The Wall Street Journal’s Conor Daugherty reports that state and local revenues were down seven percent in the third quarter of 2009 from a year ago — and the third quarter of 2008 was not exactly the salad days of local revenue collection. The culprit is less money from income taxes and sales taxes. The result is that states must increase tax rates and spend less at a time when the federal government is cutting taxes and spending more. The Obama administration and Congress leavened this huge federal-local disconnect by handing states fiscal stabilization money from the stimulus bill. However, the administration has not responded to the crisis in local governance with the comprehensive aid package that they provided to, say, financial firms in peril.

Daugherty had a longer piece this weekend on the problem for city governments:

Months after many economists declared the recession over, cities are only now beginning to feel the full brunt of it. Recessions often take longer to trickle down to local government, in part because it takes time for the sales and property-tax revenues on which municipalities depend to catch up with a depressed economy.

But the sting this time around is expected to be far more acute and long-lasting then in previous recessions. Projected deficits are especially deep in some places and tax revenues could be pinched for years as consumers turn thrifty and real-estate prices remain diminished. That means the relatively painless measures such as borrowing, deferred payments to pension plans and scattered layoffs that have been used during past episodes of fiscal strain are unlikely to be effective in some cities.

State governments went through the same problem on a larger scale around July 1. That was when almost every state tried to fulfill requirements to pass a balanced budget — despite states like Illinois and California enduring deficits about a 1/4 of their total annual spending.  So highly populous states like Illinois, California, Florida and New York did a lot of creative accounting, pension payment deferments, and painful cutbacks in health care, education and infrastructure. For example, Illinois ended early-childhood education subsidies to 30,000 pre-school kids. California cut off medical care for thousands of low-income children. Nearly every state was forced to lay off employees like teachers and health service workers.

The spectacle of states trying to balance their budgets prompted the New Yorker’s James Suroweicki to pen a column called “Fifty Ways To Kill Recovery.” Suroweicki argued:

Think about the $787-billion federal stimulus package. It’s built on the idea that during serious economic downturns the government can use spending increases and tax cuts to counteract the effects of consumers who are cutting back on spending and businesses that are cutting back on investment. So fiscal policy at the national level is countercyclical: as the economy shrinks, government expands. At the state level, though, the opposite is happening. Nearly every state government is required to balance its budget. When times are bad, jobs vanish, sales plummet, investment declines, and tax revenues fall precipitously—in New York, for instance, state revenues in April and May were down thirty-six per cent from a year earlier. So states have to raise taxes or cut spending, or both, and that’s precisely what they’re doing.

So, the crisis in state governance not only impacts local businesses, schools and medical centers: it is also akin to a bucket with a hole in it.  With the health care debate nearing completion, the Obama administration is expected to next collaborate with Congress on a job creation program. The most direct way to do this would be pump money into state and city governments so states avoid further layoffs of important public service workers. Money to states and cities could also get infrastructure projects going. With the administration dealing with complex challenges such as global warming, money to save local government should be relatively straightforward. The question is whether the White House and Congress have the inclination to solve a classic outside the beltway problem in which governors and mayors suffer most of the political consequences.

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