Special Briefing: COVID-19, the American Rescue Plan, and 2022 State and Local Budgets

With the U.S. economy on the rebound from the pandemic, state and local budget officials are starting to deploy a half a trillion dollars in federal stimulus, stirring concern that some will create programs they can't afford when the support expires in 2024.

"Budget officers are always concerned about that fiscal cliff," Shelby Kerns, Executive Director of the National Association of State Budget Officers, said at a June 17 webinar. "It's something we talk about a lot," she said. "That you're going to set yourself for a big hole if you do have ongoing expenses and your revenue doesn't grow to take on those expenses later."

The online event, Special Briefing: the American Rescue Plan and 2022 State and Local Budgets, was the 21st in a series organized by the Volcker Alliance and the Penn Institute for Urban Research. It was co-hosted by William Glasgall, Senior Vice President and Director of State and Local Initiatives at Volcker Alliance, and Penn IUR Co-Director Susan Wachter.

Kerns was joined on the panel by Mark Zandi, Chief Economist at Moody’s Analytics; Hughey Newsome, Chief Financial Officer of Wayne County, Michigan; and Kim Norton, Mayor of Rochester, Minnesota.

Zandi said the economic outlook is favorable. "Prospects are very good for the next 12 to 18 months. The economy should be back to full employment, or something pretty close to that, by late 2022 or early 2023."

Zandi listed three reasons for optimism: the reopening of businesses across the nation; pent up demand for spending; and what he described as "very aggressive monetary and fiscal support" from the federal government.

"We're off and running here. A lot of businesses are turning back on the lights," Zandi said. "Because people haven't been spending as much, there's a lot of cash out there in checking accounts. We should see a lot of consumer spending."

Stimulus money "provides a lot of juice to the economy," he added. "Totaled all up it's about $5 trillion in deficit finance support to the economy. That's about 25 percent of GDP." That compares with stimulus of 10 percent of GDP after the Great Recession, Zandi said, adding, "a lot of that support is going to state and local governments."

Zandi said the recent surge in inflation is probably transitory, and that the rate will probably settle in near the Federal Reserve's target of about 2 percent.

"I'm optimistic about state and local government fiscal situation as well," he said. "Prior to the American Rescue Plan, we were estimating the budget shortfall for state and local governments would come in somewhere between $200 billion and $250 billion over two fiscal years."

With the American Rescue Plan Act providing $200 billion directly to state and tribal governments, $150 billion to local governments, and another $150 billion for education, "that more than fills the budget hole we were anticipating," Zandi said. "If state and local governments are prudent in the way they manage the support, they should be in good shape."

He said, however, that employment by states and local governments, down by about 1 million due to the pandemic, will continue to decline as percent of overall employment. About three-quarters of the government jobs lost were related to education, and will return soon, while another quarter million will come back more slowly, Zandi said.

Kerns said states cut their fiscal 2021 budgets by 1.1 percent on average from fiscal year 2020, the first such net decrease in more than a decade. That amounted to a 5.5 percent reduction in general fund spending from governors' initial proposals for 2021. In the coming year, Kerns said spending is expected to grow in most states, though not to the levels state officials had expected before the pandemic.

States dependent on tourism and energy suffered the hardest hit, Kerns said. She cited data from the Urban Institute that state revenues increased by 1 percent from April 2020 to March 2021. Within that aggregate number, however, two states had revenue increases of more than 8 percent, while six states reported declines of more than 8 percent, she said.

Kerns said spending plans for the federal money are starting to take shape, with states using the funds to: address the pandemic; provide economic relief; enhance public health; provide education and workforce training; support economic development and tourism; give bonuses for first responders; and pay for housing assistance, infrastructure, and the restoration of unemployment funds.

Glasgall raised the specter of the fiscal cliff, saying big states like California, New York, and New Jersey are proposing or enacting program expansions that may be unsustainable in 2024, when the federal support expires.

Kerns said some state officials expect revenue to grow enough to cover the new expenses, while some expect the need for the programs will lessen. "By and large we are seeing states focusing either on trying to minimize the cuts they would have to make if they had significant revenue loss, or one-time expenditures," she said.

"The economy seems to be recovering nicely," said Newsome, the CFO of Wayne County, which includes Detroit. "The problem is that in Wayne County—and a lot of municipalities are going to be in this boat—covid hit as we were still being hit by structural budget problems. We have constrained revenue." A state limit "staggers our ability to share in the recovery of our property tax revenue," he said.

Wayne County received $340 million—the equivalent of 60 percent of its general fund —under the American Rescue Plan, Newsome said.

"The $340 million is a nice pot of money compared to our size," Newsome said. "We still have to make sure we remain within our budgetary constraints on an ongoing basis, so—sound budget practices—we can't necessarily give raises."

In deciding how to spend the money, Wayne County officials are asking, "Is it an investment that provides a recurring reduction in operating expenditure or a recurring increase in our general revenue?" Newsome said. "We're trying to take a very strategic approach, using that as a parameter. Because this is transformative money, even though it's not recurring money."

Wayne County is keeping its ARPA funds separate from operational funds, and focusing on investing the stimulus money to modernize the county and make it more livable. "Do we want to make Wayne County a green jobs destination?" Newsome said. "Is there something we should be doing to attract business?"

Triple-A rated Rochester, Minnesota, is the home to the Mayo Clinic. It doesn't depend on property tax revenue, but is dependent on medical tourism, Mayor Norton said. The passenger load at Rochester's airport, occupancy at its hotels, and transit ridership were all hit hard by the pandemic, cutting into Rochester's revenue.

"We get over 3 million visitors a year in a town of roughly 120,000. The pandemic did hit us financially," she said. "We had to cut over $100 million in the current budget to provide the services we needed in a fiscally responsible way."

The city received $17 million in ARPA money, a relatively small amount compared to its $472 million budget. 

"We are going to see the greatest hit this coming year, in the 2022 budget starting in January," Norton said. "We are front loading our ARPA funds to help fill that gap for the first two years, and then tapering off in the years going out of the recession."

The city is considering an increase in levies. Norton said it would be "a tiny increase, maybe 3-4 percent perhaps, in order to handle that cliff."