The Antistimulus

As the economy grinds along in an extremely low gear, investors and executives continue to look to Washington for relief. Despite December's gridlock, many hold out hope that a stimulus package -- a magical grab bag of corporate and individual tax cuts and targeted spending increases -- will jolt the world's greatest wealth-creation machine out of its torpor.

With an election year upon us, the prospect of a federal stimulus package seems about as likely as disgraced Enron (ENRNQ - commentary - Cramer's Take) CEO Kenneth Lay giving the keynote address at the 2004 Democratic Party convention. But even if it does come, any stimulus package from Washington is likely to be offset, and perhaps more than offset, by the fiscal policies of other U.S. government entities.

The federal government isn't the only public entity that has seen its fiscal situation deteriorate over the past year. The nation's cities and states have been hit by the sagging economy, rising health care costs, slumping markets and increased costs tied to the response to Sept. 11.

But there's a crucial difference between the way the good folks in Washington, D.C., and the good folks in Washington state deal with their finances. States and cities, by and large, are prohibited by law, or by their constitutions, from running deficits. You'll find no Keynesians in Albany, N.Y., or Jackson, Miss.

So when tax revenues decline, states quickly run into trouble. And that's exactly what's happening now. According to the Nelson A. Rockefeller Institute of Government, state tax revenues fell 3.1% in the third quarter of 2001 from the year before -- the first such decline since 1992.

The result? A tide of red ink running in city halls and statehouses from Helena, Mont., to Baton Rouge, La. New Jersey's newly installed Gov. Jim McGreevey inherited a $2.8 billion deficit. New York's Mayor Michael Bloomberg confronts a deficit roughly the size of his personal fortune: $4 billion. New York state's fiscal year, set to begin in April, is at least $6 billion short of balanced. California's finances aren't so golden. Gov. Gray Davis this week said the state will face a $12.5 billion shortfall for the fiscal year that starts in June -- and analysts call that figure optimistic!

Over the years, resourceful governors and mayors have developed techniques to balance their budgets with a minimum of pain. But even with the impressive array of one-shot deals and gimmicks at their disposal -- borrowing from tobacco settlement money or treating asset sales as recurring revenues -- there's only so much the solons can do. No, to bring the fiscal stars back into alignment, they have to raise taxes or cut spending -- or both. In other words, they have to pursue exactly the opposite tack the federal government generally pursues to stimulate growth.

That process has already begun. New Jersey Transit, faced with a seven-figure deficit, is boosting fares 10%. Washington state passed a new cigarette tax, and New York's Gov. George Pataki is proposing to boost the tax on cigarettes from $1.11 to $1.50 a pack. (Now, I'm one of those who believes taxes on cigarettes can't be too high. But a tax hike on cigarettes has the same economic effect as a tax on books or milk.)

There's more. North Carolina last December narrowed its budget gap by enacting some $620 million in new taxes, raising the sales tax by a half-cent. Earlier this week, Kansas Gov. Bill Graves, facing a deficit of nearly half a billion dollars, advocated raising the state's cigarette tax and boosting the sales tax by a quarter-cent. Last month, Alabama sought to close a $160 million gap by raising taxes, including a tax on telephones. In Florida, Gov. Jeb Bush is delaying the implementation of tax cuts. (By the logic of his brother, President Bush, that's a tax hike.)

Governments will also have to cut spending. Bloomberg of New York City has asked many agencies to prepare for reductions of up to 15%. Most state government expenditures are for salaries, unemployment benefits and capital spending -- the sorts of activities that help stimulate the economy. But bureaucrats aren't the only ones who will be hurt by state budget cuts.

In many states, Medicaid costs eat up a huge -- and growing -- share of budgets. And across the country, states are unilaterally reducing Medicaid reimbursement rates for doctors, nurses, hospitals and clinics. Oklahoma decided last week to cut payments for prescription drugs. Indiana is hacking state Medicaid payments by 10%, or $25 million. Maine's government wants to slash the payments it makes to doctors by 5.6%. States such as Michigan are aggressively seeking to negotiate lower rates for the pharmaceuticals they buy from the likes of Pfizer (PFE - commentary - Cramer's Take) and Merck (MRK - commentary - Cramer's Take).

Are these the sorts of measures that can hurt an economy? Well, they certainly can't help. The sum that states must either raise or chop is almost certainly greater than the size of last summer's $40 billion tax rebate. Let's be conservative and say that the states and cities cause $50 billion of antistimulus. That's 0.5% of GNP.

Sadly, the tax increases and spending cuts tend to fall most heavily on the consumers who can afford them the least. The 10% hike in the ticket from Mahwah, N.J., to Penn Station in Manhattan won't put a crimp in the day of a managing director at Morgan Stanley. It will hurt the people who wash dishes in its cafeteria. The half-cent sales tax increase probably won't deter a shopper at the Tiffany (TIF - commentary - Cramer's Take) store in Charlotte, N.C.'s, SouthPark Mall; it will make a difference to the customer at Costco (COST - commentary - Cramer's Take) on Tyvola Road.

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Daniel Gross (www.danielgross.com), the author of Bull Run: Wall Street, the Democrats, and the New Politics of Personal Finance, writes frequently about the links between Wall Street and Washington. He is a Fellow at the non-partisan New America Foundation. He welcomes your feedback at [e-mail] .