains for Washington to do.

One of the biggest remaining challenges for the economy is the fiscal condition of state and local governments. Because most of these governments, unlike the federal government, must balance their budgets annually or semi-annually, they often must enact the very tax increases, service cuts, and layoffs that countercyclical economic policy cautions against.

In July, James Surowiecki described the budget cuts and tax increases employed by states to balance their budgets as unrecognized obstacles to economic recovery. "Federalism," he wrote, "has become a serious impediment to reversing the downturn." His New Yorker colleague Hendrick Hertzberg this week describes some of these cuts and notes that state governments have become "toxic waste dumps of futility" with "abnormally high levels of clownishness." And Peter Schag opens next month's Harper's with a prolonged harangue against a California state government ravaged by "a chronic disease" with symptoms that include "cuts to schools, welfare, and health services."

It is not, however, the current recession that has put the fiscal condition of state governments at risk. In fact, in a January 2008 report the GAO found that "large and recurring fiscal challenges for the state and local sector will begin to emerge within a decade." The primary driver of these fiscal challenges, the report emphasized, is "the growth in health-related expenditures."

State and local governments employ about 15% of the workforce (by comparison, the federal government employs about 2%) and most provide their employees with health insurance: 10% of the total U.S. workforce is covered by state and local employee health plans. Furthermore, these governments pay most of an individual's policy (states, for example, pay 89% on average). This means that rising health care costs place particularly significant burdens on state and local governments.

Additionally, state (and some local governments like New York City) are responsible for a portion of Medicaid expenditures. Because Medicaid costs are predicted to rise in the next several years without the federal government assuming a larger share, state and local governments will be further burdened.

Obviously, then, the federal overhaul of health care is vital to the future fiscal health of state and local governments- but also to an economic recovery that will be hindered if these governments must continue making cuts to other vital services, from education to free clinics, in order to keep up with rising health expenditures.

First, the federal government must maintain the increased share of Medicaid costs that it assumed in the American Recovery and Reinvestment Act. This accounted for a majority of the state fiscal relief included in the stimulus package. Second, any health care reform legislation should require - as the House bill does - that the federal government assume the costs of an expansion of Medicaid. Requiring states to assume additional health care costs as the stimulus bill increases the federal responsibility is counterproductive and would hinder economic recovery.

Finally, for state and local governments to experience any real fiscal relief from a health care overhaul, the legislation must include a public option that drives down costs through competition. Though the details remain unclear, state and local employees might eventually be able to access plans on the Health Insurance Exchange, where plans would compete with a public option for customers and, presumably, provide savings to state and local government responsible for their employees' health care costs.

How we fix the health care system will determine the health of our state and local governments in the near future. The budget crises faced by state and local governments are the nexus of our fiscal, economic, and health care crises.