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Why Unemployment Ex-Government Cuts Are Just Silly

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The simple answer: Nobody knows what unemployment would be if a whole bunch of things didn't happen.

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MINYANVILLE ORIGINAL Justin Lahart over at the Wall Street Journal's "Real Time Economics" blog wrote a piece recently in which he looked at what unemployment would be if state and local governments didn't cut jobs as aggressively as they did. His conclusion was that unemployment would be a full percentage point lower, from 8.1% to 7.1%. I disagree with that assessment.

First, let's start with state and local revenues. The chart shows the current receipts for state and local governments, and they've been rising.



But you'll see I made a mess of the chart with the red and green lines on it. The red line is just the linear trend I extrapolated from the go-go years of the real estate and credit bubble. The green line in 2007 is where, using my artist's eye, it looks like the trend broke, which was a full year before the recession began. The point I'm making is this: State and local receipts have been increasing, but they lost the trend growth rate.

To better understand what has happened, the next thing we can do is to break down the sources of revenues that state and local governments have. States and local governments have four primary revenue sources: property taxes, sales taxes, personal income taxes and transfers from the federal government. This chart that looks at each of these inflows for state and local governments tells us the story:



Sales taxes have been the biggest contributor to state and local government coffers followed by property taxes. If you see the sales tax line, it started slowing down in 2007, before the recession. Property taxes followed suit shortly thereafter. Transfers in from the federal government meanwhile, rose. That is to be expected as automatic stabilizers take hold and states have to spend more money on benefits as the need for assistance increases. But the severity in the breakdown in the revenue streams for state and local governments is clear: The tax base was designed to grow as a function of both positive social mood and extending horizon preferences.

States and municipalities could grow revenues even as marginal tax rates fell in that kind of environment as long as there was more development and consumption activity. The development kept pushing further out from urban centers into the suburbs and eventually the exurbs. And as that development moved from more densely populated to less densely populated locales, people built bigger houses and bought more stuff to fill their homes with.

Debt burdens didn't matter either because during periods of positive social mood and extending horizon preferences, people tend to believe good times will last forever and everyone will partake in them. Rolling loans gather no losses. Another thing to note is that in 2007, the oldes baby boomers could start retiring, and many of them did. Pensioners do not spend money the same way younger people do, so again, this is another explainer in why the trajectory of state and local revenues changed the way it did.

Between the demographic changes that are occurring and the recession in housing and credit, state and local governments never stood a chance, given the way their revenue streams have been structured. And given the way their expenditures will be driven by unemployment benefits, Medicaid and other programs, states and municipalities need to rethink revenue sources. The push for casinos and new sports franchises are their attempt at addressing these shortfalls, but they seem to be out of step with the times. It's like they're just trying to bring back yesteryear in these programs; they're not looking ahead.

Economists are fond of saying "given that x is occurring, y should occur as well, ceteris paribus" -- all things being equal, that is. But ultimately, the real problem this kind of analysis suffers from is one of the issues that the great macroeconomist Don Meredith pointed out frequently: "If 'mights' and 'buts' were candy and nuts, then we'd all be happy at Christmas time." Indeed. It's all just a big exercise in armchair quarterbacking, and it doesn't do anything to actually solve the problem, which is unemployment. The time for wishing that the credit crisis of '07 and '08 didn't happen has passed. The time for figuring out how to move forward is now.

Twitter: @japhychron
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