How State Responses to Economic Crisis Shape Income Inequality and Financial Well-Being

Abstract

This study examines how state government responses to economic crisis, in the form of unexpected changes in state fiscal policy, influence income inequality. State governments are vital actors in times of fiscal stress as nearly every state must make difficult policy decisions related to taxes and spending to address budget deficits, both of which are policies that shape the income gap. Focusing on periods of fiscal stress is important for the study of state inequality as those with fewer resources are the most likely to experience the consequences of their state’s fiscal response during these times. Using time-series cross-sectional data, this research demonstrates that income inequality increases when states respond to economic crisis by relying on unexpected spending cuts. These effects tend to persist even after initial economic downturns. In addition, one individual-level implication of the aggregate relationship between state policy responses and inequality—that people will be worse off financially when their states emphasize budget cuts in response to economic decline—is assessed using several post–Great Recession surveys. The findings have implications for the future of inequality in the United States and provide potential paths for state fiscal reform.

Fiscal Federalism and Economic Crises in the United States: Lessons from the COVID-19 Pandemic and Great Recession

“…Historically, U.S. states have first resorted to spending freezes and cuts when facing budget difficulties, in part given that they are politically and administratively less costly than tax increases ( Franko 2021 ; Klase 2011 ). According to researchers from the Center on Budget and Policy Priorities, during the Great Recession “spending cuts accounted for nearly half of state actions to close their shortfalls between 2008 and 2012, three times as much as tax increases and five times as much as ‘rainy day’ fund withdrawals” ( Leachman and Williams 2021 ).…”

“…Moody’s (2020 ,1), for instance, estimated that “revenue is unlikely to return to fiscal 2019 levels by fiscal 2024 without tax increases.” Lawmakers in some states are considering a variety of options, such as following Arizona and New Jersey’s footsteps (e.g., Minnesota), legalizing and taxing recreational marihuana (e.g., Pennsylvania, Virginia), taxing capital gains (e.g., Washington), taxing digital goods and services, as well revising the terms of economic nexus law by lowering the threshold that was upheld in South Dakota v. Wayfair ( Jetter 2020 ). While it might be costly for politicians, especially for Republicans, to increase taxes and fees, recent research suggests that people who lived in states with a revenue-based approach during the Great Recession were better off financially than those living states that relied in spending cuts ( Franko 2021 ).…”

Loss of financial well-being in the COVID-19 pandemic: Does job stability make a difference?

“…Besides expanding investments in the public health system, aiming to guarantee access to treatment for the entire population, regardless of income level, Brazil created an emergency aid program for the most vulnerable, with the transfer of income to 63.5 million people. Such a policy meets the evidence that states that can maintain or even increase spending on essential programs during times of economic decline have the potential to reduce the expansion of income inequality that will occur due to the ability of the rich to easily recover from economic downturns ( Franko, 2020 ).…”

State-of-the-Art: A Systematic Review of the Literature on Financial Well-Being

“…Lower-income consumers are more vulnerable to the loss of financial well-being due to their lower levels of financial reserves (Ponchio, Cordeiro, & Gonçalves, 2019). Moreover, due to the ability of the rich to easily recover from economic downturns (Franko, 2020), in times of crisis, the rich lose less financial well-being than the poor.…”

“…The threats to financial well-being, which Shim et al (2009) understand how the sentiment to the financial situation, is determined by the ease that contemporaneousness provides in the purchases, by the availability of credit and affordable means for loans and credit cards. The individual's financial well-being is also tied to a social and political-economic issue because the families most affected by financial concerns are low-and middle-income families (Lyons & Yilmazer, 2005;Franko, 2020).…”