In the past two years, newspapers have published more than 200 articles describing state or local budgets as “awash in cash.” There’s no mystery to this great fiscal flooding. Since the beginning of the Covid pandemic, the federal government has pumped $5 trillion into aid to local governments, hospitals, and public schools, and made extraordinary payments to families, given supplemental benefits to the unemployed, and made forgivable loans to businesses. The tap largely remained open long after the economy began bouncing back, prompting states, cities, and towns to spend billions of dollars in free money on items like parades, parks, bike paths, street performers, and subsidies for illegal aliens. Not content with this torrent, the Biden administration added $1 trillion in new infrastructure spending, too.

But in the last few weeks, the narrative has changed dramatically. The collapse of two American banks and an emerging international finance crisis prompted by rising interest rates has reminded local officials of the true cost of free money. The failure of Silicon Valley Bank in California and Signature Bank in New York has, in the immediate future, threatened government-subsidized affordable-housing plans in these states because each bank was a significant lender to these projects. Meantime, the plunge in equity markets and the slump in bank bond prices precipitated by surging interest rates has undermined already-strained public pension funds. Last year, those funds gave back many of the gains they enjoyed in 2021, pushing funding levels back to where they were in the bleak years of 2008 and 2009. Now they have slumped further, requiring even greater contributions from local governments. Some state pensions, invested in Silicon Valley Bank, even took direct hits to their portfolios as the bank’s stock plunged.

At the same time, the economic uncertainty caused by the financial crisis has upended government budget planning as officials contemplate a vastly different landscape of tightening credit, rising unemployment, and reduced tax collections. Silicon Valley Bank’s failure sent California governor Gavin Newsom pleading to the Biden administration for a bailout because of the threat to the state’s tech industry—the source of so much frothy tax revenue in the form of California’s steep capital gains tax. With memories of the 2008 financial crisis still fresh in the minds of New York officials, Governor Kathy Hochul similarly entreated Biden to offer the same guarantee to depositors of the failed Signature Bank. Meantime, North Carolina officials worry about what a banking failure contagion would do to the prospects for Charlotte, one of the country’s finance centers.

What’s happened in the past few weeks has brought to a head a problem that started to emerge even before the Covid lockdowns. In the wake of the 2008 fiscal crisis and the accompanying Obama fiscal stimulus legislation, left-leaning economists increasingly argued that government deficits were irrelevant, that we could live indefinitely in an age of rising spending and growing borrowing fueled by low interest rates. State and local leaders enthusiastically signed on, increasingly beseeching Washington for more funding for their problems, including many caused by their own bad policies. The more that states and cities received and spent on dealing with issues like homelessness, affordable housing, and mental illness, and in expanding programs like Medicaid, food stamps, and school lunches, the more they demanded.

The arrival of the Covid pandemic helped supercharge this kind of thinking. The initial Trump administration stimulus bill in March of 2020 went well beyond emergency money for hospitals and health care, providing extensive economic aid that helped to encourage and prolong costly lockdowns in many places. The spending that followed, from Trump’s departing second stimulus act to Biden’s $1.9 trillion “rescue” plan—was nothing less than a spending blowout. Combined with Biden’s overflowing federal budget and other endeavors like the infrastructure legislation, the gusher became a flood.

Even before the banking failures of this month, all this free money began undermining the good but misbegotten intentions behind it. America already had some of the highest public-sector construction spending in the world when Biden pumped another $1 trillion into the till. That has produced too much money chasing not enough labor and scarce materials. The result has been double-digit inflation in public construction that is rapidly shrinking the value of that money. Project costs have soared, and public-sector contracting is now squeezing out private dollars.

As it does with much of its spending, the Biden administration is also using the infrastructure money to engineer a social agenda—from “buy American” requirements to minority hiring and contracting programs—further raising the cost of work. In fact, federal requirements to use Biden infrastructure money are so complex and confounding that Secretary of Transportation Pete Buttigieg recently had to visit local leaders angered and “stumped” by federal regulations. “This is new, this is hard, and drawing the line in the right way can be a real challenge,” Buttigieg admitted.

Inflation has also sparked rising worker costs, eroding budgets as public-sector employees demand higher wages. Missouri lawmakers have approved a whopping 8.7 percent cost-of-living adjustment for state workers, while New Mexico is boosting state wages 5 percent. Kansas’s legislature has already greenlighted bonuses up to $10,000 to retain public workers. Austin, Texas, just gave city workers the largest pay increase in two decades. Teacher salaries, meantime, are soaring in many places. States and cities that could once afford these outlays are finding their budget surpluses eroding and, perhaps soon, turning into deficits.

What makes all this potentially so devastating is that social problems typically begin to recede during economic recoveries. But in the post-Covid rebound, the hangover from lockdowns has persisted: homelessness and addiction have grown more troublesome, urban disorder has increased, and our children are still struggling to make up lockdown learning losses. If all those Biden and Trump bucks didn’t do much to alleviate these stresses, what will cities and states do when the free money disappears?

Photo: Huang Evan/iStock


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