Launch of Initiative for State and Local Fiscal Stability

As the U.S. battles the worst pandemic in more than a century, the nation’s states, counties, cities, and towns are suffering a fiscal crisis of unprecedented magnitude. Indeed, the decline in economic activity brought on by the onset of COVID-19 this year is already saddling states and localities with $500 billion in budget shortfalls through fiscal 2022, according to Mark Zandi, Chief Economist of Moody’s Analytics and a Penn IUR Faculty Fellow.

The lack of substantial follow-on coronavirus relief spending by Congress beyond the $2 trillion CARES Act passed in March raises the likelihood state and local governments across the nation will be unable to pay for infrastructure, transportation, health, public safety, education, retirement security, and other vital services that have blessed America with the largest and most-envied economy in the world.

This dire outlook for state and municipal finances, which only has been made more complex by widespread civil unrest amid calls for greater societal equity, was the focus of a major webinar, “The Role of Federal Dollars to Address Unprecedented State and Local Needs,” held on July 29 to mark the inception of the Initiative for State and Local Fiscal Stability at Penn IUR. Cosponsored by the Volcker Alliance, the webinar brought leaders from government, labor, academia, and research institutions to discuss solutions and help set an agenda for future Initiative research and events. Said Richard Ravitch, former New York State Lieutenant Governor and Chair of the Initiative’s Advisory Board: “This is now so serious a crisis that people are paying attention who haven’t paid attention before.”

Even before the pandemic arrived on the nation’s shores, there was no more important financial relationship than the one linking the federal government to states and municipalities, which employ almost 22 million people. At almost $4 trillion, annual combined spending by states and localities are almost equal to federal expenditures and make up about 15 percent of the nation’s gross domestic product. In normal times, the U.S. government typically provides about $700 billion annually in direct appropriations to states and localities—and even more if Social Security benefits, federal employee and military wages and pensions are included. This federal aid is vital in helping states and localities fulfill their obligation, by law or longstanding practice, to produce balanced budgets each year.

In addition, there is a need for countercyclical assistance to states and localities. The Great Recession of 2007-2009 showed the danger of limiting federal stimulus aid to states and localities in times of economic crisis. The American Recovery and Reinvestment Act of 2009 provided $831 billion in aid, including grants for local education, infrastructure, and public safety. But the appropriations could generate only a painfully slow recovery of GDP and employment. As a result, real state revenues and employment took almost six years to return to their pre-recession levels, the slowest such rebound since at least 1973, according to Lucy Dadayan, Senior Research Associate at the Urban Institute.

With the economy struggling to regain its footing and state and local revenues limited, budget-slashing became the norm for years after the Great Recession. Yet, as former Philadelphia Mayor Michael Nutter told the July 29 webinar, “It is virtually impossible to cut your way out of a significant deficit.”

For example, state and local governments’ infrastructure investment, which provides four-fifths of U.S. infrastructure spending, plunged 18 percent in real dollars following the Great Recession. Eleven years after that turndown ended, state and local infrastructure spending has yet return to its pre-recession peak and is unlikely to so for years in the current economic climate. This lack of spending has already left behind at least $800 billion in deferred maintenance of state and local roads, bridges, mass transit facilities, schools, water and sewer systems, and other infrastructure, according to the Volcker Alliance, a figure that is likely to grow significantly in the absence of direct federal support.

State revenues are directly linked to the national macroeconomy. Studies estimate that state tax revenue declines $41 billion, or 3.7 percent, for each one-percentage-point increase in the U.S. unemployment rate. And austerity that starts at the state level “flows downhill” to municipalities, Marcia Van Wagner, Vice President and Senior Credit Officer at Moody’s Investors Service, observed during the webinar.

While unemployment was 8.4 percent in August (including about 1 million state and local workers laid off or furloughed), the jobless rate is more than double its level at in December 2019. If the slow recovery for state and local governments following the Great Recession is any guide, both may see significant revenue shortfalls for years to come.

 “Our options are limited,” New York State Comptroller Thomas P. DiNapoli told the webinar audience. They include budget cuts; raising taxes, which not an easy issue; or borrowing—a limited solution especially for a highly indebted state such as New York. Concluded Di Napoli: “We need that additional help from Washington, D.C.”

A Penn IUR Fellow, William Glasgall leads the Initiative for State and Local Fiscal Stability at Penn IUR and is Senior Vice President and Director of State and Local Initiatives at the Volcker Alliance.