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State Budget Fallout: 'A Hurricane That Hits All Over the Country'

The revenue drop from COVID-19 is barely starting to show up in official figures, but already furloughs and major shortfalls are common in state and local governments around the country. The pain may be sudden, but it could last for years.

On March 2, Wesley Harper started his new job as executive director of the Nevada League of Cities and Municipalities. A few days later, he went to Washington to meet with members of the state’s congressional delegation, planning on discussing a dry agenda of topics such as rural broadband, 5G infrastructure, wastewater and the Census. COVID-19 was added at the last minute, almost as an afterthought.

“That’s how much we underestimated this, and that was a month ago,” Harper says. “It was in those meetings that I really started to grasp how severe this was going to be.”

Harper is now working overtime to help keep his members afloat as they try to combat a public health emergency, even as they’ve shifted to remote operations, furloughed some workers and reassigned others. As cities in Nevada and elsewhere struggle to keep from drowning in the current tsunami, they know they’re about to be pounded by another big wave — the fiscal impact from the nation’s economy all but shutting down. 

Nevada cities had been seeing healthy revenues, exceeding budgeted expectations. Now, they collectively face shortfalls of about 4 percent for the current fiscal year, which ends on June 30, and anticipate shortfalls as high as 14 percent in the next fiscal year. “We have essentially no taxes coming in from gaming and hospitality,” Harper says. “The state is going to be through its rainy-day fund in fairly short order.”

Nevada depends the most of any state on sales taxes, while its municipalities are the most reliant on unrestricted state aid as a share of revenue. But the story is dire all over. Cities from Santa Barbara, Calif., to Scranton, Pa., have furloughed workers. In Akron, Ohio, 600 city employees — a third of the total workforce — have been furloughed. Already, numerous states are projecting shortfalls that reach into the billions of dollars. That’s before they’ve fully registered the anticipated drop in revenues. 

The effect on March numbers was uneven, due to the suddenness of the economic shutdown. The real pain will start this month. More than 40 states have delayed income tax filing deadlines, meaning April — normally their best month for collections — will leave them far short. “We still haven’t seen tons of states take action yet, as far as significant budget cuts,” says Brian Sigritz, director of state fiscal studies at the National Association of State Budget Officers. “I would expect more budget cuts to come.”

Most economists are predicting that, after a catastrophic drop, the economy will start growing again as early as this summer. Even if that plays out as hoped, a lot of damage will already have been done. Each percentage point increase in the unemployment rate historically has led to a 3.7 percent drop in state revenues, which would be about $45 billion, according to the Brookings Institution. The official unemployment rate rose nearly 1 percent in March, to 4.4 percent. It’s widely expected to reach into double digits soon.

Both states and municipalities went into the crisis with record levels of reserves on hand. That will help, as will federal assistance. The stimulus package known as the CARES Act included $150 billion in fiscal relief for states and localities, with additional programmatic assistance. More help from Washington is likely to come, perhaps as early as Thursday.

It’s still too soon to know how deep the damage to state and local budgets will be, or how long-lasting. It took state and local governments years to dig out of the fiscal holes left by the Great Recession that ended in 2009.

“Municipal governments have only recently returned to where they were in 2006 and 2007,” says Michael Pagano, director of the University of Illinois at Chicago’s Government Finance Research Center. “Will city governments be in another 10- to 15-year trough before they get back to where they were in February?” 

Pain Already Being Felt

When Minnesota passed a $330 million coronavirus response package last week, House GOP Leader Kurt Daudt warned that the state could see shortfalls that end up being worse than the $6.2 billion deficits it saw following the Great Recession. 

New York, which began its fiscal year on April 1, is projecting budget shortfalls ranging from at least $4 billion to more than $10 billion. Neighboring Connecticut expects to fall $500 million short by June 30, then face a bigger hole of $1.4 billion in the next fiscal year. Michigan projects its tax revenues could drop as much as $3 billion for the current fiscal year and as much as $4 billion next year.

It’s tough to cut that kind of money with only weeks left in the fiscal year, just as demands on government services are rising fast. Pennsylvania has let go 2,500 part-time or seasonal workers. Nearly 9,000 full-time state employees, representing more than 10 percent of its workforce, will stop getting paid by the end of the week. 

Washington Gov. Jay Inslee issued line-item vetoes cutting $235 million from the state’s current budget and $210 million from the next. He axed dozens of programs, including some of his own priorities. “Under normal circumstances, I would not veto bills and budget items that are good policy and smart investments for the state,” Inslee said. “As everyone knows, these are not normal times.”

Washington, D.C., has implemented a hiring freeze as it seeks cuts of $607 million to its current budget and at least as much again next year. Cincinnati has furloughed 600 full-time employees and more than 1,100 part-time workers. Mayor John Cranley has assured them that leave will be temporary, but no one can say how long the economy will remain on hold. 

Even after stay-at-home orders start to be lifted, the economy will restart in stages. Businesses that have closed will take some time to gear back up. Don’t count on going to any concerts or sporting events soon after the stores have reopened. Consumers might be tentative about purchases, given the high unemployment rate. 

You can’t store services. When salons reopen, people will only pay for one haircut, not all the appointments they missed. 

“You shut down the economy for however long — if those businesses are shuttered, states are facing very different economies than they went into this with,” says Tracy Gordon, a senior fellow at the Urban Institute.

Flexibility Isn’t Enough

Last year, Gordon coauthored a study that found roughly 70 percent of state spending is on autopilot. Costs associated with Medicaid, pensions, debt service and K-12 education funding formulas are not subject to changes during annual or biennial appropriations. 

States and localities are now trying to protect emergency services, public safety and utilities from cuts. That puts more pressure on the rest of their budgets.

Gordon says they have more flexibility to move money around during a crisis. Just as the U.S. Treasury secretary can take “extraordinary measures” to avoid bumping up against the debt ceiling, state and local officials can take unusual steps such as borrowing from dedicated funds. But that money has to be repaid, often with interest and fairly quickly.

State and local officials are trying to give themselves some wiggle room. Last week, Kentucky passed a one-year budget, rather than its regular two-year spending plan. San Diego is considering moving from an annual to a quarterly budget. New Jersey legislators are expected to vote next week to extend the current fiscal year from June through September, in part to capture 2019 income tax filings now due in July. 

Whatever the timeframe, most budgets in place now or passed soon will have to be revised as the economic fallout becomes more clear. No state had to make adjustments to its fiscal 2019 budget, says Sigritz, the NASBO official. Lots of states will have to revisit their budgets in fiscal 2021. “From every indication right now, states are going to be facing very significant revenue decline,” he says.

Time to Rethink Tax Systems?

Fiscal relief in the CARES Act was largely limited to states, as well as localities with populations larger than 500,000. Smaller cities and counties are hoping they can count on direct assistance in the near future. 

Congressional Democrats are calling for an additional $150 billion in aid to states and localities as part of a deal, which may pass Thursday, to increase a federal small business loan program. They’re widely expected to push for more when Congress returns from recess on April 30.

Federal aid will buy states, cities and counties some time. It probably won't be enough to make them whole. The University of Illinois’ Pagano suggests that the feds should consider reviving general revenue sharing, a system of unconditional grants to states and localities that ended in 1986.

He also argues that local governments in particular may be forced to restructure their tax systems to better reflect the current economy. As the economy’s service base has grown, sales tax collections have been eroding. But ideas such as taxing services or wealth have proven almost impossible to implement.

In a recession, it’s easier for states and localities to cut services than to raise taxes. At this point, the only question is how deep and how enduring the cuts will be.

“It’s not clear how short-term this is going to be,” says Gordon, the Urban Institute economist. “It’s like a Category 5 hurricane, but it lasts over many quarters — a hurricane that hits all over the country.”

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