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State Infrastructure Programs as a Countercyclical Tool


By Yonghong Wu
July 14, 2021

The COVID-19 pandemic has created and will continue to create unprecedented challenges to regional economic growth and the government fiscal landscape. Although employment numbers rebounded after the end of stay-at-home orders, job losses persisted for low-wage workers. According to the Opportunity Insights Economic Tracker, the employment rate among workers in the lowest wage quartile as of March 2021 was about 24% lower than January 2020. The ongoing economic and fiscal challenges highlight one important role of government—economic stabilization.

One important way to stabilize the economy is to invest in public infrastructure. Well-implemented infrastructure investments can stimulate the economy and generate sustained benefits to a diverse workforce, including unskilled workers. Infrastructure investment is generally considered to be a highly effective engine of job creation, which is much needed during recessionary periods.

Moreover, there has been a substantial gap between the condition of critical infrastructure in the United States and the amount invested in it. The American Society of Civil Engineers estimated an infrastructure investment gap of $2.59 trillion over the next ten years in a 2021 report. Substantial government investment is required to improve public infrastructure, which is a major determinant of economic competitiveness.

Orthodox public finance theorists are suspicious about the role state governments play in economic stabilization because of substantial fiscal spillovers, the benefits to neighboring states and limited fiscal capacity at the state level. While it may be theoretically sound to assign an economic stabilization function only to the federal government, this conventional wisdom has been criticized on both theorical and empirical grounds. Edward M. Gramlich, for example, points out that changes in the economy may make state countercyclical fiscal policies necessary.

He also notes that states, particularly large states, may be able to internalize a large share of the benefits of stimulating their economies when there are underutilized resources.

On the empirical side, Gerald Carlino and Robert P. Inman find that state level stimulus fiscal policies may become attractive when all states in a region agree to cooperate and collectively adopt similar fiscal stimulus policies.

The academic debate aside, political impasses often prevent the federal government from playing the anticipated role in economic stabilization. One recent example has been the difficult negotiations between the White House and Republican senators in June, 2021 over a bipartisan infrastructure bill.

With that in mind, there is a practical need for states to play a significant role in stabilizing regional economies through capital investment. The state role can be complimentary to the federal fiscal stimulus program or fill in the gap of government action if federal policymaking is absent or delayed. In addition, the underutilized workforce during an economic recession can help contain the fiscal spillovers within state boundaries. Another advantage of state countercyclical fiscal policy is that state stimulus programs can be well tailored to address specific regional and state economic needs and challenges.

There is, however, room for caution in an effort to utilize state infrastructure projects as economic catalysts. An attendant lack of fiscal capacity is a major constraint at the state level. The projects are financed by a state’s own current revenues, funds provided by the federal government and borrowed funds that are repaid using future tax revenues or user charges. The uses of current revenues and borrowed funds are often limited by constitutional or statutory rules. The balanced budget requirement (BBR) prevents a state government from spending more than their revenues. Various debt limits restrict the issuance of state government debt.

States can enhance their fiscal capacity, though, by utilizing funding from multiple sources including a separate state infrastructure investment fund. I propose that each state establish an infrastructure investment fund to support the economic stabilization function by saving cash during expansionary periods and investing in infrastructure projects during recessionary periods. In this way, state governments take responsible actions to stabilize both their budgets and economies. Necessary deposit rules should be enacted to accumulate sufficient resources in the infrastructure investment fund, which can only be released under certain conditions such as precipitous decline of statewide employment.

Since constitutional and statutory rules such as BBRs and debt limits constrain necessary state countercyclical policy responses during economic recessions, I suggest that BBRs be made responsive to business cycles through temporary suspension of the requirements if needed.

Such temporary measures can provide necessary funding for state infrastructure investment during economic downturn and still maintains the BBRs’ spirit of controlling excessive government spending. The deficits during recessionary periods can be balanced by raising additional revenues during expansionary periods. As a result, state budgets will be in balance over a multi-year timeframe, although the annual or biennial budgets are not necessarily balanced.

Debt limits can be made flexible in a similar way by allowing government debt to temporarily exceed the limits if economic conditions require that measure, and steps are taken to achieve control of the debt level over a multi-year period. This recommendation can be helpful if a state’s current debt level is close to its legal limits.

Author: Yonghong Wu, professor and director of graduate studies in public administration, and faculty advisory panel member, Government Finance Research Center, University of Illinois at Chicago.

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