The Bureau of Economic Analysis (BEA) released its updated estimate of fourth quarter (4Q’10) GDP growth in a report last Friday. According to the BEA’s latest measure, the US economy expanded at a slower pace than originally estimated, both in the last quarter and over the last year. Real GDP growth in Q4’10 was adjusted downward, from and annual rate of 3.2 percent to 2.8 percent. Based on this update, growth for the calendar year 2010 came in at 2.8 percent, as well, as compared to a contraction of 2.6 percent in 2009.
Contributing to the downward adjustment in the Q4’10 GDP estimate, state and local government activity contracted more than originally anticipated. Overall, the drop in state and local activity, which reflects a decline in public payrolls and investment, cut 0.3 percentage points from the GDP measure.
The scaling of back of state and local government activity is a necessary result of deep budget deficits and the inability of governments at these levels to finance shortfalls as a matter of course. In many states, obligations related to Medicare, Medicaid, and other entitlements have grown rapidly over the course of the downturn. And so expenses are sharply higher than at the recession’s outset. On the other hand, revenues are flat or declining.
Absent robust job growth and given the troubled state of the housing market, income, sales, and residential property taxes have failed to rebound even as the economy has returned to expansion. In an effort to address their deficits, some state governments are now in the problematic position of raising taxes on employers, discouraging the very job growth that they seek to foment.
In the realm of public payrolls, the situation is hardly better. In Providence, Rhode Island, every one of the city’s nearly 2,000 teachers will receive a termination notice. The school board does not plan to close every school, but the termination notices provide a degree of flexibility commensurate with its budgetary challenges.
The local economic drags that will result from a necessary rebalancing of taxes and expenditures present real obstacles for the return to expansion. The negative impact of government austerity during a recession is observable on a national scale in the United Kingdom, where a double-dip is now a credible risk, in part as a result of deep government cutbacks. The Office of National Statistics reported last week that the British economy contracted in Q4’10, shrinking by 0.6 percent.
Governments at all levels must balance the need for fiscal probity with a desire to avoid cutting so deeply and so soon into the recovery that growth is undermined. That balance will be difficult to achieve, as we have seen just a few weeks ago with the White House’s federal budget proposal. The projections contained within that proposal clearly demonstrate how long-term structural imbalances can ultimately imperil economy growth. We face that predicament now in the United States.
While not tackling the entitlements that are the principal drivers of the long-term structural deficit, the federal budget proposal does seek to manage the non-security discretionary outlays that account for 12 percent of total spending in FY 2012. It also leverages a slowly expanding economy in projecting positive adjustments in revenues and outlays as compared to the period of fiscal crisis and recession.
Unfortunately, the growth assumptions embedded in the budget are significantly more optimistic than the consensus outlook. That is unfortunate since the lack of a clear and credible plan for managing the deficit is undermining to business confidence and private sector job creation. All things being equal, if we begin to address the problem of the deficit in a more serious way during this new Congress, we will face painful but necessary headwinds to growth at the national level just as we now face them in so many states.