With Congress poised to give states and local governments $350 billion, pandemic budget hit for many was smaller than predicted

When the coronavirus pandemic was declared nearly a year ago, the future for state and local government finances looked grim. Millions of people had lost their jobs, the stock market tanked and governors ordered nonessential businesses to close — all of which threatened to pummel many of the tax revenue streams states and municipalities rely on.

Now, the picture appears rosier than many states and localities had feared. State tax revenues, on average, have not fallen as much as initially predicted, and several economic forecasters have ratcheted down their estimates of budget shortfalls. The situation, however, varies widely, with states dependent on tourism or oil — like Alaska, Hawaii, North Dakota and Nevada — faring worst.

Congress is nevertheless poised to provide state and local governments with the largest injection of direct pandemic assistance to date as part of President Joe Biden’s $1.9 trillion stimulus package. Now that Democrats are in control of the White House and Capitol Hill, they are ready to send $350 billion to states and municipalities — with fewer of the strings that limited the use of the $150 billion in federal support approved last March.

Republicans, who succeeded in blocking additional aid last year, point to the improving picture and say the measure is a bailout for spendthrift blue states, though the data shows that the states that are in the financial hole are led by both parties. And even some who support giving more help to state and local governments say it could be smaller and more targeted, freeing up money to directly help others in need, such as through the small business Paycheck Protection Program.

“If the point of the stimulus bill is to just prevent state and local governments from having to cut back on spending or having to implement tax increases, then the $350 billion is way too much,” said Dan White, director of public-sector research at Moody’s Analytics. “Is that money better spent directly in terms of federal fiscal stimulus, as opposed to it flowing through states? If you use that money for PPP or for enhanced unemployment insurance, does it have a bigger bang for the buck in terms of economic stimulus?”

Moody’s Analytics now pegs the state and local budget shortfall at $61 billion when taking existing federal help into account. The left-leaning Center on Budget and Policy Priorities recently estimated that the budget gap is around $225 billion, but it noted that that doesn’t include states’ and localities’ costs to continue fighting the virus or helping their struggling residents and businesses.

But state and local officials maintain that the nationwide average hides the fact that many governments continue to suffer financially. Plus, they point out, the focus on smaller-than-predicted tax revenue declines masks the large increases in expenditures needed to fight the coronavirus, including vaccine and testing expenses.

What’s more, state and local governments have slashed about 1.3 million jobs, more than 5% of their pre-pandemic workforce. Most of the cuts have come at the local level, particularly in education. State and local government finances play an important role in the nation’s economy. If they are hurting, it can slow the overall recovery, as happened in the Great Recession.

State budgets buoyed by the stock market and work-from-home

Total state tax revenues declined by only 1.8% from April to December compared with the same period in 2019, according to preliminary data collected by the Urban Institute’s State and Local Finance Initiative.

Since last spring, the stock market has roared back and many higher-wage workers have been able to hold on to their jobs by telecommuting so income taxes held up better than expected. Also, the unprecedented infusion of federal support for Americans — particularly two rounds of stimulus checks and enhanced unemployment benefits — have allowed consumers to keep spending, aiding sales taxes.

Some 22 states are enjoying higher year-over-year revenues, including Idaho, Utah, South Dakota and Colorado.

In Virginia, for instance, state officials initially projected a $2.7 billion revenue shortfall over its 2021-2022 biennium budget, prompting a freeze in spending. But the state’s many defense and tech companies continued to prosper and add higher-paying jobs, fueled in part by more federal spending. This helped shelter the state from the pandemic’s economic storm, said Aubrey Layne Jr., Virginia’s finance secretary.

The state has since revised its revenue projections upward by nearly $2 billion, allowing it to provide raises for teachers and state workers, add funding for broadband and its free community college tuition program and pour $900 million into its reserve fund.

“I don’t think anybody thought we’d be doing this well when everything was shut down initially,” Layne told CNN.

New York recently found itself with $2.5 billion more in revenue than it had forecast, but that doesn’t mean its finances are on solid footing. The Empire State still faces a $17.5 billion revenue shortfall over two years.

“Revenues coming in higher than expectations is good news, but we’re still contending with devastating revenue losses caused entirely by the pandemic that we need the federal government to offset so we can continue to fund baseline services over two years,” said State Budget Director Robert Mujica.

However, 28 states saw their overall state tax collections drop during this period, with seven reporting double-digit declines, the institute found. The worst off were states that rely heavily on tourism and fossil fuel production, as well as those that depend on sales tax revenue because they don’t have income taxes.

“Everyone is doing better than they feared, but some states are quite still below where they would have been pre-pandemic,” said Louise Sheiner, policy director for the Hutchins Center on Fiscal and Monetary Policy at the Brookings Institution.

Revised shortfall estimates

Moody’s Analytics now estimates that the pandemic-fueled fiscal shock to states will be about $148 billion over two years, down from a projected $260 billion just after the start of the outbreak — not including the aid from Congress they’ve already received. The figure takes into account both the drop in revenues and the surge in state spending on Medicaid.

Some 31 states have sufficient reserves and federal assistance to fully weather the economic upheaval, while seven states have most of the reserves and aid they need to avoid making substantial budget cuts or tax increases, Moody’s found.

But another dozen states will face budget gaps of 5% of more, even after accounting for reserves and aid. And nine of those states will have to fill gaps of 10% or more.

Local government finances are harder to gauge, but they are generally under more stress than states, particularly because of the higher cost of delivering municipal services during the pandemic, White said. The combined level of fiscal shock for states and local governments totals nearly $220 billion over two years, according to Moody’s.

Counties, which are largely responsible for public health in communities, are seeing expenditures increase amid the pandemic.

“Covid-19 response costs are outpacing local government revenues across the nation, leaving communities short on services, programs and jobs,” said Teryn Zmuda, chief economist for the National Association of Counties.

Municipalities estimate they are facing a revenue shortfall of $90 billion for their current year, according to a survey conducted in November by the National League of Cities. The decline is steeper than any recession in recent history, including the Great Recession.

Some 69% of cities said the pandemic has hurt them economically, the survey found. For those with year-over-year losses, revenues fell around 21% on average, while expenditures grew 17%.

Unlike states, municipalities are more dependent on middle- and lower-wage workers, who have been hit harder by the downturn, as well as on property taxes and service fees.

Still, the forecast has improved since May, when the league estimated a shortfall of $134 billion for 2020. The economy has bounced back faster than initially expected in the spring, as has employment, said Christiana McFarland, research director at the league.

League officials stress that many of their members continue to struggle and need the roughly $60 billion infusion that Senate’s latest relief package would send to cities.

Counties would receive $60 billion under the Senate bill, while the House version provides $65 billion each for cities and counties. States and the District of Columbia would split $195 billion, and tribes and territories would get about $25 billion under both bills. The Senate bill also contains $10 billion for a Coronavirus Capital Projects Fund.

“Although the outlook for some places has improved, the outlook for other places is still dire,” McFarland said. “Beyond the horizon, there are still fiscal challenges that cities are anticipating and that they are experiencing currently.”