How States Can Recession-Proof Their Budgets, Promote Opportunity
Ongoing economic uncertainty indicates a recession remains possible in the next year. Instead of tax cuts for the wealthy and corporations that worsen inequality and make states more vulnerable, state policymakers should prioritize policies that strengthen economic resiliency and protect workers, families, and the services that increase opportunity. This blog series recommends four things states can do to help recession-proof their budgets and state economies.
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In many states policymakers are starting 2023 legislative sessions with calls to layer more tax cuts on top of wasteful ones already enacted over the past two years. But with state revenues slowing and a potential recession looming, such a path could pose serious harm for workers, families, and communities nationwide.
States should instead be taking the opposite approach: avoiding additional short-sighted tax cuts, reversing or at least trimming recently enacted ones, and enacting policies to raise revenues where possible. That way, their revenue systems and the vital public services they support will be better prepared for a rocky economic road that could lie ahead.
State revenue collections are facing significant uncertainty that demands caution, even if the direst scenarios don’t materialize. Revenue collections have been strong over the last two years, fueled by the economy healing from the pandemic and supported by major federal relief efforts that both strengthened the recovery and directly bolstered state revenues. But revenue growth slowed significantly over the latter half of 2022 due to factors including high gas prices, supply chain shocks caused by geopolitical disruption, and a weak stock market. National and many state forecasters expect revenue growth could continue to slow over the course of 2023.
The most serious headwind facing state revenues is a potential economic downturn. While economic growth has proven more resilient than some gloomier forecasts had predicted, it has generally weakened over the course of the past year. And repeated interest rate hikes by the Federal Reserve could dampen economic activity further, by making it more expensive to get a car loan, buy a house, carry a balance on a credit card, or borrow for business investment. A full-fledged recession, whose probability economists pegged at 61 percent in the next 12 months in a survey last week, is not guaranteed but is certainly possible.
Recessions are especially harmful to states because state leaders, unlike their federal counterparts, must balance their budgets each year, even when revenues are down. And unless they offset these revenue drops with targeted tax hikes or by using other fiscal planning tools such as rainy day funds, they must make sizable cuts in essential services that could prompt teacher layoffs and growth in class sizes, less access to affordable health care or child care, deferred maintenance on roads and other vital infrastructure, and cutbacks to libraries, senior centers, and other local services.
After the Great Recession, for example, states enacted enormous cuts to K-12 education, which in many states were never fully reversed and, nationwide, led to significant harm to children’s learning. Cuts to economic supports, meanwhile, slowed the recovery, increased hardship, and worsened long-standing structural inequities that hold back Black, brown, and Indigenous people as well as women and low-paid workers.
In addition to the threat of a recession, states will also have to contend with the effects of major federal relief measures winding down in the next few years. For one, states must fully allocate the flexible COVID-19 recovery funds they received under the American Rescue Plan by the end of 2024, adding another risk factor to dwindling revenue surpluses and potentially spurring a need for new revenues to fund ongoing investments states made using the recovery funds. Many of these investments, such as housing assistance and workforce development, were key to helping residents hit hardest by the pandemic recession and will remain crucial for households struggling to afford the basics or seeking new opportunities to get ahead, whether in good economic times or bad.
The pending expiration in 2025 of large parts of the federal Tax Cuts and Jobs Act, enacted in 2017, also adds some uncertainty to state budgets, due to deep and intricate linkages between state and federal income tax codes. At the same time, state budgets could see some indirect gains from the infrastructure legislation and the Inflation Reduction Act enacted last year, since their sizable climate and infrastructure investments may help foster stronger economic growth.
Unfortunately, state tax policy choices made in the past two years already put many states in an unnecessarily precarious position. In several statehouses, policymakers used the temporary surge in revenues from the COVID-19 recovery to justify permanent cuts to their state revenue systems. Twenty-one states cut their personal or corporate income tax rates in 2021 and 2022, with Arizona, Iowa, Kentucky, and Mississippi (to name a few) enacting especially costly cuts. Kentucky’s tax cut package, for example, could cost as much as $1.2 billion annually once fully phased in by 2025 — more than that state’s entire budget for its colleges and universities. And Iowa’s could cost nearly $2 billion a year by 2028, compared to what’s now an $8.2 billion budget for the entire state.
Some policymakers have also shown a desire to continue the tax-cutting spree when state legislatures return in January. Mississippi’s governor, for example, is renewing his two-plus-year push to eliminate the state’s personal income tax, using many of the same arguments that fueled failed tax cut experiments in Kansas and other states. This reckless idea could also see serious consideration in Arkansas and Louisiana this year.
In other cases, lawmakers could move to accelerate the phase-in of previously passed cuts or slash rates further. And a broad swath of other states appear likely to consider either new rate cuts or more modest, but still costly and (often) poorly targeted, one-time rebate packages. Such rebates would deliver scant benefits to most workers and families — while losing sizable revenues that would be better used to strengthen services crucial to helping support families and communities, particularly in times of recession.
Given the uncertainty and potential economic headwinds ahead, states should resist the tax-cut temptation. They should instead learn from the mistakes of the Great Recession by prioritizing revenue and shoring up their tax systems to protect jobs, vital state services, and the families and communities these services help support. Options available to states include exploring targeted revenue increases, especially on high-income households and profitable corporations, which are relatively resilient to economic swings; pausing or rolling back recently enacted tax cuts; and looking to economy-boosting, targeted tax credits as a responsible alternative to costly rate cuts. States can also continue building on some commendable efforts to strengthen their rainy day funds (which are in better position today than before the Great Recession) by pursuing additional policies — such as stronger unemployment programs and access to health care — that can help strengthen state budgets and economies in preparation for a downturn.
Many recent economic signs are encouraging but don’t preclude a possible recession soon, and in the face of this uncertainty states should closely examine the strength of their rainy day funds. More states should join the commendable savings efforts that many states are already engaged in, and all states can explore improving the processes behind building and using their funds. That way states can ensure they’ll have fiscal flexibility to protect families, jobs, and public services from the harms of an economic slowdown, while continuing to make investments that address the current needs of people and communities.
A turbulent past few years for states — the pandemic recession and recovery and uneven economic growth overall in 2022 — has meant that significant needs for current investment remain. That’s especially true for people whom public and private investment have historically excluded, including low-income people and many communities of color. Helping them meet their immediate needs is a high priority, for example by enacting targeted tax credits, boosting support for colleges and K-12 public schools, expanding access to health care and child care, and rejecting misguided tax cuts that sap the revenue such services depend on.
At the same time, a possible economic downturn poses some significant risks that state policymakers should factor into their budget decisions this year. When the economy slows, consumer spending goes down and jobs are lost. That creates more pressure on state unemployment insurance programs and increases demand on many other state services that provide temporary help to workers and families, such as Medicaid, cash assistance to families with low incomes, and behavioral health services. Most state revenues are closely tied to the strength of the economy and typically decline during slowdowns, making it even harder for states to meet rising needs.
That’s among the reasons why states early in 2023 should be prioritizing revenues so that their fiscal houses and economies are well prepared both to meet people’s current needs and to guard against further harm. One way states can do that is to halt — and reverse — the harmful wave of income tax cuts and other reckless tax policies many of them enacted over the past two years, and instead strive to protect revenues and raise new ones to promote shared economic prosperity.
Another way states can ensure they’re well prepared is by ensuring their rainy day funds are sound. These reserve accounts are designed to be built up in good times and drawn from in difficult times, so that states can avoid harmful cuts as they move to keep their budgets balanced, which they must do even amid severe shocks such as a recession or environmental disaster. Robust rainy day funds help states avoid layoffs and cuts, thereby mitigating the inequitable harms that result from recessions. They’re an essential component of strong revenue systems that can endure economic ups and downs and preserve stability, especially during difficult times when they’re needed most.
Cash reserves are no substitute for permanent, meaningful investments that support families and communities and broaden opportunity. But strong rainy day funds buy time to strategically enact polices that limit the harm a downturn can cause for people and help keep the economic engine of the state running by minimizing layoffs and furloughs for teachers, health and child care workers, and other frontline workers.
Fortunately, states in recent years have done a much better job than in the past to buoy these funds. Aided by a stronger-than-expected economic bounce-back from the COVID-19 recession and the large influx of federal relief funds, state cash reserves have grown threefold over the last two years, to $343 billion. That’s nearly one-third of total state general fund expenditures.
Some state policymakers may question the need to have weightier nest eggs over cutting taxes or placing their sole focus on new investments. But according to a recent Moody’s Analytics forecast, only 18 states have enough reserves to adequately respond to a moderate recession without cutting services or raising taxes. That means if a downturn does materialize, communities and families in most states could face layoffs and spending cuts that risk making a recession only deeper and longer.
Tax cuts threaten states’ ability to respond to unforeseen economic turmoil, and the current levels of cash reserves can be misleading. The discrepancy between high overall reserves and states’ preparedness is due to some tricky dynamics of how state reserve funds work. For one, less than half of the total cash reserves, or $135 billion, are explicitly rainy day funds available to empower state policymakers to limit the damage of a recession. Much of the remaining reserves are already earmarked, obligated for specific uses, or — as state aid provided under the American Rescue Plan — are prohibited from being deposited into rainy day funds.
Median state rainy day balances in 2022 are estimated to be about 11.6 percent of total state spending (see first chart), or just about 42 days’ worth of funding for health services, education, emergency response, and transportation infrastructure. While states would benefit from having more, that level is far better than it was before the Great Recession, when inadequate savings weren’t enough to prevent deep and harmful cuts in most states.
During that period, states were able to mitigate roughly $60 billion in revenue losses by tapping their rainy day funds. States’ primary response to budget shortfalls was to make nearly $300 billion in cuts. Those cuts affected education, health care, public safety, transportation infrastructure, and other state services between 2008 and 2012. We know now that if states had adequately built up their rainy day funds and made them easier to replenish in the good times, and if the federal response to that recession had been more robust, an accelerated recovery would likely have resulted, preventing many people from struggling as they did.
To avoid similar service cuts or tax increases on those who can least afford it, if and when the next downturn hits, states can take some concrete steps on their rainy day funds this legislative session — alongside any of their other efforts to meet their residents’ more immediate needs.
States that didn’t make as much progress saving in recent years should act now to increase their rainy day funds. And all states can consider some sensible reforms to remove restrictions on building up those reserves and to give policymakers broader discretion over how to use the funds in an emergency.
For instance, many states’ rainy day funds have built-in restrictions that make it hard to quickly access them when needed. And some states cap their funds at levels that are less than 10 percent of the budget, while others have spending limits and supermajority requirements that create needless roadblocks to using the funds when they’re needed most. States should roll back these arbitrary restrictions, increase the target size of their funds, and perform stress tests to determine their adequacy. States with rigid, out-of-date rules should improve the design of their rainy day funds by instituting new guidelines to strategically build up their rainy day funds once core state budget needs are satisfied.
Whether or not the direst economic forecasts materialize, states would be better safe than sorry when it comes to their rainy day funds. Revenues are already beginning to slow. And a banner year for harmful, revenue-losing state tax cuts in 2022, with the bulk of them flowing to wealthier households and business, only adds urgency to states getting their fiscal houses in order and reinforcing their toolbox for helping people and communities thrive, both now and down the road.
A recession may or may not be around the corner, but the chances are significant enough that states should be prudent and take steps to bolster their unemployment insurance (UI) systems and, in some cases, to reverse recent years’ policies that have weakened them. Investments in state UI programs should be prioritized over calls for wasteful tax cuts that will leave states underprepared for economic downturn.
States with too few maximum weeks of benefits should increase those maximums, and all states should raise their maximum benefit amounts. All states should also fix their outdated eligibility requirements, which leave out too many unemployed workers, particularly women, people of color, and people who are immigrants.
UI serves a vital role for workers and state economies by providing cash benefits to eligible workers who have been laid off from their jobs. The program becomes especially crucial during economic downturns, when more people lose their jobs and when declining household spending can deepen and lengthen the downturn. Following massive and rapid job losses at the outset of the COVID-19 pandemic, for example, an expansive set of new UI benefits provided on an emergency basis by the federal government helped saved millions of people from severe hardship.
When workers are laid off, having some level of income through the UI system can help them avoid immediate financial distress and outcomes like eviction, food insecurity, and even homelessness. And UI benefits enable jobless workers to continue purchasing goods and services, helping to keep businesses afloat, to prevent additional layoffs, and to keep the recession from becoming worse.
While the federal government provides some minimal program requirements, states have significant flexibility over nearly every facet of basic UI policies. That includes benefit levels and duration, eligibility criteria, adjustment of employer tax rates, and the extent and duration of prior employment required to qualify for benefits. This broad flexibility has resulted in a patchwork of state UI systems with varied abilities to support workers when they lose their jobs, including during recessions. Policies some states have enacted over the past few years, such as cutting back on the duration of benefits, have significantly weakened their unemployment systems.
The result of these varied and often harmful policy approaches is that UI benefits currently reach fewer than 20 percent of jobless workers in 34 states, Puerto Rico, and the District of Columbia. (See map.) In three states — Alabama, North Carolina, and South Dakota — less than 1 in 10 unemployed workers receive benefits. Conversely, California, Minnesota, and New Jersey are the only states in which more than 40 percent of eligible workers receive UI payments. Despite increased recipiency during recessions, no year since 1975 has seen national UI recipiency come close to reaching 50 percent until Pandemic Unemployment Assistance was temporarily established in 2020 to expand UI coverage to workers usually excluded from the program.
In the face of continued economic uncertainty, and with a possible downturn looming, states should bolster their UI systems this legislative session in the following ways:
- States with too few weeks of maximum benefits should increase those maximums. From the 1960s until recent years, every state provided a maximum of 26 weeks or more of benefits for eligible jobless workers. Since the Great Recession, many states have cut the maximum weeks allowed, regardless of economic conditions. In 2022 alone, four state legislatures enacted laws to reduce the number of weeks of unemployment benefits. Even in the pandemic, nearly half of states chose to stop providing federally funded emergency UI benefits before their scheduled end in September 2021, leaving millions of people without income for months and forfeiting an estimated $2 billion in consumer spending. Today, 12 states allow fewer than 26 weeks of UI benefits and two states — North Carolina and Florida — allow no more than 12 weeks, even in the worst recession. Short benefit duration can mean that a worker who is laid off from their job may lose UI benefits before they’re able to find a new role, or face pressure to take a job that’s a poor match for their skills and unlikely to keep them employed.
- All states should make UI eligibility more equitable. Most state UI systems also have outdated eligibility requirements that leave out many unemployed workers, particularly women, people of color, and immigrants. Few states offer UI benefits to people who need to leave their jobs for reasons such as to care for a sick family member. Many states require workers laid off from part-time jobs — including parents caring for young children — to seek full-time employment to qualify for UI. Because people of color are more likely to hold jobs that pay low wages, provide unstable hours, or fail to provide paid sick or family leave, these rules exacerbate racial inequity, especially for Black, Latina, and Native American women, who hold intersecting identities and face both racial and gender discrimination. Women in general are much likelier than men to work in part-time jobs and to leave work for caregiving responsibilities. In addition, Black workers are more likely than workers of other races to live in the South, where states have adopted some of the most restrictive UI eligibility rules in the country. Immigrants without documented status, meanwhile, are locked out of receiving UI benefits altogether. Several states made a commendable effort in the pandemic to offer them direct cash support, and Colorado has established a new program to do so permanently — more states should join it as they address the many inequities in UI eligibility.
- All states should raise benefit amounts. UI benefits that are too low to adequately replace workers’ lost wages make it harder for families to stave off hardship and for the broader economy to rebound from recession. States vary widely in the value of the average weekly UI benefit they provide: in 12 states and the District of Columbia, it’s only a quarter or less of the state’s average weekly wage, compared to it being nearly half the average weekly wage in Hawai’i, Iowa, Montana, and North Dakota. All states should raise benefits to more effectively support workers, and should make concerted efforts to address the potential effect of biases within the broader labor market on their UI systems. For example, Black workers at every education level are paid less than similar white workers, and lower-paid workers are less likely to meet monetary eligibility requirements for UI in many states. States could account for that bias and make their UI systems more equitable with some sensible reforms designed to lower or remove barriers to receiving benefits, as states like Massachusetts and Washington have done.
Improving UI systems by increasing benefits, lengthening their duration, and broadening eligibility to workers previously left out can strengthen the protective effects of UI for both workers and state economies. Common-sense reforms adopted today would help states face whatever lies ahead, whenever the next downturn might come.
The economy is showing resiliency despite predictions of a potential recession soon, but the mere threat of one should be sign enough for states to shore up their public, postsecondary education programs. Demand for postsecondary education typically grows during recessions, and research has proven the benefits of postsecondary degrees and training in reducing unemployment and underemployment rates while improving people’s health outcomes, savings, and civic engagement.
Public postsecondary programs — including community colleges, apprenticeships programs, trade or vocational schools, and public universities — are crucial elements of state success in both good times and bad. They can increase long-term opportunities for students and workers and help make state economies more resilient.
And when a recession looms, state support for higher education becomes even more important. However, some states are recklessly using temporary surpluses to justify permanent tax cuts this legislative session, which would reduce critical funding for services like public higher education. States should be taking this opportunity to strengthen postsecondary education and make it more accessible and affordable. States with weaker higher education systems should expand funding for them, and states where those systems are more adequate should at the very least seek to protect their current funding levels.
Workers who lose their jobs or see their hours reduced often seek additional training and education to improve their skills and future job prospects. Affordable, well-funded postsecondary programs are particularly critical for those most impacted during economic downturns to have opportunities when the job market is weak. Expanding access to postsecondary education and training during a downturn can help workers come out of the recession better equipped to succeed during the economic recovery and can put the states’ economy overall in a stronger position with a better-trained workforce.
Accessibility remains a challenge at many public institutions of higher education, due in large part to inadequate state support. Notably, after the Great Recession states made sharp cuts to higher education funding and shifted tuition costs onto students. Between the 2008 and 2019 school years, 37 states cut per-student funding, six of them by more than 30 percent: Alabama, Arizona, Louisiana, Oklahoma, Mississippi, and Pennsylvania. In the years leading up to the pandemic, 32 states still had not recovered to pre-recessionary funding levels for higher education.
Those decisions led to reduced course offerings, cuts in student services, closed campuses, and higher costs for students and families. And they’ve made it harder for prospective students — disproportionately students of color and students with low incomes, among other historically excluded groups — to obtain the benefits of a college degree or other credential.
Exorbitant costs associated with public higher education programs pose a significant barrier to economic opportunity, as well as to state prosperity broadly. They prevent some prospective students from pursuing a credential altogether, and those who do pursue them often face higher debt loads. That debt makes it harder for them to achieve economic stability, save for the future, and afford basic needs. The high cost of attendance is often exacerbated by other significant expenses such as housing, food, supplies, and child care, and financial aid options and families’ income have not kept pace with these expenses.
These barriers are especially prevalent for those who have been systematically excluded from income- and wealth-building opportunities: students with low incomes, students of color, formerly incarcerated students, non-traditional students (such as those who delay enrolling in postsecondary education), and students who don’t have a documented immigration status. Some states worsen racial and income disparities by awarding an overwhelming majority of their financial aid in a way that disregards need.
Many states have yet to provide financial aid to individuals who are incarcerated (in contrast to some positive federal reforms recently) or in-state tuition to people regardless of immigration status. The inclusion of the federal Pell grant to people in prisons beginning in the 2023-2024 school year will help, but that still leaves other steps states will need to take to improve affordability for people who are incarcerated. In-prison postsecondary education programs strengthen career pathways beyond the carceral system, better equip formerly incarcerated people with competitive skills and qualifications for the workforce, and increase their likelihood of successful reentry into communities.
All told, these affordability challenges make it harder for prospective students from these groups to avail themselves of higher education that can help them prepare for economic success, especially compared to higher-income students with the resources to access higher education more easily.
To strengthen higher education and make it more accessible to everyone in good economic times and bad, states should:
- Shift state-funded assistance from merit-based to need-based aid. Traditional measures of merit (typically high school GPA or college entry exams) favor those who already benefit from well-resourced K-12 schools and expensive college test prep. Need-based aid is a more targeted approach to reducing the cost of attendance for students facing systemic disadvantages so that they have opportunities to attend college, occupational, or technical programs during and after recessions.
- Expand options for more students to begin or re-enter postsecondary pathways. More inclusive state grants for students who lack a documented status, such as the CA Dream Grant, and in-state tuition rates for such students provide opportunities for the transition from public K-12 schools to affordable colleges. Thanks to a ballot measure approved by Arizona voters, the state joined 21 others and D.C. that offer in-state tuition to students regardless of immigration status. States can complement funding with initiatives to re-enroll and support students in degree or credential programs, especially with a disproportionate share of students of color and those from families with low incomes undertaking caretaking and financial roles in the last few years.
- Shore up state revenues, for instance by taxing wealth and high incomes, to offset budget shortfalls that lead to under-investment in postsecondary programs. Given the economic uncertainty ahead, states should prioritize targeted revenue raising, especially on the highest-income households and profitable corporations, to maintain affordable postsecondary programs. For example, Massachusetts voters recently passed a 4 percent tax on incomes over $1 million to create revenue for public services. With the additional forthcoming revenue, the state’s Board of Higher Education approved doubling state-funded financial aid, from $200 million to $400 million, for public college and universities students.
Sustaining and expanding opportunities for people to pursue degrees or training in the face of an economic downturn has long-term implications for people’s well-being and state economies. With a divided Congress, there’s no guarantee of federal aid in case of a recession, as there was in response to COVID-19. That’s another reason why, during 2023 legislative sessions, states should proactively strengthen higher education and ensure that those who wish to seek educational and skills programs during a recession have affordable, high-quality options.