Recession’s Effect on Intergovernmental Grants

Starting in 2008 the United States entered an economic downturn that would become know as the Great Recession.  As unemployment and prices fell, the federal government experienced a loss in income taxes, which resulted in lowertax revenue relative to GDP.  From 2006 to 2008 the percentage fell from 11.89 to 8.48 resulting in a 29% decrease.  To help fix the slumping economy President Obama and the Democratic Congress passed the American Recovery and Reinvestment Act of 2009, which became better known as the Stimulus Bill.  The bill invested $787 billion into education, healthcare and infrastructure mostly through governmental grants to state and local governments.  In 2008, states and local governments received $419.5 billion in grants from the federal government; in 2009, due to the stimulus, that number grew to $664.9 billion, a 58.5% increase.  Although that number has shrunk every year since 2009 with the 2012 grant total being $537.1 billion, the Great Recession definitely saw an increase in federal governmental grants.

While the size of government grew at the federal level from the stimulus, the size of the total government actually shrunk in the last fouryears.  States, and to a lesser extent local governments, on a whole greatly reduced their size.  From 2005 to 2008 state and local governments increased their operating budgets and investment by 2.5 and 3.5 respectively.  From 2008 to 2009 those numbers fell to -3.7 and -11.6.  Local government from 2007 to 2009 saw almost no change in revenue from intergovernmental grants.  Since we know the federal government increased spending to local governments during this time, its safe to conclude that’s states cut their funding to local governments during this period.  New Mexico led the way with a 10.4% cut to its local governments in 2009-2010.  Many other states including Minnesota cut over 5% annually.

Looking at the overall results we see that tax revenue from income, sales, and property taxes fell during the Great Recession.  The federal government’s solution to this problem was to try and stimulate the economy by giving state and local governments a lot of money.  While this policy helped stimulate the economy, it did result in large debt for the federal government.  Most states, including Minnesota, are not allowed to run deficits, so in order to make up for the loss in tax revenue they cut grants to local governments and accepted more revenue from the federal government.  Local governments saw an increase in federal grants and a decrease in local grants.  As a result, many local governments were forced to increase their property tax rates in order to make up for the loss in revenue.

A large part of the difference in the different governmental responses to changing revenues relates to whether or not they are allowed to take on debt.  The winners from the changes in governmental grants were clearly the states; they received increased grant amounts from the federal government while decreasing their grants to local governments.