BAILING OUT THE STATES….Paul Krugman writes today about the Bush tax plan ? he doesn’t like it ? and at the end throws in a quick sentence about a topic that has pretty much dropped off the radar screen in Washington: the increasingly horrific budget problems of state governments. It’s a bit of a throwaway line:

If the administration really cared about jobs, it would provide an emergency package of aid to state governments ? not to pay for new spending, but simply to maintain basic services. How about $78 billion ? the same sum just allocated for the Iraq war?

The fiscal meltdown of the states has been truly catastrophic, and back in December there was a lot of talk that Bush’s plan would include some kind of state bailout. In the event, though, it never happened.

There’s a good reason to be opposed to a state bailout, too: moral hazard. If the states come to expect that the feds will save their bacon any time they get into trouble, they’ll be less careful in the future. Bail them out once, and you can expect to do it again and again.

This is an argument that I take seriously, but life is all about making difficult choices and this is one that Bush and his team got wrong. Running a federal budget deficit as a fiscal stimulus but then forcing the states to cut spending makes little sense, and pretending that the Bush tax plan is a “jobs” program while simultaneously watching the states cut thousands of jobs is foolhardy in the extreme.

There are plenty of ways that a bailout could be structured to avoid the worst of the moral hazard problem. After all, we were willing to spend hundreds of billions of dollars to bail out the S&L industry in the 80s and Long Term Capital Management in the 90s. Why are we willing to bail out big corporate interests but unwilling to bail out state and local governments that provide basic services to the indigent?

Do I really need to ask?