FEDERAL AID AND STATE ECONOMIES: EVALUATING THE OBAMA STIMULUS. Gerald Carlino Federal Reserve Bank, Philadelphia

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1 FEDERAL AID AND STATE ECONOMIES: EVALUATING THE OBAMA STIMULUS Gerald Carlino Federal Reserve Bank, Philadelphia Robert Inman Wharton School, University of Pennsylvania OVERVIEW I. U.S. States as Agents for Federal Policy What Do US States Do for the Federal Government? II. The Obama Stimulus: A Bailout? Stimulus and State Assistance A Reward for Past Fiscal Indiscretions? III. How Will the States (As Agents) Spend the Stimulus? Evidence from Past ( )Agents Behavior Is the Past a Valid Guide for this Event? IV. Will the Stimulus Work? Macro Impact on National GDP and UE Micro Impact on State Economies

2 Fed Share of All Gov't Service Provision (Non-Defense) % Share Year Fed Share of All Gov't Transfer Spending % Share Year

3 Fed Aid as Share of State/Local Revenue % Share Year Real Federal Aid Per-Capita $/Person Year TOTAL Non Welfare Aid

4 I. U.S. States as Agents for Federal Policy U.S. States as Primary Providers of Non-Defense Services Education, Transportation, Health Care, Welfare, Protection, Recreation, Environment, UE Insurance. (FIGURE 1) Federal Government as Primary Financier of Redistribution Federal Administered: Income Support for Elderly, Health Insurance for Elderly. State Administered: Income Support for Poor, Health Insurance for Poor, Low-Income Housing. (FIGURE 2) Federal Government as an Important Financier of Services Service Aid as a Marginal Dollar: The Flypaper Effect Service Aid as a Fraction of State Revenues:.06 Service Aid as a Fraction of State Incomes:.02 (FIGURES 3 AND 4) The Agents in Trouble: 2009 States Budgets Reveal a Serious Fiscal Gap (TABLE 1)

5 TABLE 1: STATE BUDGETS in 2009 (Working Through an Example for An Average State) NORMAL TIMES OWN CURRENT REV. OWN CURRENT EXP. OWN SURPLUS/DEFICIT NON-WELFARE AID FINAL SURPLUS $3000/person $3516/person -$516/person $544/person $28/person THIS RECESSION OWN CURRENT REV. OWN CURRENT EXP. OWN SURPLUS/DEFICIT NON-WELFARE AID FINAL SURPLUS $2800/person $3679/person -$879/person $544/person -$335/person* EXHIBIT: California s 2009 Budget Gap per Person = $997/person IT S EASY TO SEE WHY THE STATES CALLED FOR: HELP(!) * Source: Center for Budget and Policy Priorities, State Budget Troubles Worsen, March 13, 2009.

6 II. The Obama Stimulus: A Bailout? How Much Federal Money for the States? The American Recovery and Reinvestment Act: 3 YEAR (TOTAL) = $223.2 Billion 3 YEAR (Recovery = Stabilization + Welfare) = $101.4 Billion 3 YEAR (Reinvestment = Program + Projects) = $121.8 Billion Approximate Annual Dollars Per Capita TOTAL = $240/person Recovery = $109/person Reinvestment = $131/person (Table 2) Does ARRA State Assistance Look Like a Bailout? Recovery Aid Correlated with Budget Gap and Poverty Reinvestment Aid Correlated with Budget Gap and Politics (Table 3) Budget Gap Correlated with 2009 UE Only (Table 4) EXHIBIT: So, How Did California Do? ANSWER: $253/person

7 TABLE 2: AMERICAN RECOVERY AND REINVESTMENT ACT (Billions of 2009 Dollars) PROGRAM TOTAL ARRA ASSISTANCE TOTAL STATE ASSISTANCE 3 Year Allocation (Billions) $787 Billion $223.2 Billion NON-WELFARE ASSISTANCE Stabilization Fund: General Purpose $8.8 Stabilization Fund: Education $39.7 State Fiscal Relief: Title I (Education) $12.9 State Fiscal Relief: Special Education $12.1 Transportation $34.3 Miscellaneous $14.9 SUB-TOTAL: Non-Welfare Assistance EXHIBIT: Per Capita Non-Welfare Assistance $122.7 Billion $396/person WELFARE ASSISTANCE TANF $5.0 Unemployment $7.0 Health Insurance: MEDICAID $80.6 Public Housing $7.8 SUB-TOTAL: Welfare Assistance $100.4 EXHIBIT: Per Capita Welfare Assistance $324/person AVERAGE ANNUAL NEW FEDERAL AID: NON-WELFARE: $132/person WELFARE: $108/person Source: Federal Funds Information for States, Budget Brief 09-04, February 23, 2009.

8 TABLE 3: CORRELATES OF OBAMA STIMULUS AID TOTAL STIMULUS AID ($761/person) TOTAL STIMULUS AID ($761/person) STABILITY AID ($158/person) MEDICAID AID ($247/person) TRANSPORTATION AID ($117/person) OTHER AID ($239/person) Constant 695 (34)* -269 (191) 165 (3.24)* 119 (55.2)* (12.43)* (53.06) Budget Gap Per Capita (2009).252 (.097)*.195 (.103).003 (.004).225 (.055)*.068 (.023)*.025 (.045) State UE Rate (2009) (11.42) (.442) State Poverty Rate (2008) (5.92)* (3.85) - - State Highway Miles (2008) (1.95)* (.49)* - State Income Per Capita (2008) (.003)* (.001)* Population (2008) (.002)*.000 (.000) (.002) (.001)* (.001)* R 2 (Adj) * Standard errors reported within parentheses. An * indicates estimated coefficient is twice its standard error.

9 TABLE 4: CORRELATES OF THE 2009 BUDGET GAP BUDGET GAP ($257) BUDGET GAP ($257) BUDGET GAP ($257) BUDGET GAP ($257) Constant -124 (123) -145 (157) -400 (244) -375 (231) State UE Rate (2009) (14.96)* (16.51)* (16.38)* (15.70)* State Own Surplus Per Capita (2005) (.23) - - State Cash Per Capita (2005) -.01 (.03) -.01 (.03) -.02 (.03) State Expenditure Per Capita (2005) State Own Revenue Per Capita (2005) (.239) (.240).274 (.256).027 (.255) Exp SD/Income (2005) Rev SD/Income (2005) (18022) 3045 (18181) R 2 (Adj) * Standard errors within parentheses. An * indicates estimated coefficient is twice its standard error.

10 III. How Will the States (As Agents) Spend the Stimulus? AGENT: GOVERNOR AS AGENDA-SETTER TO HOUSEHOLDS/LEGISLATURE Maximize: V = [U(g, t) + (1- ) r (a, k C 0, D 0, K 0 )] + (1 - )[P(g) + p (a, k C 0, D 0, K 0 )] Subject to: AID + t = g + k + a, where a = (c - d) Yields a Demand System for Services (g), income (-t), investment (k), future income (d and c). Estimated over with Year and State Fixed Effects: How Will $132 of Stimulus Aid be Allocated by the States? OWN SURPLUS s = t - g - CURRENT REV. (-t) CURRENT EXP. (g) OWN WELFARE EXP. ( ) CAPITAL OUTLAYS: k DEBT INCURRED: d CASH AND SECURITIES: c -$69/person -$59/person $10/person (Imposed*) $0 $8/person - $4/person (Imposed*) $51/person * Adding-up requires: s + AID = [ t - g - ] + $132 = current accounts surplus = allocation to capital accounts = k + c - d. Unexpected UE shocks Reduce Own Surplus, Lower Own Investment, and Increase LT Debt (Tables 5 and 6)

11 TABLE 5: Federal Aid and State Budgeting: Current Accounts ( ) Own Surplus s Own Surplus s Own Surplus s Own Exp. g Own Exp. g Own Transfer Exp. Own Rev. t Own Rev. t N/W N/W IV:N/W N/W IV:N/W IV: N/W N/W IV:N/W Non-Welfare Aid (G) (.094)* (.092)* (.210)*.356 (.053)*.194 (.231).039 (.092).016 (.109 ) (.244) Economic Shock ( UE ) -3591* (825) -3544* (824) -3654* (780) 3480* (967) 3454* (860) 767 (511) (1135) (1083) Lagged Cash/Sec. (C -1 ) (.012) (.014).043 (.012)*.045* (.010) (.005).033 (.016)*.046 (.018)* Sample Size Regression F F Test for IV Instruments Hansen s J 2 P-Value All regressions include year and state fixed effects. Estimation uses the Newey-West (N/W) estimator for standard errors robust to heteroskedasticity and autocorrelation. * Standard errors within parenthesis. An * indicates the estimated coefficient is at least twice its standard error.

12 TABLE 6: Federal Aid and State Budgeting: Capital Accounts ( ) Investment k Investment k Investment k LT Debt d LT Debt d LT Debt d Savings c Savings c Savings c N/W N/W IV: N/W N/W N/W IV: N/W N/W N/W IV: N/W Non-Welfare Aid (G).051 (.018)*.049 (.017)*.061 (.044) (.064)* (.061).057 (.222).442 (.132)*.515 (.122)*.385 (.303) Economic Shock ( UE ) -543 (244)* -554 (241)* -531 (231)* 2147 (1256) 2407 (1226) 2360 (1185)* -900 (1457) -585 (1419) -691 (1376) Lagged Cash/Sec. (C -1 ) (.003).001 (.003) (.014)* (.016)* (.018)* (.020)* Sample Size Regression F F Test for IV Instruments Hansen s J 2 P-Value All regressions include year and state fixed effects. Estimation uses the Newey-West (N/W) estimator for standard errors robust to heteroskedasticity and autocorrelation. * Standard errors within parenthesis. An * indicates the estimated coefficient is at least twice its standard error.

13 IV. Will the Stimulus Work? Macro Impact on UE and GDP No Impact of State Deficits on State UE (Table 7) BEWARE: FALLACY OF COMPOSITION Estimate of Federal Deficit Financed Aid on GDP & UE (Work In Progress: Estimation of Structural VAR) Y t = {g fed, t fed, aid fed, g s/, t s/, gdp} B(L) Y t = t or Y t = B(L) -1 t or Y t = D(L) t where D(L) is the structural impulse response function of Y t w.r.t. t Back of the Envelope Estimates Based on Blanchard-Perotti July 1, 2009: GDP = $17.2 B July 1, 2010: GDP = $50.7 B July 1, 2011: GDP = $87.1 B July 1, 2012: GDP = $69.8 B INCREASE OVER 3 YEARS OF $220 B STIMULUS = $225 B (Tables 8A and 8B)

14 TABLE 7: FEDERAL AID AND STATE (UN)EMPLOYMENT RATES 1. STATE EMPLOYMENT Employment Rate = (year effects, state effects) EmpRate EmpRate EmpRate -3 (.028)* (.041)* (.027)* R 2 (Adj.) = IS THERE A KEYNESIAN IMPACT OF STATE DEFICITS AT THE STATE LEVEL? Employment Rate = (year effects, state effects) + -t EmpRate -t s s -2 ( ) ( ) R 2 (Adj.) = WILL THE OBAMA STIMULUS HELP STATE EMPLOYMENT RATES? Employment Rate = (year effects, state effects) + -t EmpRate -t ( ) R 2 (Adj.) =.94 F Test for IV Instruments = 49.99; Hansen s J 2 P-Value =.64

15 TABLE 8A: Back of the Envelope Estimates of Impact of $1 of Stimulus Aid on GDP GDP QUARTER 1 GDP QUARTER 4 GDP QUARTER 8 GDP QUARTER 12 TAX = - $.45 SPENDING = $.14 TOTAL IMPACT -.69(-.45) = (-.45) = (-.45) = (-.45) =.10.84(.14) =.12.45(.14) =.06.54(.14) = (.14) =.16 $.43 $.39 $.40 $.26 TABLE 8B: Back of the Envelope Estimates of Impact of Aggregate Stimulus Aid on GDP Aggregate Impact by July 1, 2009 Aggregate Impact by July 1, 2010 Aggregate Impact by July 1, 2011 Aggregate Impact by July 1, 2012 $40 Billion March, 2009 $17.2 B $15.6 B $16 B $10.4 B $90 Billion July 1, $35.1 B $36 B $23.4 B $90 Billion July 1, $35.1 B $36 B TOTAL AGGREGATE IMPACT $17.2 B $50.7 $87.1 B $69.8 B TOTAL IMPACT OF $220 B OF STIMULUS AID IS $225 B (+)

16 IV. Will the Stimulus Work? Micro Impact on State Economies Micro Economic Impact of Differentially Good State Fiscal Policies Households Move In, Rents Rise, Wages Fall Firms Move In, Jobs Increase, Rents Rise, Wages Rise OVERALL EFFECTS: Population Increases, Jobs Increase, Rents Rise, Wages Uncertain DIFFERENTIAL FEDERAL AID THE STATE S REAL ECONOMY Annual Rate of Net In-Migration Annual Rate of New Job Creation Annual Rate of Wage Growth Annual Rate of House Price Appreciation Mean Value: CONTRIBUTION OF: s k d c TOTAL EFFECT % IMPROVEMENT 75% 5.2% 0% 21% BEWARE, AGAIN: FALLACY OF COMPOSITION (Table 9)

17 TABLE 9: State Budgeting and the State Economy ( ) Net In-migration n Net In-migration n Labor Force Growth Labor Force Growth Wage Growth w Wage Growth w Home Value Appreciation r Home Value Appreciation r N/W IV: N/W N/W IV: N/W N/W IV: N/W N/W IV: N/W Lagged Investment: k ( )* ( )* (.00001) ( )* - Lagged LT Debt: d ( )* ( )* ( ) ( )* - Lagged Savings: c ( )* ( )* ( ) ( )* - Contemporaneous Ln(Prod. Shock) (.003) (.003)*.002 (.003).002 (.004).013 (.004)*.013 (.005)*.017 (.009).008 (.011) Non-Welfare Aid G ( ) ( ) ( ) (.00004) Sample Size Regression F F Test for IV Instruments Hansen s J 2 P-Value All regressions include year and state fixed effects. Estimation uses the Newey-West (MN/W) estimator for standard errors robust to heteroskedasticity and autocorrelation. * Standard errors within parentheses. An * indicates the estimated coefficient is at least twice its standard error.

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