The Second Wave

Michael Gerson

11/12/2010 12:01:00 AM - Michael Gerson

WASHINGTON -- Following the midterm elections, attention understandably focused on those parts of the South and Midwest where the Obama coalition collapsed. But a second wave of trouble is coming for the president and his party, precisely in those states where the first wave barely reached. Having experienced the revolt of red America, Democrats must now deal with the fiscal crisis of blue America.

While massive state budget shortfalls are not limited to predominantly Democratic states, they are concentrated in them. "In California and New York," says John Hood of the John Locke Foundation, "the fiscal crisis flirts with bankruptcy." Explanations include rising Medicaid costs, increased spending on higher education, and the long-term challenge of funding public pensions. At the same time, says Hood, "All the major sources of revenue have cratered." The states doing worst are the ones, such as California and New York, that had irresponsible budgets going into the recession. States that were fiscally responsible during good economic times, such as Indiana, have had a softer landing.

The political crisis in many states has been delayed by President Obama's 2009 stimulus package, which temporarily plugged gaps in state budgets, and by a variety of budget gimmicks. Illinois, for example, has simply delayed payouts to doctors providing Medicaid, leaving about $6 billion in unpaid bills that will be eventually covered by the issuing of debt.

But now comes the reckoning. Stimulus support of state budgets is running out. Gimmicks generally work only once. And much of the country has turned hard against tax increases that might help close the gaps. Following the economic panic of 2008, a number of states hiked taxes as an emergency measure. But with Republicans recently electing their highest total number of state legislators since 1928, even Democratic governors will think twice about proposing tax increases.

Governors are seeing their options dramatically narrowed, leading them toward severe spending reductions -- cuts in popular programs and in aid to local governments. We are likely to see more municipal defaults, with state governments unwilling or unable to bail out failing cities. While it remains unlikely that states themselves will default on their debt, several governors have attempted to claw back past benefit promises to public employees -- which Josh Barro of the Manhattan Institute calls "an implicit default."

What are the political effects of the blue-state budget crisis? In Washington, it will set up a conflict between desperate governors and the new Republican House. States will seek federal help and pressure their congressional delegations for support. But there is little chance that conservatives will add a new state bailout to all the bailouts that have come before. Any additional economic stimulus would likely be in the form of tax relief, perhaps a payroll tax holiday, not in cash payments to state governments.

For the president, entering his own re-election campaign, the teetering finances of blue America are a serious challenge. Obama, fairly or unfairly (but mainly fairly), has become a big-government brand name. West Virginia's governor and future senator, Joe Manchin, demonstrated that Democrats are willing to run in contrast to Obama when it serves their interests. Other Democratic governors -- perhaps in Colorado and Illinois -- might be tempted to distance themselves as well, establishing what Hood calls "alternative brands to Obama himself."

Most significantly, the blue-state financial misery continues and deepens the ideological crisis of American liberalism. Few politicians in traditionally liberal states now speak about the expanding promise of progressive government and the welfare state. New Jersey is already in conservative revolt. New York's Democratic governor-elect, Andrew Cuomo, campaigned on a promise of budget cuts without tax increases. The New York congressional delegation shifted significantly in a Republican direction. While California remains in denial -- even after a budget crisis that has lasted for a decade -- that could rapidly change as well. It may be Democratic governors who are forced by economic reality to limit the size and ambitions of government, delivering a body blow to liberalism itself. If progressive activism can't survive in these places, it will be difficult for it to survive anywhere.

All these calculations change, of course, with a dramatically growing economy, providing states with additional revenue and the president with political breathing room. But absent that desired development, Obama's political challenges, and the backlash against liberal government, are only beginning.