The Public Finance Outlook for 2021 in 10 Themes

Vaccines, a new presidency, a reshuffled Congress and a pandemic-shifted economy will transfigure the state and local fiscal landscape.

In my last column closing out 2020, I identified public finance lessons from a year that "challenged and stressed our systems of public finance in ways not experienced since the Great Depression." Now, as a new year begins to unfold amid the pandemic's continuing grip, it's time to look forward to what lies ahead for leaders in state and local finance. I don't claim a crystal ball here, just a crow's-nest view of coming issues, concerns and likely trends. Here are 10 of them:

Pandemic intergovernmental aid will be on the table again, but don't expect an avalanche of cash. It's a good bet that the House and the White House will take a shot at some more COVID-19 stimulus funding for states and localities. Whether Republican resistance in the Senate can be overcome is the big unknown. If moderates in both parties can cobble together a modest compromise package, chances can improve. Look for centrist proposals for aid to offset demonstrable revenue shortfalls, reopen schools, fill public safety vacancies and fund public health expenditures over the next six months.

Even with mass vaccinations, the fiscal drag will be real in 2021. State and local revenues should recover by August, but public payrolls will keep lagging this year. While the U.S. economy should expand by this summer, public-sector layoffs and hiring freezes will remain the soft spot in national GDP. Exhaustion of rainy-day funds will be a problem for many public budgets, making the coming months the worst for some. Nonetheless, in some states the frothy stock market's capital-gains tax revenues are offsetting losses from pandemic unemployment and business closures. Households will help by spending stimulus cash.

Small-business bankruptcies will continue to reshape Main Street. Even with two rounds of federal aid, a couple hundred thousand small businesses have already closed their doors forever in this pandemic, and roughly a thousand more are closing every day. Eventually, however, many will be replaced by newcomer startups and buy-outs from competitors. Brick-and-mortar retail stores and malls will continue to suffer for now, but shoppers will return this summer once vaccinations are widespread. Bankrupt bars and restaurants will find new owners, as nature hates a void. Property taxes will not be affected as much overall as once feared, but vacancies, rent abatements and loan defaults in certain commercial, office and apartment buildings will spawn a wave of property assessment appeals that will drag on all year.

More businesses (and their high-paid executives) will migrate to low-tax and low-cost states. The exodus from high-tax states will continue, and it's a race to the bottom with "beggar-thy-neighbor" economic development incentives. Some of this is structurally inevitable in a federal system and a geographically diverse economy, but "giveaways to greedy capitalists" will draw headlines. For local officials finding the temptation to uncork the incentives hard to resist, professional association guidance is worth a review.

Public workers will return to offices, but not full time for many. As with the private sector, public-sector employers will re-engineer their workforce to permit large numbers of office employees to continue to work from home, at least a few days weekly. Ultimately this worldwide trend will reduce office space requirements and costs, but it will require cold cash to pay for renovations. Thereafter, public agencies should find ways to redeploy unused space, perhaps for low-rent local startup-business incubators. In some cities, office building property values will take a small hit on the tax rolls. Suburbs win, center cities lose.

Medicaid reform can be a fiscal shot in the arm for the states. States now disburse 15 percent of their revenues for Medicaid. Health-care reform would ultimately need to broaden that system's safety net for lower income Americans, and that would crush state budgets unless Congress changes the formula. The silver lining here is that by reducing or eliminating the states' share of Medicaid costs, Congress and the new administration can federalize the income redistribution feature of Medicaid subsidies (arguably where it belongs anyway). That will free up to $200 billion of current state costs — more than enough to finance two years of tuition-free public education beyond high school nationwide. Two birds with one stone, if a Biden administration can muster the votes.

Medicare for All is D.O.A., but "Medicare-at-Cost" is possible. A first step would be to open the Medicare system to those age 60-64 who opt in, with premiums based actuarially to cover cohort-group costs. That variety of "public option" will take at least a year to implement, and can be followed by opening the Medicare system at cost to successively lower age groups. For public employers, the reduction of retiree medical costs, especially for public safety personnel who retire early, could be significant. Moving all public workers aged 60 and over onto Medicare-at-Cost would cut bills even further. Bonus: This all costs federal taxpayers nothing.

Expect no progress on pensions. The revenue just isn't there for employers to contribute more to fix the underfunding of public pensions and other post-employment benefits, and elected officials will be reluctant to trim benefits formulas for incumbent public employees, even prospectively. Financing reform efforts will stay on the back burner. Unfunded liabilities for the entire baby boom workforce (especially public safety) must now be paid by their children's generation; that ship has now sailed.

Low interest rates mean dark days for public cash managers. Investment returns from idle funds were once a touted revenue source, but those days are gone. Treasury offices across the nation simply don't need as many staff people to invest short-term cash at a miniscule fraction of 1 percent. Private-sector cash managers are waiving fees like crazy, and their businesses will remain miserable in 2021 and probably 2022. The jeopardy now is that an ambitious fool somewhere takes undue investment risks. States should consider expanding their laws permitting diversified investments in taxable municipal notes, as long as they are AA-rated or insured.

Finally, "Infrastructure Week" may not sound like a joke. Odds now favor a congressional push to provide a trillion or two of infrastructure dollars. GOP resistance will center on where the money will come from and what share must be borne by local taxpayers. Although most projects will be legitimate and our nation sorely needs upgrades, the dysfunction of our political system is such that by the time federal money finally reaches the pockets of construction workers, the industry will already be near full employment. The irony is that unemployed restaurant and retail workers are not great candidates for construction jobs, so the end result will be higher construction costs in the housing market. To logroll an infrastructure bill through Congress, members will likely earmark pet projects and attach environmental and social strings: Expect an abundance of red tape (and now "green tape"), some scattered senseless pork, pro-union workplace rules that increase costs, and aggressive workforce quotas for women and minorities on the construction sites. And with a lot of noise about public-private partnerships, "P3" will resurface as a buzzword.

Governing's opinion columns reflect the views of their authors and not necessarily those of Governing's editors or management.

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