Without Another Massive Federal Stimulus, State and Local Governments Will Face Brutal Austerity
Even with Trump’s defeat, state and local government are facing brutal cuts to vital public services like education and health care. We can’t let the Biden years be four more years of austerity.
The defeat of Donald Trump is welcome news. But as we turn our attention to a Joe Biden administration, it is important to underscore how little has actually changed, and how much damage has been done — by the Trump administration, and by the virus it tried to wish away.
Dramatic policy shifts (aside from having actual scientists take the lead on COVID response) seem unlikely unless the Democrats sweep the Senate runoffs in Georgia. Centrist Democrats are tacking hard right on the shaky premise that calls for Medicare for All and policing reform flattened the anticipated “blue wave.” And in statehouses, that wave proved less than a ripple: Republicans now control both legislatures in thirty states and have a “trifecta” stranglehold (claiming the governor’s office, too) in twenty-three of those.
All this will make it harder to address one of the starkest failures of the government’s response to the COVID-19 economic crisis: the sustained neglect of state and local finances. State and local governments are directly responsible for providing essential services, including education and public health. And they are an important source of (mostly) good jobs, employing almost 20 million people — or about one in eight workers — when the virus struck.
The CARES Act included $150 billion in aid to state and local governments, but with the proviso that it could only be used to defray the unanticipated costs of fighting the pandemic — not for any “regular” budgetary lines. In some states, governors either skirted these limits (using federal funds, for instance, to fill potholes) or made dubious decisions as to who to protect. Both Arizona and Iowa used large chunks of their CARES grants to backfill their unemployment insurance trust funds — shielding employers from future tax increases even as their workers lost access to extended or expanded unemployment benefits.
The only other assistance was an effort to financialize state and local desperation. The CARES Act authorized the Federal Reserve (through a new Municipal Liquidity Facility) to buy state and local bonds. This line of credit just kicked the crisis down the road. And the loan terms and costs were so onerous that, as the Center for Popular Democracy concluded in June, all but a handful of the jurisdictions that met the program’s population thresholds were “functionally excluded.”
As summer spilled into fall, it became clear that no further federal money was on the way. The Heroes Act earmarked more than $1 trillion for state and local aid for any pressing needs (including shoring up revenues) but the Republican response — not a penny for state and local governments and sweeping immunity for business from COVID-related lawsuits — ground negotiations to a halt.
Recessions always savage state and local budgets, but this one — given its suddenness and severity — has been especially rough. Sales taxes account for about half of all state tax revenues and a fifth of local tax revenues (although this varies considerably from state to state, as seen in Figure 1). Sales tax receipts collapsed with the economy, especially since household consumption was fairly stable on goods that are taxed lightly (like groceries), but contracted dramatically on higher taxed goods and services (tourism, transportation). Income tax receipts have been more stable — thanks in part to the extended unemployment programs (especially the $600-per-week PUC program), and to the sorry fact that job and income losses have been so heavily concentrated among low-wage workers.
Figure 1: State and Local Tax Revenues by Source, 2018
As revenues shrink, state and local governments are constrained by a tangle of self-imposed tax and spending limits. Without the latitude to run a deficit, and without federal support, state and local options are limited — and those dismal options have yielded a litany of bad decisions and lasting damage.
As the COVID recession took hold in early spring, state and local governments laid off more than a million workers. Nationally, state and local employment in September 2020 was over a million below where it had been in September 2019. While some states are making cautious claims of recovery, almost all (see Figure 2 below) still show substantial public sector job losses compared to this time last year.
Figure 2: State and Local Job Losses, September 1919 to September 2020
States have also made deep budget cuts. As of early October, twenty-one states had slashed education spending; twenty-six had instituted furloughs or pay freezes for public employees; ten had reduced contributions to public employee retirement plans; fifteen had pared back state contributions to children’s health or Medicaid; nine had cut human services (childcare, housing, TANF) budgets. The response to the virus, in short, has been to make things worse — deepening unemployment and defunding social services just when they are needed most.
All of this compounded the crisis. The rush to reopen state economies was dressed up with public health “gating” criteria, but the decisions themselves rested on a combination of local business pressure and the dismal fiscal outlook. The public health targets varied widely from state to state, and state officials routinely ignored or adjusted them to ensure that “back to normal” plans were unimpeded: kids to school so their parents could work, parents to work so that sales and income tax revenues would flow again.
The resulting damage will be felt for years. Revenue estimation is an inexact — and deeply political — process. Rosy projections are sometimes used to calm anxieties. But more commonly, an uncertain fiscal outlook (see Figure 3 below for estimates running into 2022) becomes an opportunity to move the “starve the beast” rhetoric up another notch or two. Budget cuts are not restored and instead create new, lower baselines. And revenue anxieties are exploited to justify shortsighted — or counterproductive — program cuts. Extended unemployment benefits were instrumental in softening the blow of the Great Recession, but states responded (as soon as the recovery began) by shortening the duration of eligibility.
Figure 3: Estimated State Revenue Losses, 2020–2022
In turn, state and local austerity tend to offset the benefits of increased federal spending, exacerbating the recession and dragging on any recovery. In the five business cycles before the Great Recession, state and local spending rebounded along with the economy, growing 6 percent on average in the first three years of each recovery. Coming out of the Great Recession, however, state and local spending contracted by 4 percent over the same span — dramatically slowing the pace and progress of the recovery.
If there is one ragged thread of silver lining to this, it is that some states and localities — losing faith in federal aid — have begun to explore new and progressive revenue sources. Legislators in California, Maryland, Massachusetts, New Jersey, and New York have all proposed or enacted taxes or surcharges on high earners. California legislators have also proposed a wealth tax. Such a measure that would not only generate revenue but — in a small way — address both the startling inequity of the COVID recession’s impact and the persistent racial wealth gap.
But the larger picture is not promising. A Republican-controlled Senate would likely block any substantive program of state and local aid. That’s bad news for all state governments, who will need to find new revenue sources or slash spending. Some (and especially the Republican trifectas) will embrace this austerity — and used it as a blunt tool to cut even deeper.