It's a "now-and-hopefully-never-again" idea. Of all the things you could do with federal dollars, helping state and local governments rehire people they have fired or expand their public-safety payrolls seems like the most absurd. In normal times, if the public-sector is downsizing, that's probably a good thing. But this is not a normal time.That's reasonable, but I think there's a different and better case to be made for this sort of thing as a standard tool during all recessions, not just the unusual present one. I'm not sure why Klein believes that the public sector at the state and local level is inherently too large; I'd think that the federal government should be, probably, relatively neutral about that. But regardless, the long-term problem here is that since state governments can't run deficits, they're prone to boom and bust cycles, with perverse consequences: during recessions their revenues shrink automatically with decreasing economic activity, which then forces them to lay off employees, which in turn decreases economic activity.
Now, states could budget for recessions; the flip side of this is that their revenues soar (again, automatically) when the economy booms, and they could all be responsible about putting away that money for the future. But, we know, they mostly don't. The federal government could help, via some sort of triggered automatic scheme, which would give money to the states during recessions and then get paid back when the threat was over.
Now, in practice, when recessions are short and mild, all of this becomes unnecessary. In fact, the nature of state budget cycles probably winds up saving them from themselves. After all, the cuts aren't needed until the budget year following the downturn, and by the time the cuts take effect odds are that the economy is already recovering. Still, it's dangerous to the economy during a prolonged downturn, and even when there's no danger to the larger economy it still is most likely inefficient for states to embrace the boom-and-bust.
To be clear: a scheme to automatically stabilize state budgets isn't what Barack Obama has asked Congress for and therefore isn't what Klein is specifically talking about. However, in terms of lessons from the economic disaster of the last few yeas, in my view the effects of state budgeting should go very high on the list of obvious and relatively easy things to fix.
By the way, I'm still wondering whether any economist has estimated the total effects of state and local layoffs on the overall economy, including the indirect effect of still-employed teachers and others who stopped spending because of fears of future cuts.