Authors’ note: Throughout this column, we use “state and local governments” as shorthand to refer to all states, municipalities, territories, and tribal governments.
As Congress prepares to debate a fourth coronavirus response package, a crucial concern is whether policymakers have learned a key lesson of the Great Recession—that robust, timely, and durable aid to state and local governments is critical to limiting the size and scale of recessions and fostering a strong recovery.
During the Great Recession, state and local government austerity—owing to a combination of declining tax revenues, increased need for public assistance, and balanced-budget rules—was a driving force in delaying economic recovery for years. Today, with state and local governments experiencing unprecedented short-term economic shocks, a failure to quickly deliver substantial and sustained aid puts the next decade of economic growth at risk.
Three features of the economic and public health challenge the nation faces in the months ahead call for immediate and substantial aid—well beyond the assistance provided to date—to states, municipalities, territories, and tribal governments:
- Governments are experiencing or anticipating significantly increased costs as a result of testing and treating those with the coronavirus and due to increased demand for public services as a result of the crisis. State and local governments on the front lines of the pandemic must be equipped with the resources to lead the necessary public health response. These governments need an immediate influx of funds to both stop the spread of disease and allay immediate human suffering.
- Critical physical distancing measures have forced state and local governments to take a variety of appropriate steps that have in turn directly and significantly reduced the economic activity on which they rely for tax revenue. Absent sufficient federal aid, the widespread economic disruption that is slowing the spread of disease will incentivize states to relax these measures prematurely, risking hard-won progress and lives.
- The unprecedented economic challenge faced by state and local governments is amplified by uncertainty and balanced-budget rules. While the federal government can and should engage in aggressive deficit-financed spending to address COVID-19, states and localities do not have that option, due to almost-universal balanced-budget constraints that are very difficult to relax, even in a crisis. Absent federal aid, states and localities will be forced to cut spending, which would both hamper the immediate public health response and extend and exacerbate the economic fallout to include layoffs of teachers, first responders, and others. This risk is further heightened by the July 1 budget deadline in most states that may force them to make painful cuts sooner rather than later.
Immediate aid is necessary to avoid forcing state and local governments to make choices that will be both harmful to public health and result in a deeper, longer, and more painful recession. Congress should immediately provide at least three times as much in additional aid to state and local governments as the roughly $250 billion offered to date, while ensuring that aid automatically extends for the duration of the health and economic crisis.
Background
The 2008 financial crisis starkly demonstrated how the challenges facing state and local budgets in a recession can not only exact a deep human cost but also serve as a major barrier to recovery. Robust and lasting support for state and local governments is crucial to recovery in an economic downturn.
While the federal government ultimately did not provide enough stimulus to meet the scale of the Great Recession, the stimulus that was provided was also counteracted by rapid and deep state and local budget cuts. State governments alone faced around $600 billion in budget shortfalls, driving much of the austerity that slowed recovery. While the federal government did provide roughly $150 billion in aid as part of the American Recovery and Reinvestment Act, primarily in the form of increased Medicaid and education funding, that only covered a fraction of the budget gap and wound down too quickly, as Congress failed to extend relief even as widespread state budget crises continued for years into the recovery.
The impact of the unaddressed shortfall was immense, in both macroeconomic and human terms. By 2012, research from the International Monetary Fund identified it as a macroeconomic drag, noting that states had engaged in austerity policy every year between 2008 and 2012. Researchers at the Federal Reserve decomposed the macroeconomic effect of federal and state and local fiscal policy, finding that state and local austerity was a drag on gross domestic product (GDP) growth in 23 of 26 quarters between 2008 and the middle of 2014, and that without excess austerity during the recovery, GDP would have been roughly 3.5 percent larger ($650 billion) by the end of 2015.
The extent of the damage could also be seen in terms of both job losses and reduced government services. State and local governments employ nearly 20 million people—by contrast, the federal government only employs about 2 million—and resorted to every measure available to close budget gaps during the recession. At first, rainy-day and stimulus funds helped blunt the damage, but by 2012, states had enacted often-regressive tax hikes of around $100 billion and made widespread, severe cuts in public services, as documented by the Center on Budget and Policy Priorities. More than 30 states cut public health spending, reducing benefits or eliminating health care coverage for hundreds of thousands of Americans. More than 40 states cut higher education spending, with large tuition increases becoming common. More than 34 states cut early childhood and K-12 spending, cutting more than 250,000 teachers and education workers. Overall, state and local governments cut 750,000 jobs in the aftermath of the Great Recession.
The impact of this state and local austerity was still being felt a decade after the Great Recession began. State and local government payrolls only recovered to prerecession levels six months ago. Even by 2018, 23 states still spent less in real terms than they had in 2008. State funding per K-12 student was still lower in 2016 than before the recession in more than half of states. In higher education, 2018 spending was 13 percent lower than prerecession levels in real per-student terms, leading to higher tuition and more student debt.
3 principles for state and local aid: Speed, scale, and certainty
In designing the next state and local aid package, policymakers need to grapple with the magnitude of the challenge facing the governments that are on the front lines of addressing this crisis. In particular, Congress must design a package that acts quickly to get aid to states and localities, that is large and flexible enough to meet the scale of the challenge those governments face today, and that includes automatic extensions if needed to provide certainty that relief will exist through the duration of both the health and economic crises. While the roughly $250 billion in aid provided to date in earlier packages is an important down payment, Congress should immediately enact at least three times that in additional assistance to states and localities now, along with automatic extensions to continue that assistance for the duration of the crisis—in keeping with these principles of speed, scale, and certainty.
Speed
The need for state and local aid is urgent. The first reason is to enable state and local health systems to respond as swiftly and aggressively as possible. Aggressive efforts to scale up testing, provide treatment, and take other steps to control the virus—as outlined in a recent Center for American Progress column—are central to limiting both the human toll of COVID-19 and preparing for the strongest possible recovery. But as they engage in aggressive stay-at-home orders and plans to delay tax collections, states and localities that are taking the appropriate public health measures are—in the absence of swift federal aid—already contemplating painful budget cuts. The country is already seeing the consequences of projected tax revenue shortfalls, with states reporting revenue declines that outpace those of the Great Recession and both cities and states ramping up layoffs.
As a result, even beyond providing resources to respond to the health crisis, speed is necessary to prevent state and local governments from amplifying the economic crisis—a challenge exacerbated by the timing of the pandemic relative to state budget cycles. This crisis comes just as state budgets must be negotiated to meet balanced-budget deadlines for fiscal years beginning on July 1. States have begun resorting to extraordinary measures just to make payroll, and in recent weeks the Federal Reserve has taken the previously unprecedented step of establishing a new emergency short-term lending program for state and local governments.
Over the next month, structural factors will only amplify these trends, as a failure to act quickly could lock in austerity for at least the next full year. While balanced-budget rules force pro-cyclical austerity, requiring tax increases and spending cuts to fully cover projected deficits in the coming year, stricter “no-carry” rules in as many as 38 states require additional austerity, with budgets required to run an additional surplus to make up for any shortfalls from the previous fiscal year.
Absent robust relief that comes quickly, states and localities will need to make decisions in the coming weeks that will both limit their effectiveness in addressing the public health crisis and lock in cuts that would result in reduced access to public services; the layoffs of teachers, firefighters, and other public employees; and increases in college costs.
States and cities are already considering deep cuts
As revenues fall off a cliff, state and local governments are already making cuts as they warn of dire consequences to come.
“Maryland Gov. Larry Hogan froze all non-coronavirus state spending … after a new analysis showed the pandemic could reduce the state’s tax revenue by $2.8 billion over the next three months.”
“[Pennsylvania] Gov. Tom Wolf’s administration … told nearly 9,000 state employees—more than 10% of its workforce—that it will stop paying them by the end of next week.”
“Bottom Line: [California income tax] Withholding has shown significant weakness for three weeks in a row. This weakness has been similar to what was seen during the trough of the Great Recession.”
“Shutting down much of the economy to slow the spread of COVID-19 will sap nearly $300 million from Miami-Dade County’s budget over the next year, and that’s only the start of the pandemic’s damage to the tax dollars and fees that sustain local government.”
“The survey found 96% of cities are seeing budget shortfalls due to unanticipated revenue declines, which are a result of lost revenue sources from services such as permitting fees, utility fees and sales taxes.”
“This will be an economic problem that will probably [be] closer to the Great Depression-era level of numbers, and we will not be able to get through it without federal help.”
Scale
State budgets will be strained by both falling revenues and increased need for state-funded safety net programs. As noted above, state budget shortfalls came in at $600 billion in the first four years of the Great Recession, likely an underestimate of the unmet needs of state programs since budget baselines do not account for growing demands on state-funded social safety net expenses during recessions. But the worst quarter for GDP during the Great Recession was a contraction of nearly 8.5 percent. Current forecasts for this quarter suggest it may be four times as bad—although both the depth and duration of the slowdown in economic activity will, of course, depend on the persistence of the public health crisis as well as the relative success of economic policy measures taken now.
While the duration of this crisis is uncertain, and therefore aid must automatically extend as needed, there is already sufficient data to show that the immediate need justifies significant upfront aid in the next congressional package.
The National Governors Association has called for an additional $500 billion in state aid to meet budget shortfalls alone, not including an increase in the Medicaid Federal Medical Assistance Percentage from 6.2 percentage points to 12 percentage points or aid directly to localities. The state of California has requested $1 trillion in state and local aid nationwide, noting actual shortfall may exceed this sum considerably. The Center on Budget and Policy Priorities has estimated that—based on current economic forecasts—state budget shortfalls alone could be $500 billion, a figure that does not take into account local shortfalls, the added costs of responding to COVID-19, or other elements of the economic decline that may have a disproportionately large negative effect on revenues.
Any of these figures can certainly be justified by comparing the depth of the crisis relative to the Great Recession. A drop in real state and local tax revenue that was akin to the Great Recession could cut revenues by $250 billion per year, given the sudden simultaneous revenue shocks.* But revenue shortfalls could be made significantly worse by a potential unprecedented decline in sales taxes. Consumer spending fell less than 4 percent during the Great Recession; if sales tax revenue declined as steeply as income taxes, the revenue loss would increase to $350 billion per year. And at least for the moment, the country is in a crisis that is significantly deeper than the nadir of the Great Recession, suggesting that revenue declines significantly larger than that are indeed likely and could be felt over not just the current fiscal year and next year but beyond.
Those revenue declines will be matched by significant increases in the costs that state and local governments must incur to address both the public health and economic consequences of this crisis.
Medicaid accounts for about $220 billion in state budget costs in typical years, covering roughly 71 million Americans through Medicaid and the Children’s Health Insurance Program. Recent work by Matthew Fiedler and Wilson Powell finds state Medicaid costs rise by roughly $2.7 billion per year for each percentage point increase in unemployment. Using December 2019’s 3.5 percent unemployment rate as a baseline, this suggests an unemployment rate of 10 percent would strain state budgets by an additional $17.5 billion, while an unemployment rate as high as 20 percent could cost states a combined $45 billion. States also spent roughly $66 billion on social benefits for public assistance last year and will need considerable support to maintain benefit sufficiency in the face of this unprecedented shock.**
Finally, the ability of some states and localities to access a new short-term facility from the Federal Reserve—while welcome—is not sufficient to address these challenges. A short-term loan can provide help for state and local governments seeking to manage their cash flow, but it is not a substitute for direct grant aid when states and localities are unlikely to recoup lost revenue even in a recovery. Likewise, it is important that Congress and the administration ensure not only that states and localities receive sufficient funding but also that they have appropriate flexibility to use these funds to fill their budget shortfalls. While funds should not be used for new regressive tax cuts—and protections must be made so that states and localities do not cut services despite receiving aid—Congress should make it possible for aid to cover spending that was enacted before the crisis, given that unprecedented revenue gaps are well outstripping the capacity of even those states that had significant rainy-day funds.
Certainty
The United States currently faces a high degree of uncertainty around what it will take to respond to the immediate public health crisis, let alone prevent a deep and protracted recession once the coronavirus is contained. In addition to providing significant and flexible immediate relief, Congress should assist states and cities by at least providing certainty that aid will be available for as long as it is needed.
Additional stimulus is likely to be required for much more than a single fiscal year, with considerable uncertainty about how much help the economy will need extending well into the future. Overall state tax revenue did not exceed prerecession levels until five years after the Great Recession affected state finances, with some states taking much longer than that. The clear lesson of the last recession is that aid to states should not be short term. The lesson from policy research since the recovery is policymakers can and should design aid spending to decline in response to economic events rather than calendar dates.
Recent work on automatic fiscal responses to recessions represents an important road map for policy and offers clear templates for fiscal triggers; it has been incorporated into recent proposals such as those put forward by House Democrats. This research has, wisely, emphasized rigorous approaches to phasing in and delivering stimulus. Similar policy rules derived to achieve these goals with monetary and fiscal policy suggest an even more gradual phasedown of stimulus when interest rates are low. Given the unusual speed, apparent depth, and historically low interest rates at the onset of this recession, the macroeconomic risks of too little stimulus remain greater than the risks of doing too much. A prudent approach must combine robust aid right now with a cautious phasing down in individual states once economic indicators have shown sustained economic health for a significant time. In other words, it is critical at this moment that Congress both enact a significant amount of aid immediately and that it automatically extend this aid until longer-term, durable signals of economic health have returned.
It should be noted that this approach—upfront aid combined with automatic extensions based on economic conditions—should be considered both the best means of ensuring states and localities receive the aid they need and the most fiscally prudent approach when coupled with stimulus large enough to rapidly restore demand. Automatic extensions take out some of the upfront guesswork that could lead policymakers to either undershoot or overshoot the level of aid needed; Congress should view triggers as allowing it to take the largest sources of uncertainty off the table in a way that providing relief based on calendar dates alone cannot.
A proposed design
State and local aid should come in three forms—all of which have precedent both in COVID-19 legislation and in previous crises, but all of which must be immediately made significantly larger, more flexible, and automatically extended—if it is to address the full magnitude of the crisis. Below, the authors lay out a three-part approach that addresses the principles above and can be easily expanded and extended as necessary in response to the crisis.
Increased Medicaid funding
Medicaid is a federal-state partnership in which the federal government covers a share of costs incurred by states in administering the program. The Federal Medical Assistance Percentage (FMAP) for traditional Medicaid varies between states based on a formula that compares the average per-capita income for each state relative to the national average. The FMAP for traditional Medicaid cannot be less than 50 percent; in fiscal year 2020, FMAPs ranged from 50 percent to 76.98 percent. The FMAP for Medicaid expansion is set at 90 percent. Building on an approach used under Presidents George W. Bush and Barack Obama to fight recessions, the Families First Coronavirus Response Act increased each state’s traditional Medicaid FMAP by 6.2 percentage points for the duration of the COVID-19 public health emergency.
Increasing the share of Medicaid funding is a particularly important piece of this response for two reasons. The first is that states are incurring higher health care costs, so additional funding is needed for a robust public health response. Increasing the share of federal spending provides a much-needed boost of resources to ensure that states and their health systems can adequately provide care for those who need it as a result of COVID-19.
At the same time, an increase in the FMAP provides a quick infusion of money into state budgets to reduce the strain caused by a decline in revenues. By operating through an existing funding channel, an increase in state aid through this method can immediately and flexibly alleviate strains on state budgets. The American Recovery and Reinvestment Act, passed at the peak of the Great Recession, provided one model for how that could occur. Subsequent research has shown this $88 billion in funding provided large job gains and afforded states additional budget flexibility during the two years it was distributed, considerably limiting state-level austerity while it was in place.
Congress should immediately increase the FMAP bump to be at least 12 percentage points—as the nation’s governors have requested—for the traditional Medicaid population, and by 10 percentage points for the expansion population (to bring the federal share to 100 percent for that group). This aid should be continued for the duration of the economic disruption, with the elevated level tied to state unemployment rates, as proposed in the House bill for the third coronavirus package.
In doing so, Congress must continue to ensure that states do not take steps that undermine health care coverage—reinforcing, as in the earlier FMAP boost, maintenance-of-effort provisions that prevent states from limiting Medicaid eligibility or taking away coverage. Congress must also block the Medicaid Fiscal Accountability Rule put forward by the administration, which would limit states’ ability to raise their share of Medicaid funding and undercut this relief.
In addition to increased Medicaid funding, Congress must include $30 billion in emergency funding proposed by Senate Democratic leadership in its RESULTS proposal in order to quickly scale up the nation’s COVID-19 testing capacity and put in place the infrastructure needed to administer tests across the country. Establishing a mass testing program for every community across the country is an essential step for reopening the country.
Flexible funding to states and localities
The Coronavirus Aid, Relief, and Economic Security (CARES) Act included a $150 billion Coronavirus Relief Fund, with money allocated to states and localities that could be used for new costs incurred as a result of the COVID-19 crisis. This fund was an important down payment on fiscal relief for states and many localities, but for it to provide sufficient support for the public health response and the eventual economic recovery, it must be both expanded and substantially improved. A much larger amount of money should be made available now, with the possibility of automatically extending relief based on similar economic measures to the FMAP trigger above. Moreover, the fund should be improved in the following ways.
Allow funds to be used to cover budget shortfalls
The initial Coronavirus Relief Fund was designed to prevent states and localities from using the funds to pay for items for which they had already budgeted. While it is reasonable for Congress to want to support additional new funds related to COVID-19-specific needs, it is imperative that states and localities be able to use money to maintain existing services. Quite simply, there is no alternative form of funding available for states and cities that can fill the gap that is being created now. It would not be advantageous to institute broad-based tax increases now, and while flexible borrowing can help smooth some costs over time, one can reasonably expect that shortfalls today will not be quickly reversed within the recovery. With appropriate maintenance-of-effort requirements that ensure that states do not, for example, reduce tax rates dedicated to education funding, this money should be available to fill budget shortfalls caused by COVID-19 as well as to cover new costs.
Adjust relief to the magnitude of the public health crisis
Even as all states and localities receive aid, Congress should consider triggered approaches that ensure additional funding is available for states and localities that experience the most acute impacts, both from a public health and an economic perspective. Some portion of money should be set aside to be automatically allocated as a share of national hospitalizations and/or positive COVID-19 tests and to adjust with local/state unemployment rate increases.
Provide appropriate support for Washington, D.C.
One particular failing of the CARES Act’s Coronavirus Relief Fund is that it significantly underfunded Washington, D.C., despite the fact that its residents are federal taxpayers and facing impacts of COVID-19 like any other part of the country. The Coronavirus Relief Fund provided Washington, D.C., with only $500 million, while the minimum allocation for any state was $1.25 billion. Given that the district has experienced more COVID-19 cases than more than a dozen states, it is hard to attribute this choice to any rationale except for the district’s lack of representation in Congress. Any future bill should provide resources to Washington, D.C., commensurate to what a state of the equivalent size would receive.
Programmatic funding to address shortfalls
On top of an increase in funding through a higher FMAP and a flexible fund, Congress must provide considerably more resources targeted to specific areas where state and local governments will need to provide additional services and/or address shortfalls. Congress might well consider other areas beyond the ones below for programmatic aid to states and localities. However, Congress must ensure that providing such aid is not considered a substitute for more flexible aid that can help fill budget shortfalls, save jobs today, and contain the economic fallout from the coronavirus crisis.
Support for education
Congress must dedicate money to states and localities to address both the immediate needs that have arisen for school systems and public higher education as a result of stay-at-home orders, as well as to address the coming fiscal challenges that will arise. The CARES Act provided just more than $40 billion in funding for early, K-12, and higher education, but this will be nowhere near enough to cover the overall need. The last recession resulted in cuts to education funding that are still having an impact more than a decade later, and policymakers should not repeat the mistakes of the previous crisis by requiring states and cities to respond to budget challenges with teacher layoffs, cuts in early education availability, or tuition hikes. Congress should provide significant, dedicated funding streams for early education, K-12, and public higher education—of $250 billion or more—while putting in place protections to ensure that states do not use federal money as an opportunity to cut their own contributions to education, including state preschool programs. Broad waiver authority provided to the secretary of education in the CARES Act is likely to provide the ability for states to skirt these maintenance-of-effort requirements; future legislation should limit these waivers.
Child care
Many child care providers have been forced to shut their doors during the pandemic, while others have remained open to care for the children of essential workers. Nearly all child care providers face a steep drop in revenue, and given low wages and thin profit margins in child care, the industry faces a threat of massive closures. Additional federal resources are needed so that child care providers can serve essential workers in the near term and stay afloat so that they can reopen their doors when parents return to work. The child care industry enables others to work, and without an investment of federal dollars, economic recovery will be significantly compromised.
Housing and other human services needs
As millions of people cannot make rental and mortgage payments due to the economic downturn caused by the pandemic, states across the nation have been at the forefront of immediate relief initiatives. Several states have suspended foreclosures and evictions, and established emergency funds to assist the homeless population and those facing housing insecurity because of the pandemic. The CARES Act provides some Community Development Block Grant (CDBG) funding for states and local government, but a fourth package must address the funding needs of states, particularly those with high-cost housing markets, in their immediate and long-term response to the housing affordability crisis that is being amplified by the pandemic. Congress must provide protections for the large majority of renters and the roughly one-third of homeowners with home mortgages that are not government-backed.
It is therefore critical that states are not left on their own with the burden of safeguarding housing for all residents during the pandemic and of providing much-needed affordable housing in the long run. This starts by helping states financially address the housing crisis immediately, with additional CDBG and other emergency funds to address homelessness; provide rental assistance; and extend funding to small landlords, mortgage assistance programs, and housing counseling. Additional funding should also be made available to local governments to prevent property tax defaults and ensure the pandemic and its aftereffects do not force residents out of their homes—including residents of motels who have been excluded from existing eviction protections. As discussed below, it is crucial that resident protections extend to fines, late fees and utility shut-offs that result from a pandemic well-beyond residents’ control.
Infrastructure aid
A fourth coronavirus response package should also provide aid to address revenue shortfalls that are having a concentrated impact on infrastructure. In addition to general revenues, the crisis will have a deep impact on revenue sources that fund special-purpose entities such as water and transit authorities and state trust funds. In the absence of federal assistance, these governments will begin furloughing staff and slashing construction programs. This would make an already bad situation worse.
Congress should provide state departments of transportation $50 billion to backfill expected revenue losses. States should have the flexibility to use 20 percent of these funds for salaries and other operational expenses. The remaining funds should be dedicated exclusively to maintenance, repair, and reconstruction projects, including suballocating funds directly to public transit providers of all sizes for the same purposes. This requirement will allow money to flow to the maintenance projects that can be undertaken most quickly—allowing money to flow into the economy without delay—while addressing an enormous existing backlog of infrastructure need.
The next package should also include $10 billion for drinking water and wastewater authorities. Safe drinking water and clean water are essential services. However, the downturn will generate the kinds of public funding pressures that led state and local officials to create a lasting and wholly preventable public and mental health crisis in response to Flint, Michigan’s, financial troubles. Rising unemployment will also mean that many households simply cannot pay their utility and water bills in the coming months, amplifying a burgeoning public health crisis as a result of the United States’ failure to ensure universal, affordable, safe water for all Americans. Federal funds should support ongoing capital and operational expenses and cover the shortfall created from deferred residential billings. Moreover, water authorities that receive federal assistance should not be permitted to shut off water or assess fines, penalties, or late fees to a residential customer for a minimum of one year or for as long as assistance is provided.
Conclusion
State, local, tribal, and territorial governments are facing an unprecedented crisis—one that is forcing them to grapple simultaneously with the costs of addressing a public health emergency and a sudden, unexpected drop in revenues. Absent federal assistance, these governments may be forced to make decisions that hamstring their ability to contain the coronavirus, that result in painful layoffs and cuts to government services, and that slow the United States’ economic recovery once activity restarts. Marshaling the most effective response to the pandemic and limiting the depth and duration of the recession requires providing immediate, robust, and lasting support to these governments now.
Michael Madowitz is an economist at the Center for American Progress. Jacob Leibenluft is a senior fellow at the Center.
We are grateful for helpful comments from many of our CAP colleagues, including Maura Calsyn, Neil Campbell, Alan Cohen, Kevin DeGood, Rejane Frederick, Emily Gee, Katie Hamm, Khalilah Harris, Ben Miller, Lisette Partelow, Jerry Parshall, Scott Sargrad, Andres Vinelli, Simon Workman, and Michela Zonta.
* The authors estimated this number based on the largest percentage drop in each tax base from the third quarter of 2007 to the first quarter of 2012, applied to fourth-quarter 2019 levels using the Bureau of Economic Analysis’ National Income and Product Accounts Table 3.3.
** State and local expenditures on family assistance, Supplemental Security Income, general assistance, energy assistance, and other public benefits (lines 35–39) from the Bureau of Economic Analysis’ National Income and Product Accounts Table 3.12 gives $66.6 billion in the fourth quarter of 2019.
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