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State Borrowing Can’t Substitute for More Direct Aid to Cope With Recession

Contrary to suggestions by Treasury Secretary Steven Mnuchin and others, borrowing isn’t a viable substitute for the substantial direct federal aid that states need to offset their sharp revenue declines and cost increases due to the deep, pandemic-driven, recession, our new report explains.

Without more federal aid, states will have to lay off even more workers and make even deeper cuts in services, which will likely mean thousands of teacher layoffs and cuts in health care and other services that would worsen the recession and disproportionately hurt people of color and low-income people, who recession is already hitting the hardest.

The argument that states don’t need federal aid because they can borrow to cover their shortfalls have three key shortcomings:

  • States’ fundamental problem is that their tax revenues will likely fall far short of covering their necessary expenses for health care, education, and other critical services for several years — we estimate by $615 billion over just three fiscal years. If states borrowed enough to avoid the deep cuts that they’ll have to make without substantially more direct aid, they wouldn’t be in good enough financial shape to repay it when the debt came due in a year or two.

    States might decide to borrow very short term — say, 6-12 months — to manage cash flow or buy time in hopes that federal policymakers will provide more direct aid. But without substantially more aid, short-term borrowing likely would only delay damaging layoffs and spending cuts, not avert them, since the state budget crisis will last far longer than a year.

  • Some analysts have proposed longer-term state borrowing as an alternative to more direct aid, but most state constitutions include balanced budget requirements and/or debt limits barring them from building borrowing into their enacted budgets and borrowing to cover unanticipated revenue shortfalls for more than a short period, often less than a year.
  • Even a state without these constitutional constraints would find it risky to borrow for long periods to cover budget gaps, which could set the state up for even deeper financial problems down the road. No one knows how long the recovery from this recession might last before the next one starts or when a natural disaster might strike; states could find themselves in new fiscal straits before paying off the debt they incurred during this recession. Moreover, every dollar that a state uses used to pay off new debt would be a dollar that it doesn’t have to deposit in a “rainy day fund” to prepare for the next recession.

    Even if states could take out big loans to mitigate the need for immediate service cuts, that would likely drive up interest rates on borrowing that states routinely — and appropriately — do to finance long-lived capital assets like highways and state university facilities, further squeezing their finances.