Internet Explorer 11 is not supported

For optimal browsing, we recommend Chrome, Firefox or Safari browsers.

Absent Federal Aid, How Bad Are State Budgets?

The new congressional stimulus package does not include direct aid for states and localities. Only a few states have seen revenues increase from last year, meaning cutbacks are coming due to COVID spending pressures.

California's state capitol building.
California's state capitol. The Golden State’s budget is looking healthier than was imagined back in June. (Shutterstock)
Last week, Virginia Gov. Ralph Northam revealed a two-year budget package that included no tax increases and substantial new spending. It would restore nearly half the nearly $3 billion in spending that Northam froze earlier this year, while increasing education spending by $500 million, mostly to help schools retrofit for the coronavirus pandemic. Northam’s budget even allows for more savings, devoting $650 million to Virginia’s rainy-day fund.

Most of the new spending is set for the second year of the proposed two-year budget. "By then, we hope most Virginians will be vaccinated, and our society — and economy — will have begun returning to more normal activities," Northam said.

Back in the spring, few people back would have predicted that Virginia – or any other state – would be preparing a budget with no taxes and sizable spending increases. Some states, including California, Georgia, Massachusetts and New Mexico, have announced revenue numbers that have not only recovered from the spring trough, but are running ahead of receipts at this time last year.

“The broader economic recovery has meant that the stock market has held up and incomes for relatively well-off people have held up,” says Michael Leachman, vice president for state fiscal policy at the Center on Budget and Policy Priorities, a progressive think tank. “In addition to the Cares Act working, that means that revenues have been in recovery mode this fall.”

The Cares Act, which Congress passed in March, included $150 billion in aid for states and large localities and $2 trillion worth of help for the economy. The $900 billion stimulus package passed Monday will help goose the economy, but direct aid to states and localities was left on the chopping block.

The surprisingly robust balance sheets of some states undermined the political argument that more help is still needed. “The further we get into this hopeful recovery stage in many sectors, it becomes more apparent that there’s less need for broad aid to the states,” says Jonathan Williams, chief economist for the conservative American Legislative Exchange Council and a leading critic of additional federal aid.

Local governments are arguably facing worse conditions than states. A recent survey by the National League of Cities found that municipalities have seen revenues decline by an average of 21 percent, while expenditures have increased by 17 percent due to the pandemic. “It is beyond disappointing that after months of watching our hometowns and our local economies ravaged by COVID-19, congressional leaders have failed to deliver critical support,” says NLC Executive Director Clarence Anthony.

States are by no means out of the woods. Despite the rollout of vaccines, the pandemic has taken a dark turn heading into the holidays, with a quarter-million new cases on Saturday alone. New or renewed restrictions are likely to hamper growth, at least in the near term. Meanwhile, most states are still running behind on revenues, even as expenses in areas such as Medicaid, unemployment and now vaccine distribution are increasing.

From April through September, all but eight states saw revenue declines, compared with last year, according to the Urban-Brookings Tax Policy Center. Collectively, state revenues are running five percent behind where they were last year. That’s much better than the 20 to 40 percent drops forecast in the spring, thanks in large part to the massive influxes of cash Congress and the Federal Reserve have put into the economy. But the recovery for states has been uneven.

“States that have heavy reliance on service industries or tourism, such as Hawaii or Nevada, are in really bad shape because of the reduced business activity in both industries,” says Lucy Dadayan, a senior research associate with the Tax Policy Center. “States that have high reliance on oil or a high reliance on sales taxes have seen steep declines in overall revenues.”

Even if millions of vaccinations occur on an optimistic timetable, it will still be months before the economy returns to something resembling a normal footing. Most states are projecting revenue declines in 2021. Moody's Analytics, a research firm, projects that states are looking at shortfalls totaling $224 billion through fiscal 2022.

“Right now, states are facing a lot of uncertainty about what the coming months could bring,” says Brian Sigritz, director of state fiscal studies at the National Association of State Budget Officers (NASBO). “We’re expecting state budgets to remain challenged through the remainder of fiscal 2021 and moving on to fiscal 2022.”

Effects of an Unusual Recession

When California enacted its budget back in June, it included $11 billion worth of spending cuts that came with an asterisk. The money would be restored if additional federal aid, which then seemed likely, was provided by Oct. 15.

California, and other states, are still waiting on more help from Washington. But the Golden State’s budget is looking healthier than imagined back in June. Gov. Gavin Newsom recently said that his upcoming budget will include a $15.5 billion tax collection windfall. The Legislative Analyst’s Office is even more optimistic, projecting a $26 billion windfall

Some of that is due to the numbers game. Like other states, California suddenly grew ultra-conservative with its revenue forecasts once the pandemic’s effects began to be felt.

But a lot of it has to do with the nature of this year’s downturn. Unemployment has hit service sectors such as restaurants and tourism the hardest. People who work in those industries don’t make great salaries to begin with. “It’s an unusual recession,” Leachman says. “It’s unusual for the economic pain to be so concentrated among lower-income families. Those families often bear the brunt of downturns, but that’s been particularly the case with this one.”

Meanwhile, higher-paid office workers who are now working remotely have largely seen their taxable incomes kept intact. And, following its abrupt plunge in February and March, the stock market has more than made back its losses. That means big bonuses on Wall Street and continued capital gains tax collections for states.

During the Great Recession, California’s highly-progressive income tax system left it badly exposed, but right now the situation is reversed. “The low-wage taxpayers’ contribution is much lower than high-income taxpayers,” Dadayan says. “That’s one of the reasons why income-tax revenue in California is doing much better than in other states.”

Spending Pressures Continue to Mount

Dadayan notes that other states are benefiting for particular reasons. States including Idaho, South Dakota and Utah that impose either full or partial taxes on groceries have benefited as higher shares of household income have shifted toward eating at home. “New Mexico is doing better because they engaged legislative changes last year, before the pandemic, that were supposed to increase tax revenues,” Dadayan says.

Sales taxes in Texas, which has no personal income tax, are down seven percent compared to last year, including an 8.5 percent drop in November. Florida, another state without an income tax, is looking at a $2.7 billion shortfall. Nevada is expecting revenues to be down $400 million, from a $9 billion budget, compared to its pre-pandemic forecast. 

States, cities and counties have laid off or furloughed 1.3 million workers – far more than the 750,000 jobs lost during the Great Recession. Governors and legislators appear, for the most part, highly reluctant to raise broad-based taxes.

“I think you’re going to see a handful of states go through an argument about tax increases,” says Williams, the ALEC economist. “In others, especially with the fragile state the economy is in, you’ll hear that this is exactly the wrong time to raise taxes.”

With states already borrowing billions from the federal government to pay unemployment benefits, the question of how to shore up unemployment trust funds – through borrowing or tax increases – will also be a prominent issue in 2021, Williams says.

Meanwhile, other spending pressures are only going up. “There’s increased demand for Medicaid and public assistance programs,” says NASBO’s Sigritz. “There are cost pressures in K-12 education related to online learning and, as schools reopen, to make them safe.”

The new federal stimulus package includes additional assistance for small businesses, the unemployed and renters, along with money for schools, transportation and vaccine distribution. All of that will help states, if only indirectly, by boosting economic activity, which can then be taxed.

But states will have to wait until next year for further assistance from Washington, which may or may not be forthcoming.

“If we’re at a point to move from recession to recovery, if states don’t get aid and continue to lay people off, that will be a drag on any recovery,” says public finance expert Kim Rueben of the Urban Institute.

Alan Greenblatt is a senior staff writer for Governing. He can be found on Twitter at @AlanGreenblatt.
Special Projects