Mark Thoma brings up a couple of related themes. The first being:
Recessions lower revenues and increase the demand for state and local services, and this pushes state and local governments into the red. Since state and local government are required to balance their budgets, this forces forcing them to either cut spending or raise taxes (most are choosing to cut spending).However, since both tax increases and cuts in spending are harmful to employment and growth, as state and local governments bring their budgets into balance it makes it more difficult for the economy to recover.
Those balanced budget requirements force state and local governments to adopt pro-cyclical fiscal policies, which has been recently dubbed the 50 Little Herbert Hoovers problem (I believe Paul Krugman coined this term). This problem is generally well known by at least the school of economists who appreciate what Lord Keynes was saying in his General Theory and one remedy for this problem is countercyclical movements in Federal revenue sharing. But let’s have Mark continue:
If the federal government steps in and helps to close the state and local budget gaps, the negative consequences can be reduced, but budget pressures at the federal level make federal help unlikely. In the worst case, states could face large federal-to-state cost shifts or cutbacks in federal payments as a result of attempts to balance the federal budget, something that cannot be ruled out. That would lower growth even more. Thus, the extent to which Congress chooses to shift costs or reduce payments to the states as a remedy to federal budget problems could be an important factor in the recovery.
My limited contribution is simply the above graph showing the ratio of Federal revenue sharing to GDP over the past half century. Note in particular that this ratio climbed during the last recession and that it reached 3.5 percent during the current one. Given the severity of the recession, some of us would have hoped for even more Federal revenue sharing. But alas – there does seem to be a tendency for some D.C. politicians to adopt Herbert Hoover economics at the Federal level.