Vice President for State Fiscal Policy
Senate Majority Leader Mitch McConnell defends his opposition to more fiscal relief for state and local governments by arguing that it would just “bail out” states that have mismanaged their finances, particularly their state employee pension systems. That’s far off base. In reality, states would use the money to avoid massive layoffs and deep spending cuts due to the public health emergency and its economic effects. If they impose these cuts, the recession will be considerably deeper and longer. That’s why the next COVID-19 federal aid package needs to include fiscal relief to state and local governments for lost revenues, as President Trump himself acknowledged earlier this week.
We project that state budget shortfalls in fiscal year 2021 (which starts July 1 in most states) will far exceed those in the worst year of the Great Recession and will extend into 2022. In total, we project $500 billion in state shortfalls over fiscal years 2020-2022. This figure doesn’t include the shortfalls many local governments will face.
States must balance their budgets every year, even in recessions. Without substantial federal help, states very likely will deeply cut areas such as education and health care, lay off teachers and other workers, and cancel contracts with businesses. This would worsen the recession, delay recovery, and harm families and communities. The resulting cuts in health care could also shortchange coronavirus response efforts. The large budget shortfalls could lead states and localities to raise taxes and fees, too.
Sales and income taxes account for 70 percent of state tax revenue, but sales tax revenues have fallen through the floor because the places where people shop are closed. Income tax revenues also are collapsing due to mass layoffs and the stock market plunge. And state costs are up as states respond to the crisis and millions of newly jobless people turn to government assistance.
States couldn’t have predicted these extraordinary events. Moreover, they did a reasonable job of saving for a recession: states held much larger reserves when this crisis struck than when the last recession started. Heading into the current crisis, “rainy day” funds — reserves designated for responding to unanticipated revenue declines or spending needs — equaled about 7.6 percent of state budgets, versus about 5 percent in 2006, the high point before the Great Recession. And total state reserves (which include general-fund ending balances) now equal about 13 percent of state budgets, also well above 2006. Similarly, in 38 states the trust funds that support state unemployment insurance programs were better prepared before the current crisis than they were before the Great Recession, and most state trust funds met the U.S. Labor Department standard for recession preparation. The problem is that state revenues have fallen so severely that the resulting shortfalls are swamping states’ reserves.
Nor have states been overspending. As a share of the economy, spending from state general funds (which support current operations, like schools, health care, the justice system, and public health) is well below its levels heading into the last downturn. In some key areas, states have been too frugal. States still employ fewer teachers and other school workers than a decade ago, even though many more students are enrolled. Similarly, state funding for higher education per pupil is down 13 percent on average from roughly a decade ago, after adjusting for inflation, pushing up tuition and making college less accessible. And spending on infrastructure stands at historic lows as a share of the economy.
The idea that states would spend additional federal aid primarily on pensions also is mistaken. Emergency federal aid would go into state general funds, which are collapsing for the reasons noted above. States pay retirees’ pension benefits out of separate trust funds. While states (and localities) use general funds to make regular payments toward future pension obligations, these payments amount to only about 4.7 percent of state and local general fund spending, on average. And every state has adopted pension reforms over the last decade, leaving benefits for new employees in many states significantly weaker on average than in the past.
Senator McConnell suggested that, rather than helping states, the federal government should allow them to go bankrupt (which the federal bankruptcy code doesn’t now permit). That wouldn’t help either state budgets or the national economy and could actually make things worse. Bankruptcy is a tool for addressing high debt levels by canceling obligations to creditors. But state debt isn’t high by historical standards, and once state economies return to normal, they should be able to meet those obligations. As we wrote during the last recession, states have a strong track record in being faithful in paying their debts and have done so since the late 1800s; only one state (Arkansas in 1934) has ever defaulted on its general obligation debt.
Moreover, allowing states to declare bankruptcy — an idea panned across the political spectrum in the past – could significantly raise states’ cost of issuing bonds to pay for major transportation projects and other investments that boost the economy. That’s because investors, worrying more that they might not be repaid, would demand higher interest payments.
The bottom line is that strong fiscal relief for states is one of the most important and badly needed steps federal policymakers can take now. Senator McConnell’s misunderstandings and misrepresentations on this matter do nothing to alter that reality.