Economy & Business

The Pointless, Meddling State-and-Local Bailout

President Biden delivers remarks on the economy in Washington, D.C., May 10, 2021. (Kevin Lamarque/Reuters)

California’s state government has announced a budget surplus of more than $75 billion, thanks in large part to a strong stock market.

California’s state government is set to receive about $27 billion in direct federal aid from the American Rescue Plan, a figure that does not include help targeted to schools, transportation, and local governments in the state.

This doesn’t add up. Can we even call it a “bailout” if the state has more money than it knows what to do with?

And yet the mismatch isn’t surprising.

Well before Biden’s COVID bill became law, it was clear that state budgets were in much better shape than expected, that the overall size of the Democrats’ proposal dwarfed any reasonable estimate of these governments’ revenue shortfalls, and that many states would get billions upon billions of dollars they didn’t need — money that would come on top of aid from previous relief bills. The Committee for a Responsible Federal Budget and Tax Foundation were making all of these points in February and early March.

Democrats pushed forward anyway, ponying up about half-a-trillion dollars for states, localities, schools, and transit. They also used the money as leverage to meddle in state policy-making. States are prohibited from using their federal windfalls to fund tax cuts, even “indirectly.” In practice, this amounts to a vague and troubling limitation on how and when states may cut their own taxes. Numerous Republican-led states have already sued to fight this encroachment.

In some ways, a new rule from the Treasury Department this week provides helpful clarity. For example, tax cuts are allowed when states see their tax collections rise from a strong economy, as California has, and the tax cuts are funded out of this new revenue.

As it happens, California governor Gavin Newsom, who is facing a recall election, wants to use the state’s stock-fueled surplus to send more stimulus checks to Golden State residents. It is not the federal government’s place to stop California from creating such a program. But it remains the case that money is fungible — meaning that wholly unnecessary federal largesse is freeing up money in California’s budget while the governor contemplates blowing cash on handouts to buy votes.

Further, the new rule fails to resolve some of the provision’s biggest practical problems. For instance, it could still prove difficult for states to fund tax cuts with spending cuts in many cases. And more fundamentally, it is absurd to give states billions of dollars they don’t need and yet insist they ignore those funds when setting tax rates — a problem with the law itself that no executive-branch rule can fix.

This policy was a mistake. It provides money to state and local governments far in excess of what they lost during the pandemic; it throws boatloads of cash at some states, such as California, that don’t need help at all; and it meddles in tax decisions that states themselves should make. It’s too late to pull back now — Treasury began sending out the money this week — but this disaster illustrates what the Biden Democrats stand for: big spending that is poorly targeted and accompanied by massive federal intrusion.

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