Save the States

March 31, 2020

Max B. Sawicky

It’s been said that the Federal government is like a huge insurance company with an army. Aside from deploying military force around the world, what the Feds mainly do is mail checks — to seniors, to the disabled, to veterans, to health care providers, and to state and local governments. The public services that make daily living possible are delivered by state and local governments. In a health and economic crisis like that caused by the current COVID-19 pandemic, the fiscal capacity of the states is severely curtailed. State and local governments cannot fund basic services by borrowing. They depend on tax revenues, and those revenues will sink along with the economy. 

We have been here before. In the wake of the Great Recession of 2008, state and local government revenues declined sharply and never made it back to their prior trend. Consequently, a wide variety of services has been permanently cut back.

For 2019, state and local “own-source” revenues (mostly taxes) were $1,988 billion. Estimates of the impact of the pandemic in the April to June period on Gross Domestic Product (GDP) vary widely, from a decline of 24 percent to a decline of 30 percent or even 50 percent. Whatever the magnitude of the decline, state and local revenues will follow it down. At the same time, state and local government expenses for health care are ballooning. The reduction in revenues will be made up by cutting public services. 

GDP had already taken a hit in March, as states with some of the largest economies in the country went into lockdowns of various sorts, and claims for unemployment insurance skyrocketed. After the shock of a 30 percent plunge in the current quarter, a snap-back later this year to GDP levels reached in February is unlikely. There will be no small amount of carnage to overcome, in the form of bankrupted small businesses, mortgage foreclosures, and loan defaults. Suggestions of a return to normalcy by the fall are dubious.

In light of this unprecedented situation, predictions of GDP for the current year aren’t worth much. However, we can say something about the inadequacy of relief provided by the CARES Act. The CARES Act is the most recent, and largest of the three coronavirus relief bills enacted since March 6th.

A key distinction among its provisions is between assistance that will be eaten up by new expenses related to the pandemic, and assistance that can offset declines in revenues needed to finance routine state and local government public services. For the latter, there is only $150 billion in the Act, which is well under 10 percent of 2019 state and local revenue levels, as noted above. 

Adequate relief has to fill two gaps. One is the revenue increase that would have prevailed absent the pandemic. Going by the experience since 2008, that would have been five percent. The other gap is the additional decline from 2019 levels. The combined impact is very likely to exceed $150 billion. Without adequate help from the federal government, the reduction in state and local tax revenues will result in cuts in the basic services that people rely on and layoffs of public sector workers.

The $150 billion to states and localities found in the CARES Act is in addition to funds made available in the two previous relief bills.  Those funds include a 6.2 percent increase in the Medicaid matching rate contained in the FFCR Act, and nearly $13.5 billion in K-12 education aid and $24 billion in transit infrastructure in the latest act.

There are limited funds for local governments in the package through an expansion of the Community Development Block Grant (CDBG), but not enough to preserve existing child care businesses, let alone to make up for the likely trickle-down reductions in state government aid to localities. In the wake of budget cuts by the Reagan and Bush Administrations in the 80s, CDBG is one of the few surviving Federal-to-local assistance programs in the Federal budget

As noted above, much of the aid in these bills, like the expansion of Medicaid funding championed by the National Governors Association, will be fully offset by additional, associated expenses. They will not be available for maintaining existing services. And the funds for states and localities in the two bills will not close the gap between what is available for maintaining public services and what is required. Public services still have not recovered from the Great Recession of 2008. Without a serious program of automatic anti-recession aid to the states, recessions are like ratchets, progressively tamping down the provision of public services from the state and local sector. 

Another limitation of the new stimulus package, besides its inadequate size, is the lack of any rhyme or reason to the way the funds will be distributed. The money will be provided to states on an equal per capita basis, notwithstanding the diversity of economic conditions, the ability to self-finance, and the extent of damage from the pandemic from one state to another. A better recovery plan could improve upon this by varying funding allocations according to up-to-date unemployment data for each state.

The dirty secret of Federal grants to state and local governments is that although they do increase overall revenues, they often have little impact on the programs they are intended to help. If a federal grant only matches, say, up to 80 percent of a state’s spending on a program, that reduces the state’s obligation and frees up those funds for other uses, but it usually fails to increase spending on that program by the amount the state has saved. The assistance is effectively fungible and amounts to what used to be called revenue sharing, a stand-alone Federal program that died in the 1980s. 

In the current situation, a wide array of state and local services will need to be curtailed without Federal aid to replace the lost revenue, so the impact of aid is likely to be greater. 

The good news in all this is that under present circumstances, most any grant has at least as great an impact as general assistance, and general assistance is arguably what state and local governments need the most right now.

States, and especially local urban areas where the incidence of the pandemic is growing alarmingly, are not prepared for the current challenge. Law enforcement is often said to be essential to ensuring public safety. But beyond police, the full range of public services really makes the difference between business as usual and heretofore unimaginable social breakdown.

In looking past the immediate crisis, when considering permanent, long-term reforms that will protect the country from future calamities, improving our system of Federal grants should rank high among the priorities. Among those improvements should be general assistance to state and local governments that is distributed under a well-designed formula and automatically triggered by recession. We shouldn’t wait for the next deluge of rain to fix the roof.

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