Barnett and Company

COVID Wave Washes Over State And Local Governments

Every state in the Union has to some degree rescinded stay-at-home orders and the economy is beginning to reawaken. Last week’s monthly jobs report brought a surprising but welcome dose of (relatively) good news: 2.5 million new jobs were created in May. Economists are admittedly wary of the drop in unemployment due to what the Bureau of Labor Statistics called a “classification error”, but the report was better than expected.

Yet while the broader economy is showing signs of recovery, there is a growing crisis brewing among state and local governments hard hit by the pandemic. These entities were caught in a devastating vortex of emergency outlays necessary to combat the virus over against sharply reduced tax revenues due to the national shutdown. Thrust suddenly into survival mode, states and local localities laid off or furloughed nearly 1 million workers in April, roughly one third more than during the entire Great Recession. The May jobs report wasn’t much better, with another 600,000 sent home. Absent more assistance from Congress, the devastation in the sector will place a significant drag on the pace of recovery for the US economy.

State governments plus localities (cities, counties, school districts, etc.) are significant contributors to US GDP. They make up 13% of the total workforce and are responsible for 11% of total economic output, larger than the share of US manufacturing. These entities account for 80% of all water and transportation infrastructure, and are responsible for 92% of spending for K-12 education. Besides the 50 states, there are over 87 thousand municipalities, each of which must balance its budget each year. When confronted with a fiscal crisis, options are limited: increase taxes or cut spending. With tax hikes off the table, programs and personnel are the unavoidable target. And unfortunately many of those cuts will be in essential areas like public safety and education.

In Tennessee, the budget deficit is projected to be $1 billion. Teachers here have been told not to expect the previously promised pay increase scheduled for this budget year. Across the border in Catoosa County, teachers will take a 5.5% pay cut, and the Governor has warned of possible layoffs.

States have been confronted with extraordinary virus-related outlays to hospitals and health care facilities as well as a sudden rise in Medicaid costs (shared with the Federal Government) thanks to the spike in unemployment. Meanwhile, most states depend heavily on sales and income taxes which obviously have dropped precipitously during the crisis. The result is an intractable shortfall. Moody’s Analytics estimates the deficits at $300 billion this year and another $200 billion in 2021. The Center for Budget and Policy Priorities ciphers the 3-year state shortfall at $650 billion. Clearly, these deficits are beyond the ability of states to deal with alone. Estimates of local government shortfalls range around half that amount.

The Federal Government acted swiftly in enacting a significant Covid aid package that included $150 billion in direct budget aid to state and local governments. But the size of the effort has proved to be woefully insufficient given the economic carnage. And the bill mandated aid to municipalities with populations of over 500,000, leaving roughly one third of the US population out of the mix.

State and local legislators are appealing for more action. And while the House passed a $3 trillion measure last month, the Senate refuses to take up the measure. A Senate bill cosponsored by Bob Menendez (D-NJ) and Bill Cassidy (R-LA) would split $500 billion between states and municipalities. But Senate Majority Leader McConnell is inclined to “wait and see” if additional Federal help is warranted.

The lessons from the Great Recession are that the damage to states and local governments crimped the recovery, and that a more robust response from Washington could have offset much of the damage. In testimony before the Senate Banking Committee, former head of the Congressional Budget Office and virulent deficit hawk Douglas Holtz-Eakin stated: “To focus on the budgetary impact at the expense of the economy is the most fundamental error we could make at this moment. I think we’re making it”.

Time will tell if the lessons were learned.

Christopher A. Hopkins, CFA

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