Back in the early days of COVID, most analysts believed that the pandemic would devastate state and local government budgets. Mass unemployment and business shutdowns threatened to smash their tax bases while public health costs furiously stacked up.
But over the past several months, the picture has started to look much less bleak.
The standout surprise has been California, where Gov. Gavin Newsom recently proposed the largest spending plan in the state’s history thanks to an unexpected $15 billion budget surplus. (“California is again swimming in money,” the AP reported, matter-of-factly.) But many other states are faring better than anticipated, too. Some, such as Minnesota, have projected their own unforeseen surpluses, while others, such as Texas, now predict their deficits will be much smaller than previously feared. A recent report by JPMorgan Chase concluded that state tax collections fell by just 0.12 percent on average in 2020, while preliminary data from the Bureau of Economic Analysis suggests they may have increased slightly.
States have beat their dour expectations for several reasons. While the economy is still weak, hiring and consumer spending have bounced back faster than many economists forecasted (in part because Americans in large swaths of the country have decided to shrug off the virus and dine out, even if it means catching the plague). Inequality has helped too, perversely: Most job losses have been concentrated among low-wage service workers, while well-paid professionals have largely kept their jobs, to the benefit of states that rely on progressive income taxes. The booming stock market, meanwhile, has plumped capital gains collections.
The federal rescue has helped, too. Last year, Republicans stymied Democratic efforts to provide states with an unrestricted pot of money they could use to deal with their potential budget woes. But Congress did provide them with $150 billion to spend on combating the virus in the CARES Act last March and increased the federal portion of Medicaid funding during the COVID emergency. The generous federal unemployment insurance programs Congress created also helped, since many states tax those benefits.
Our unequal, K-shaped recovery has worked out especially well for California, where Silicon Valley’s workers have kept on coding from home, and record capital gains driven by the initial public offerings of companies like Airbnb and DoorDash helped hand the state an $18.5 billion windfall. “This budget reflects this state is doing pretty damn well,” Newsom said last month, as he unveiled his record-breaking spending proposal. “We’ve got a lot of work to do to help small and medium-sized businesses, but folks at the top are doing pretty damn well.” As if that point weren’t clear enough, the governor announced last week that the state had found another $10.3 billion on hand, as if it had discovered some loose change under the couch.
Not every state has been so lucky. Those that rely heavily on sales taxes, energy royalties, or tourism have been especially hard-hit, as have been cities and towns that have seen various revenue streams like parking fees evaporate. Of the 47 states JPMorgan examined in its report, 26 saw their tax revenues decline in 2020, several by more than 5 percent. Florida is currently facing a $2.75 billion shortfall; New York is staring at a $15 billion gap.
The situation also looks worse when you consider that cities and states usually need their revenue to grow each year in order to keep providing the same level of services to their residents (teacher and cop salaries go up; the number of school kids and Medicaid patients grows). In December, the National Association of State Budget Officers reported that overall state revenues for fiscal year 2021, which began in July, were expected to come in 10.8 percent below pre-COVID projections, and were on pace to trail 2020’s totals by 4.4 percent.
Still, the steady drumbeat of good news about state budgets has lead to a new, last-minute policy debate in Washington, as Democrats have started putting together their massive new coronavirus relief bill. The legislation proposed in the House would hand state and local governments $350 billion to patch budget holes created by the crisis, as well as $30 billion to bail out transit agencies, which have seen ridership collapse, and another $128 billion for public schools. It’s a generous get-well package for America’s put-upon governors and mayors—but do they actually need all that cash?
Republicans, who spent 2020 blocking unrestricted aid to state governments, have predictably argued that the funding is completely unnecessary. Florida Sen. Rick Scott, for instance, recently accused Democrats of “lying about the need for this money.” But more moderate pundits and think tankers have suggested that the amount may be excessive and could be better used for other purposes.
“Between the direct aid and the money for public schools and transit, we’re giving state and local governments more than half a trillion dollars, when it seems hard to justify even half that,” Marc Goldwein, senior vice president and senior policy director for the centrist Committee for a Responsible Federal Budget, told me. “We’d be better off taking some of this money and spending it on things like extending unemployment benefits past August, when we’re still going to have a jobs problem.”
Where you come down on this question probably depends, at least in part, on whose projections you believe about the shortfalls states are facing right now. Democrats have relied partly on figures from the left-leaning Center on Budget and Policy Priorities, which currently forecasts that states, territories, and tribal areas are down about $300 billion, not counting the trouble at transit agencies. If you subtract the $75 billion states had in their rainy day funds at the beginning of the crisis, it falls to $225 billion.
Other leading forecasts have come in much lower. The public finance team at Moody’s Analytics now believes that states face a $165 billion gross shortfall, or $86 billion after reserves, far lower than their estimates earlier in the pandemic.
There are a number of (frankly boring) technical reasons these two estimates diverge so much, but the split underscores a basic point about this debate, which is that nobody is really objectively correct about what the magic number for state aid ought to be. For starters, Michael Leachman of CBPP told me that his team’s analysis assumes that states’ revenues should grow about 3.5 percent per year, absent the pandemic. The Moody’s folks, on the other hand, only assume they should have grown at the inflation rate. Moody’s estimates are based on a full economic model in which they try to incorporate the effects of $700 billion of other stimulus spending; CBPP’s estimates don’t involve any macro modeling at all, so it doesn’t factor in what the additional stimulus Congress is considering may or may not do to state tax bases. Both sides are also working with somewhat incomplete information, since there isn’t really a good, comprehensive source of data on local government finances (even the federal government’s numbers, published by the BEA, are extremely rough and are usually revised heavily over time).
What seems notable, in the end, is that both estimates are ultimately quite a bit lower than the number Congress is currently contemplating, especially once you factor in the additional money for public schools, which already received a big infusion of cash in the bipartisan relief bill passed in December.
Is giving states too much money a problem? Possibly. Harvard economist and former Obama adviser Jason Furman told me he was worried that some states might use a sudden influx of revenue to cut taxes: “They may use a temporary windfall for permanent tax cuts, in which case you’ve created a longer-term problem.” If that sounds far-fetched at the moment, West Virginia Gov. Jim Justice is already using his state’s recent budget surplus as an opportunity to advocate for tax cuts. One solution might be to simply attach a few extra strings onto state aid (like a no-cutting-taxes-for-the-year rule). Or Congress could tie some aid to the health of the economy: Rather than dole out all the cash now, it could automatically boost the federal share of Medicaid spending if unemployment remains high in 2022 or beyond.
The bigger issue, really, may just be that some of the cash could be used somewhere better in this relief bill, such as on longer-lasting unemployment benefits, food stamp benefits for the poor, or, at the risk of reopening a grisly debate, bigger checks. (And I say this as someone who spent much of last year screaming for Congress to give more money to states.) It probably isn’t a tragedy if Democrats go a bit overboard helping the cash-strapped capitals in Tallahassee and Albany. There just might be more useful ways to spend some of these billions.
