California Gov. Gavin Newsom (C) with state and local leaders at The Unity Council on May 10, 2021 in Oakland, California. (Photo by Justin Sullivan/Getty Images) ·Justin Sullivan via Getty Images
Two months into the coronavirus pandemic last year, California Gov. Gavin Newsom predicted his state would face a massive budget deficit of $54 billion in the fiscal year beginning July 1. “It's fundamental that we get support from the federal government,” Newsom said.
A year later, Newsom has gotten more than he could have dreamed of. Instead of a deficit, the state is now luxuriating in a $76 billion surplus. And that’s before the state receives $27 billion in federal aid from the American Rescue Plan Congress passed in March. Instead of the fiscal wipeout Newsom predicted, the governor now wants to send 11 million Californians tax rebates.
California has had the most dramatic resurgence, but most states are doing far better than expected after the coronavirus pandemic exploded last year. Analysis by the Tax Foundation finds that state revenue in 2020 fell by just 1%, or $11 billion, while local revenue rose by 6%, or $44 billion. States hurting the most are those dependent on tourism, such as Hawaii and Nevada, or energy, such as Alaska and North Dakota. But many states are essentially back to normal, in budgetary terms.
This is obviously good news, reflecting a robust recovery from the coronavirus recession. But it’s also politically problematic for President Biden and his fellow Democrats, who sent an additional $350 billion to states and cities in the relief bill passed just two months ago, with zero Republican support. Many states now have questionable need for the money.
“There are pockets of hardship,” says Jared Walczak, vice president of state projects at the Tax Foundation. “But the greatest fiscal challenge most state and local governments currently face is figuring out how to spend a massive federal windfall when there are no budget holes to patch. States literally don't know what to do with the federal aid they've been given.”
This jeopardizes the infrastructure and green-energy programs Biden is still urging Congress to pass. With billions in federal aid still unspent, and some of it possibly even returning to the Treasury, Republicans have new ammunition to oppose more big spending bills from Washington. Some Republicans now say some or all of the $350 billion from the American Rescue Plan should be used to finance the new infrastructure Biden wants to build. Those talks are bogged down in Congress as Democrats who control both houses purport to seek a bipartisan plan able to get some Republican support.
States and cities have come roaring back for a number of reasons. After the economy lost 22 million jobs in March and April of 2020, it quickly added back more than half of them. Most of the 8 million who are still unemployed are lower-income workers, and getting them back to work could be a stark challenge. But higher-income workers who kept their jobs continued to earn, spend and pay taxes, averting the economic bloodbath some forecasters expected. Total economic output is now nearly back to pre-pandemic levels, even with 8 million fewer workers. That means businesses have found new ways to improve efficiency and remain profitable.
The stock market has also buoyed government finances. During the Great Recession from 2007 to 2009, the S&P 500 fell by 57%, trough to peak, and capital gains realizations plunged by 71%. Most states tax capital gains just as the federal government does, and the 2007-2009 market wipeout wrecked an important source of tax revenue. Another market crash seemed to be underway in March of last year, but rapid intervention by the Federal Reserve helped head that off and generate market gains during the last year that have supported state budgets.
How states will spend the money
Governors and mayors, needless to say, are happy to have the federal aid from the American Rescue Plan, and there are still some important holes in the economy to patch. A May 24 analysis by Moody’s Analytics points out that state and local government employment is still 1.2 million jobs below pre-pandemic levels. About 72% of those missing jobs are in education, including some that disappeared with remote schooling. Those jobs should mostly return as kids get vaccinated and schools reopen.
President Joe Biden arrives to speak about the American Rescue Plan, in the State Dining Room of the White House, Wednesday, May 5, 2021, in Washington. (AP Photo/Evan Vucci) ·ASSOCIATED PRESS
The CARES Act, which Congress passed 14 months ago, included $150 billion in state and local aid. That money was supposed to be spent by the end of 2020, but some states couldn’t use it that quickly, so Congress extended the deadline by a year. States are supposed to report what they spend the money on, but they haven’t yet, so it’s not clear how much of the $150 billion has been spent, or on what.
Add in the $350 billion from the latest relief package, which runs through 2024, and states are likely to be flush for the next couple of years. “A faster economic recovery and unprecedented federal aid will provide state and local policymakers with a historical windfall over their next several budget cycles,” Moody’s Analytics predicts. “Tax revenue collections will boom over the summer, growing at their fastest pace in at least a decade.”
The research firm highlights good and bad ways state and local governments can use the windfall. Good: one-time investments in infrastructure, workforce development, education and systems needed for the next economic downturn. Bad: Puffing up existing programs or pay and benefits for government workers in ways that will be unsustainable when the windfall is gone.
Overall, the abrupt recovery in states and cities is likely to be good for Biden and his fellow Democrats, as the economy heats up and the pandemic recedes. There’s a risk that runaway spending leads to excessive inflation or speculative bubbles that end badly. And a sizable strain of voters think the government has gone too far in flooding the economy with stimulus. But it’s hard to argue with an economy that’s doing better than expected, even if Washington is printing money to make it happen.
