Centering on Coronavirus Podcast: Federal Aid for the States

As a result of the COVID-19 outbreak, many state and local governments are in dire straits.

With sales, restaurant, and hotel tax revenues collapsing, some localities have had to cut essential services and furlough frontline workers. At the same time, demand for unemployment benefits and Medicaid—which are partially funded by the states—has skyrocketed. To discuss the shortfalls state and local governments are facing and learn about potential solutions, policy analyst Julia Baumel spoke with Tracy Gordon, a senior fellow at the Urban-Brookings Tax Policy Center who specializes in state and local budgets.

Interview Transcript

Julia Baumel: Can you talk a little bit about the factors contributing to the budget shortfalls in state and local government, and why they are so serious?

Tracy Gordon: Right. So state and local governments are subject to a one two punch, basically, that when the economy is doing well, their revenues grow. But when the economy goes south, their revenues drop just as demand goes up for the services that they provide. So about two thirds of state and local budgets are for education, social services, health care, things that are in demand more. When people lose their jobs, when they lose income. And then states are subject to budget institutions, in particular balanced budget rules, but also limits on borrowing that make it difficult for them to adjust to a downturn. So typically in recessions, the federal government takes notice of that and provides some aid. But in the absence of that, it means that state governments have to either raise taxes or cut spending. And that could end up dragging down the economy and slowing a recovery.

JB: It’s been three months since the CARES Act allocated new funding for state and local governments. How far has that funding gone in terms of getting states the help they need, and in what ways has it fallen short?

TG: Yeah. It’s important to know that the CARES Act was really one of several actions that the federal government took, and the federal government really did a lot passing about 2.5 trillion dollars in relief—generally, not just to state and local governments—within three weeks in March. And before the CARES Act, there was the Families First Act, which increased the rate at which the federal government reimburses states for Medicaid expenditures. And so that accounts for about 40 billion dollars annually going to state and local government. And there was the CARES Act, as you mentioned, that included the Coronavirus Relief Fund of about $150 billion, and then additional money for education, about $30 billion and about half of that going to schools, half going to higher education. $25 billion for transit, additional money for community development, for child care. Little pots like that as well.

So all told, probably about $240 billion through those pieces of legislation. The only issue is that they basically treated this much like an act that preceded both of those as a public health crisis more than an economic crisis. So the increase in Medicaid reimbursements is tied to the secretary of Health and Human Services’ declaration of a public health emergency. And we don’t know how long that will last. The Coronavirus Relief Fund, that $150 billion, is for expenses that were not already accounted for in state and local budgets that were incurred to fight Covid, but incurred between March and December.

The Treasury has issued some guidance on the use of those funds. They were pretty clear in the beginning they were not to be used to make up for revenue shortfalls that states are suffering, but they’re taking a pretty expansive view of the kinds of expenditures that they can be used for. So things like public education spending that is going up because of remote learning as schools adjust and figure out how to do that, things like greater public safety expenditures, because now you have more need to sort of disinfect public spaces and, you know, police officers being repurposed for different needs just to maintain social distancing and that sort of thing.

So I think that’s given states some flexibility. But the magnitude is insufficient to the challenge and the timing is also an issue.

JB: Right. So unlike the federal government, most states are required to balance their annual budgets, as you mentioned. In the midst of COVID-19 and an economic crisis, what steps have they had to take to make that happen?

Yeah, you’ve probably seen there are a lot of reports about furloughs and layoffs in the news. So I think states and localities, much like households, try to do the things that are somewhat easy first. And so that typically means first one time solutions, like trying to find a way to shift money around, to push expenses off into the next fiscal year. So California’s enacted budget, for example, includes about twelve billion dollars in deferrals for education spending. And that means basically asking school districts to sort of take on that expenditure on their own and just wait. And potentially they could borrow and the state will pay them back. But you’re basically borrowing from one level of government to fund another, drawing down rainy day funds. California was fortunate to have about $20 billion, at least at the start of the fiscal year, in its rainy day fund. They’ve allocated about eight billion of that to help fill the budget gap. 

States in general were very well-prepared going into this recession. They expected to close out the year with rainy day funds at an all-time high of about eight percent of their total expenditures. Cities similarly had built up those funds, but there was a lot of variation among places. You know, some places had put aside more than others, obviously, and really nothing could have prepared them for a downturn this magnitude.

So I think, you know, happy New Year, it’s the start of the fiscal new year in many states, in about 46 states. And most of those states have passed budgets, but a lot of those budgets are kind of place holders or temporary budgets where it’s almost like a continuing resolution at the federal level. In some cases, it is a continuing resolution or to just continue the prior year spending levels or else to have a prorated expenditure level that lawmakers can revisit on a monthly basis or a three month basis. And even California’s budget assumes that certain federal aid will be forthcoming. And if it’s not, there would be additional cuts. But I do think things like tax increases can be a lot harder politically and generally at the state and local level.

Public officials take their time to both put those kinds of proposals together and to get them passed. So I think as this crisis continues and of course, it all depends on the shape of the recovery, is it going to be a V, a W, a U, a square root sign. But it’s likely that it will continue into next year, especially given projections about unemployment. The latest CBO projections, which will be updated tomorrow, suggests that by the end of next year, unemployment will still be near nine percent, which is, near where it peaked in the Great Recession. So really quite elevated, and that really, based on historical relationships, that’s expected to have a very big effect on both state and local budgets.

JB: I see. You were saying, on average, states were pretty well prepared with their rainy day funds. But it seems like there was some variation. Were there some states that were particularly unprepared in terms of what they had in reserve?

TG: Yeah, I mean, I think if I remember correctly, Wyoming had reserves of more than its general fund. And that’s because of revenue from natural resources that can be also unpredictable. So in some oil producing states, they were already facing trouble before Covid because of the supply glut globally and the falling price of oil. But Illinois is known for not having great reserves and also facing other budget challenges, in particular from underfunding pensions. They had some revenue increases that were going to appear on the ballot anyway. And so, you know, it’ll be interesting to see what the political appetite is for that going forward.

And then states, their just general exposure to this crisis obviously is not the same. So there are these maps that show sort of the hotspots where the virus is occurring. And now it does unfortunately appear to be most of the country, but not every state has a revenue system that is as exposed as others. So sales taxes were the first to go as the economies sort of shut down. And I think it’s important to note, too, that, you know, some research has shown that the economy basically shut down when people feared going out. It really, you know, there was some substitution to online spending, some, you know, higher grocery spending as people were trying to stock up. But really, it didn’t have much to do with the actual, you know, stay at home orders from either state or local officials. So it’s been interesting to me this kind of federalism in action challenge about who gets to reopen the economy. The answer is really like, the economy gets to reopen the economy when producers and consumers feel comfortable going out there and engaging in transactions. 

But anyway, sales taxes fell as people started curtailing their consumption and then income taxes fell because of this extension of filing tax deadlines. And that’s temporary. And it could be that as people start filing in what’s expected to be this month, although there were some rumors going around, the federal government might extend it again at least a week ago. But some of those revenues that were expected in April are going to come back this month. But then there’s a longer term challenge that if people are out of work, if people are working less, that will show up in income taxes. And if those economic losses are happening this year, that means next fiscal year for states.

JB: In Congress, there is bipartisan support for sending more aid to states. But some of the members on the right who are resistant to it say they don’t want to bail out fiscally mismanaged states with broken pension systems. What should we make of this argument?

TG: Yeah, you know, I spent some time looking at the Recovery Act and similar arguments came up then, and I certainly understand that, you know, it’s almost like federal lawmakers feel like they go through all the hard work of raising revenues. Why should they then write a check to mayors and governors who get to spend it? But there are certain inherent advantages to the federal government collecting revenues, you know, administratively. There are economies of scale. It’s harder for people to evade taxes by moving. And the evidence on that at the state level is less than what you might hear rhetorically. But certainly at the city level, people could get up and move in response to taxes. 

So just theoretically, principles of federalism, it makes sense for the federal government to raise revenue and then disperse it to state and local governments to spend it in accordance with the preferences of their populations, their cause, their geographies and all that good stuff. That’s especially true in a crisis because of the dynamics that we talked about of this sort of one two punch of revenues going down just as spending is going up and the balanced budget rules. But, you know, again, it’s more challenging in a crisis because there is this sense of why should we bailout states that are potentially responsible for this crisis? I would just say in this particular crisis, it’s more like a category five hurricane that’s happening all over the country. Nobody caused this. Nobody really could have prepared for it. Many states were prepared for some kind of emergency, but not something like this, which is, you know, possibly a hurricane that lasts for two years.

And so, you know, I just don’t think it’s a productive time to sort of be you know, there’s that analogy of, you know, you don’t ask who set the fire before you put it out. I feel like in this case, it’s almost like when the house is on fire saying to the owner, I’d like to talk to you about your diet. You know, it’s just it’s certainly like pensions are an issue. Certainly states could be doing things in terms of structural imbalances and aligning revenues with spending. It’s not clear to me that now is the time to address those issues, those long term issues. The federal government has leverage and I can see why it might want to use that leverage to do that. But the longer that we wait, the more that we risk harm to the economy. And so that’s my concern.

You know, some of the proposals that are going around, like the Heroes Act, the SMART Act, which I haven’t heard a ton about lately, but, you know, they have formulas that try to base aid on local economic conditions. And I’ve written a little bit about this. It’s challenging because data can be preliminary, and revised, and messy at the state level especially. But to the extent that you have triggers and formulas in there, I think you have to worry less about overspending or sending money to the wrong places. And so I think there are ways to design the assistance so that those concerns are less pronounced.

JB: Right, and those kinds of triggers, or economic stabilizer policies, could also be a great way to avoid having to wait around for Congressional action. Are there any particular automatic stabilizer policies you think would work best?

TG: Yeah, I’m a big fan of—like with the Recovery Act—using the programs that we’ve got or the existing pipes was the analogy people made then. Then, you know, there’s some issues with existing funding formulas.

And I’ve been sympathetic to some of the criticisms, for example, of the title one formula for schools. But, you know, people know the formulas. They know how they work. And especially when it comes to Medicaid, that is a quick way to get money out the door in the recession. The Recovery Act was passed, I think, on February 17th, 2009. The checks went out the door on March 2nd, retroactive to October of the previous year. So states got a big slug of money that they weren’t expecting, which freed up resources for them. So they had to meet certain requirements and not cut eligibility for Medicaid, which also is a good thing in an economic crisis.

But as long as they were continuing to provide the same level of benefits that they did before the recession, they could basically keep spending what they would have spent anyway on Medicaid and then repurpose their own money for other needs as they came up. And I think that’s a very flexible way to direct aid where it’s most needed and could be basically expanded on with what already happened, the Families First Act. But again, at a magnitude that really is sufficient to the challenge.

JB: Sure, that makes sense. Before I let you go, is there anything on this topic I didn’t cover that you think would be useful for listeners to hear?

TG: You know, I think it’s useful to remember that it really is a partnership between all levels of government and some of the numbers going around right now are so eye popping. About trillion dollar gaps or five hundred billion dollar gaps at the state and local level. And I can understand the sticker shock that people have in government or just observers. But, you know, really, the state and local sector is essential to the economy, essential to people’s daily lives. The idea is to try to stabilize their budgets so they can continue to provide services that are critical every day, but especially during a health crisis. And they can continue to employ people, which is also important in an economic downturn. So, you know, I just hate to see sort of the “us versus them” way that this gets cast sometimes, although, of course, that’s inevitable.

But really thinking about, you know, all levels of government are engaged in the same enterprise, which is just providing services that people want effectively. And so thinking about, you know, how to do that best, you know, who should bear responsibility for what programs and revenues? I just think there’s a lot of room for thinking about that creatively, not just in this recession, but going forward.