Deepening state budget holes threaten to weigh down recovery

Deepening state budget deficits threaten to become a drag on the U.S. economy when it emerges from the coronavirus recession, repeating a mistake Congress made during the Great Recession.

Ten years ago, states slowed the nascent recovery when they started cutting services and shedding jobs to balance their budgets in the absence of federal support.

Today, as governors begin to grasp the depth of their coronavirus budget holes, Congress does not appear to have learned its lesson from the previous downturn.

Legislators and budget experts say state deficits will collectively reach hundreds of billions of dollars and are likely to force massive and painful cuts to spending plans and payrolls. Without federal support to fill those gaps, state governments are likely to become an anchor that slows the eventual economic recovery.

“State actions to balance their budgets act as a brake on whatever stimulus is going on,” said Kim Rueben, director of the State and Local Finance Initiative at the Urban-Brookings Tax Policy Center. “If we’re hoping for the recovery to not be slow and for us to get out of the recession, it would really help the federal government to do things similar to what they did at the beginning of the great recession.”

Like the last recession, Congress has appropriated some money to the states. The CARES Act from March 27 included $150 billion for state and local governments, funding that was meant to help governors battle the coronavirus pandemic.

Eleven years earlier, Congress passed the American Recovery and Reinvestment Act, which included a $250 billion fiscal stabilization fund and enhanced Medicaid funding.

But after that money ran out, states were on their own.

Both sales and income tax revenues were slow to rebound, and the burst housing bubble meant property taxes — a major source of revenue for many states — took a substantial blow. The 49 states that have constitutional requirements that they balance their budgets annually were forced to cut services, spending and jobs to stay out of the red.

Those cuts slowed the recovery, experts say, because state and local government spending makes up a huge share of national gross domestic product, and is a massive source of jobs.

“State and local government employment themselves are 13 percent of total employment. And to the extent that state budgets and local government budgets are constrained to the point that they have to make cuts that lead to layoffs or longer-term furloughs of employees, that’s going to have counter-stimulus effect,” said Nick Samuels, a senior credit officer at Moody’s Investors Services.

Moody’s estimates that state governments will lose $200 billion in revenue — almost equal to the entire annual budget of California, or the equivalent of the budgets of the 19 smallest states in America, combined.

“It’s going to be a real challenge for us and all the states to balance our budgets and work through this thing,” North Carolina state Sen. Harry Brown (R), who chairs the state Senate Appropriations Committee, said by phone as he walked into a briefing with budget analysts on the scope of his state’s crisis.

The latest Democratic coronavirus response package, passed by the House earlier this month, included $500 billion in funding for states, $375 billion for local governments and $20 billion each to tribal and territorial governments. The measure included another $90 billion in education grants for states.

But Senate Republicans have signaled they have no intention of taking up or passing the bill, leaving future state funding in limbo. GOP senators, though, have said they foresee another coronavirus package in the coming weeks.

Following the previous recession, most state governments created and stocked rainy day funds to unprecedented levels, socking away billions in emergency funding that could ease the pain of an inevitable next recession. But the speed and depth at which this new downturn has hit threatens to erase those savings in a matter of weeks or months.

States reported massive declines in personal and corporate tax receipts in April, an Urban Institute analysis found, with overall collections dropping by nearly half. Part of that is attributable to states that moved their tax collection deadlines from April 15 to July 15, in line with the federal IRS. But more troubling, states also reported a nearly 16 percent drop in sales tax collections between April 2019 and April 2020, a more present indicator of the long-term revenue loss to come.

Many states have passed their own stimulus measures to ease the effects of the coronavirus recession on local economies. But most state and local governments have also begun furloughing or laying off employees. Almost two-thirds of Michigan’s state workforce will take layoff days through the end of July, and Los Angeles will force its employees to take almost a month of unpaid leave.

A survey by the National Association of Counties found at least 800,000 local government jobs were lost in April alone, most because of school closures.

“The speed and the magnitude of this downturn is unprecedented, and states, while they entered the downturn more strongly prepared than they have been certainly since the last one with very strong reserves and very strong abilities to balance their budgets, the magnitude of the cuts they are having to consider could lead to very, very severe budget cuts, absent additional assistance,” Samuels said.

In some states, legislators are sparring with governors over how the initial round of funding should be spent. State lawmakers insist they have the right to control the purse strings, even though the CARES Act directed money to governors. The Treasury Department waited weeks to issue guidance on how states could spend their slice of the federal dollars, leaving some states frustrated.

“The way these dollars were sent down, there’s very little guidance as to the roles and responsibilities,” said Alabama state Rep. Anthony Daniels (D), the minority leader. “Like everything this administration does, you can’t take it at face value. There’s a lot of uncertainty, not a lot of clarity, and they’re leaving it to the states to decide.”

Some experts said Congress has good reason to send more aid to the states, as those states build contact-tracing armies meant to suppress the coronavirus until a vaccine is widely available.

“You could imagine in any sort of additional stimulus doing things that could help them target getting more materials that are very specific to the pandemic,” Rueben said. “It would be very specific to this economy. It would be helpful employing people.”