Using data from the National Income and Product Accounts, this paper analyzes the recent budget crisis in the state and local sector. Two factors primarily external to the sector-the economic slowdown and the decline in capital gains realizations-explain roughly one-third of the swing from surplus to deficit between 1998 and 2002 and two thirds of the swing between 2000 and 2002. However, policy and other factors, including tax reductions enacted by state governments and the recent acceleration in Medicaid spending, also have played an important role. In a historical comparison, we find that macroeconomic factors have played a less important role in the current crisis that they did in the crises of the early 1980s and early 1990s.
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