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Here Comes the Hard Part: States, Cities Face Grim Budget Picture

The fiscal year begins in most states and cities on July 1. Without further federal aid, many will have to re-examine just-passed budgets for cuts down the road.

California Governor Gavin Newsom. (Genaro Molina / Los Angeles Times)
The new fiscal year is here but budget writers are still in the bargaining phase. Although it starts for most states and localities on July 1, so many uncertainties remain that budgets are effectively works in progress, with lawmakers still hoping for an after-the-last-minute rescue from Washington.

All but a few states have enacted budgets for fiscal 2021, but several have punted harder decisions until later this summer or perhaps the fall — either formally pushing back the start of the budget year or passing continuing resolutions to keep spending levels intact for a while yet, in hopes cuts can still be avoided. On Monday, California Gov. Gavin Newsom signed a new budget that is filled with asterisks. Billions of dollars’ worth of scheduled spending cuts will be canceled, if Congress comes up with an aid package.

That may well happen. Congressional Republicans have been wary of sending more aid to states, cities and counties, wanting to see whether the economy would recover without additional priming. There now appears to be a grudging realization that further aid is necessary. No one knows what that will look like, however, and help isn’t likely to come any time sooner than the end of the month.

“So far, local governments have largely been left out of the equation in Congress in providing aid,” says Vince Williams, mayor of Union City, Ga. “Forty-one percent of cities have or will soon impose a hiring freeze.”

Waiting on Washington may be the hardest part, but states and localities face other unknowns. For one thing, most states followed the feds in moving their income tax filing deadlines back, from April 15 to July 15. Since returns will reflect last year’s income levels, they should be pretty healthy. Still, quarterly payments that normally would have been due in June may come in short of expectations.

Then there’s the economy. With coronavirus cases surging, states are either putting the brakes on reopening plans or, to a limited extent, shifting them into reverse. Optimism that the disease would die down to an extent allowing the economy to shift into full recovery mode will have to be tempered for a while. That’s bad news for everyone. It also makes it difficult for revenue forecasters to know what type of receipts their jurisdictions can count on.

On Thursday, the federal Bureau of Labor Statistics will release unemployment numbers for June. Perhaps, as with the May figures, they will show some improvement. But last week, nearly 1.5 million claims for unemployment were filed — the 14th consecutive week that more than 1 million claims were filed. The unemployment rate will certainly remain in double digits. A rule of thumb for state budget writers is that every point of unemployment rate increase costs them $45 billion in lost revenue.

“States are having to adjust their budgets in a way that’s really unprecedented,” says Kim Rueben, a public finance expert at the Urban Institute. “States are having to adjust from expecting rising revenues to the bottom falling out.”

Consumer spending and savings have been buoyed by the $600-per-week increase in unemployment benefits provided by the federal government. Those are currently set to expire at the end of the month. Already, a dozen states have either borrowed or received approval to borrow billions from the federal government to cover their share of unemployment benefits.

States, cities and counties aren’t in a position to hire themselves. Already, 1.5 million state and local government jobs have been shed. That number could double by next year, absent federal help, leading to the loss of 2 million additional jobs in the private sector, according to an estimate by Timothy Bartik, an economist at the Upjohn Institute. “The state and local budget problem, due to the pandemic, is very large,” he says, “and if substantial federal aid is not coming, it will do serious damage to the economic recovery.”

The Year Began with Hope

States entered the recession in good fiscal health. They collectively had put aside a record amount of revenues into rainy-day funds and were seeing revenues come in, on average, about 10 percent higher than projected, according to Rueben.

“Most states were seeing revenues coming in ahead of projections,” says Brian Sigritz, director of state fiscal studies at the National Association of State Budget Officers (NASBO). “Partly due to the fact that we were through three quarters of fiscal 2020 (before the pandemic hit), most states were able to get through their budget years without major gaps.”

Now, revenues are expected to fall about 25 percent in the new fiscal year from earlier projections. The financial research group Moody’s Analytics is projecting a combination of $500 billion in state and local spending cuts or tax increases through fiscal 2022. The Center on Budget and Policy Priorities, a liberal think tank, projects the combined state budget shortfall will be $615 billion over three years.

Given the grim picture, cuts have been the order of the day. Maryland Gov. Larry Hogan has outlined $1.45 billion in cuts, with about half of those expected to be approved this week. Wyoming Gov. Mark Gordon has directed state agencies to come up with plans, due Wednesday, for 20 percent cuts in the coming biennium. Georgia’s new budget includes $2.2 billion worth of cuts, with more than half coming from education.

This may only be a start. States have relied on furloughs, contract restrictions and freezes on discretionary spending. Many have put off deeper program cuts in order to see what happens in Washington and the economy. Special sessions to make deeper cuts are likely in many states, including the 17 states that passed two-year budgets last year.

The budget picture may brighten. On the other hand, the longer states wait to act, the more painful cuts could be later on. States might be able to wait until fall, for instance, to decide what to cut from education, but school districts want to know what to expect before the academic year gets underway.

“We think this kind of postponement is risky, with potentially a more compressed period in which choices will have to be made if federal aid is not forthcoming,” says Marcia Van Wagner, vice president of Moody’s Investor Service.

Defaults Coming at the Local Level

Last week, the National League of Cities released a survey of more than 1,100 municipalities. It found that three-quarters of them have already made spending cuts, while nearly two-thirds have either delayed or canceled capital projects. A third plan further layoffs or furloughs, on top of the jobs already lost.

“Everything we planned for, we had to change,” says Elizabeth Kautz, the longtime mayor of Burnsville, Minn. “We have colliding crises that we are dealing with — a health crisis and now a recession and also dealing with racial justice.”

Financial problems are so severe that it would be “just naive” to assume there won’t be a substantial increase in defaults, says Matt Fabian, a partner at Municipal Markets Analytics. As of last week, 33 municipal borrowers had disclosed default already this year, with about a dozen more already forecasted. These aren’t general governments but rather special districts or bonding authorities. Still, the nation is likely to see more defaults this year than at any time since the Great Recession, Fabian says.

“It doesn’t take 100 local governments defaulting for general government borrowing costs to rise,” he says. “It only takes five or six in the headlines to create fear in the market. That could raise the cost of capital for everyone.”

Worse Than 2009?

On Monday, U.S. Sen. John Cornyn of Texas, a former Republican whip, said that further aid from Washington is “inevitable.” State lawmakers are wishing so hard for help that, as in California, federal aid is baked right into their budgets.

Moody’s Analytics estimates that every federal dollar spent in state and local support leads to $1.34 in increased GDP. Some calculations find an even bigger payoff.

“I think there will be no way to avoid the problems of 2009 being magnified or being even bigger if the federal government doesn’t act,” Austan Goolsbee, who chaired the Council of Economic Advisers under President Barack Obama, said during a webinar hosted by the Volcker Alliance and the Penn Institute for Urban Research.

Even assuming serious help does come from Washington, states and budget pain could be enduring. State and local revenues are always a lagging indicator. For years after the Great Recession, the economy grew but so slowly and unevenly that many communities and individuals felt as though the recession never ended. It took until fiscal 2019 for state revenues to return where they’d been pre-recession, when adjusted for inflation.

“In a normal downturn, states typically lag behind the national economy overall,” says Sigritz, the NASBO official. “Even if the economy starts to recover, it will take a while for state revenues to return to where they were in February.”

Alan Greenblatt is the editor of Governing. He can be found on Twitter at @AlanGreenblatt.
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