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No Rush for State Bailouts

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eye on the news

No Rush for State Bailouts

Washington should buy time with intermediate measures before committing itself to handing over as much as $1 trillion. June 1, 2020
Economy, finance, and budgets
Politics and law

Reeling from the economic effects of the coronavirus lockdown, state and local governments have already laid off 1 million workers, and Washington is debating how much more federal assistance to provide. The House of Representatives is pushing for nearly $1 trillion in assistance, while Senate Republican proposals have ranged from $500 billion to zero in the near term.

The inability to determine the scale of state budget shortfalls makes a large federal bailout premature. Washington should let states plug immediate budget holes with leftover funds from an earlier $150 billion pandemic grant and encourage them to start drawing down $113 billion in savings. This will buy time to see how quickly the economy can pick up speed after it reopens and reveal how much additional funding states really need. It will also decrease the likelihood that funds get diverted to unintended uses, such as bailing out state pension systems that have faced shortfalls for years before Covid-19 came along.

Virtually every state requires a balanced budget to some degree. Yet, when recessions reduce state tax revenues and raise unemployment costs and spending on social services, states understandably hesitate to raise taxes or reduce spending. Instead, they appeal to Washington to use its own borrowing authority to bail them out.

Washington has already given significant assistance to state governments over the last few months. The CARES Act provided $150 billion for pandemic assistance, $268 billion for additional unemployment benefits, $31 billion for education stabilization, $45 billion for FEMA disaster relief, and $36 billion for publicly owned airports and infrastructure. Earlier legislation provided $21 billion in SNAP aid and $50 billion in Medicaid assistance. Essentially, Washington is covering much of the additional state expenditures resulting from the pandemic and the recession. That still leaves unaddressed the collapse in state and local tax revenues, for which many states demand still more federal assistance.

One bailout barrier is that—given the unpredictability of the pandemic, state reopening schedules, and the speed of the economic recovery—it’s almost impossible to predict state revenue losses and needs. Thus, aid requests have ranged widely: $1 trillion (House Speaker Nancy Pelosi), $500 billion (National Governors Association), $765 billion over three years (Center on Budget and Policy Priorities), between $445 billion and $835 billion through 2021 (Progressive Policy Institute), and $250 billion for cities (Conference of Mayors).

Moody’s Analytics has provided perhaps the most specific and widely cited shortfall projections. Their April 14 report requires careful study, because its topline summary is more apocalyptic than its own data tables—often emphasizing their own worst-case scenarios—really indicate. Also, the report’s key data tables overstate state shortfalls by incorporating $30 billion in added Medicaid costs, but not the $50 billion federal Medicaid and CHIP assistance.

Adjusting for those factors, Moody’s projects state tax-revenue shortages ranging from $130 billion (baseline scenario) to $172 billion (severe scenario) through FY 2021, and a FY 2022 shortage of at least $100 billion. However, Moody’s and the National Association of State Budget Officers also note that states ended FY 2019 with $113 billion in rainy-day funds and other surplus savings. In fact, Moody’s data project that aggregate state rainy-day funds and other available balances—totaling 14.8 percent of state baseline revenues—are nearly equal to the combined state general-fund revenue shortfalls through FY 2021 in the baseline scenario. This does not mean that states require no assistance—some of these balances will be spent in the current fiscal year, and some states may hesitate to spend down their savings too quickly (though the current crisis is exactly the situation for which these funds exist).

However, those figures also show large variation between states. Moody’s report estimates that—if they were to apply all rainy-day funds and other available balances— 19 states could return FY 2021 revenues to FY 2019 levels, and 14 states would face shortfalls of less than 5 percent. However, 13 states would still face a shortfall exceeding 10 percent, led by Louisiana (34.2 percent), New Jersey (21.8 percent), New York (15.6 percent), and Kentucky (15.3 percent)—though these shortfalls are slightly inflated by including new Medicaid costs but not the additional federal Medicaid relief. Factors leading to larger shortfalls include a dependence on volatile revenue sources (such as the oil and gas or hospitality industries), steeply progressive income taxes, and longer or more severe economic lockdowns.

We should not over-interpret this data because, again, the economy and state budgets are still wildly unpredictable, and other shortfall estimates are much higher. However, the Moody’s data confirm that some states face staggering budget gaps that will require federal assistance, while other states seem to be in much better shape. In that case, it would be both premature and fiscally irresponsible for Congress to allocate nearly $1 trillion to state and local governments, as the House-passed Heroes Act proposes. If current projections are correct, states may need perhaps $100 billion in federal funding to cover deficits through FY 2021 without an unacceptable degree of belt tightening. Cities may need some additional aid, though fully funded state budgets typically cascade down to city budgets via shared-revenue programs.

In the meantime, some state aid can be provided immediately at no additional federal cost. As noted, Washington is funding not only much of the higher expenditures (unemployment aid, Medicaid, SNAP) but also $150 billion for pandemic-related costs. Several governors have asserted that this latter funding may exceed their actual needs and have asked Washington for permission to apply any excess funding to their general-revenue shortfalls. The Senate’s bipartisan Coronavirus Relief Fund Flexibility Act (S. 3638) would do just that.

Significant funding is at stake. California’s $9.5 billion pandemic grant is equal to 6 percent of its general fund (California counties and cities also received nearly $6 billion). Texas’s $8 billion grant equals nearly 15 percent of its general fund (with Texas cities and counties receiving an additional $3 billion). Even Louisiana, with a significant shortfall, received a $1.8 billion pandemic grant that equals nearly 20 percent of its general fund. If even a modest portion of these pandemic grants are left over from the pandemic funding, they could significantly reduce the pressure for additional immediate federal assistance. This legislation would assist states in financial trouble, at no additional federal cost, while buying Congress time to see how the economy performs and how much additional assistance states may need.

A key challenge in designing any federal assistance to states is ensuring that the funds are used for their congressionally intended purpose. Republican lawmakers have been disturbed by states such as Illinois hinting that general assistance would be used to bail out their long-underfunded state pension system, rather than ensure the continuation of existing state programs with minimal job layoffs. Washington’s role should be limited to addressing cyclical state budget deficits, not letting states offload their past irresponsible budgetary decisions onto the federal government. This responsibility is difficult to enforce. Congressional language can mandate the proper use (and forbidden misuse) of federal bailout dollars, yet the fungibility of money renders it easy for states to evade such a rule. If Washington funnels state aid into specific funds such as K-12 education or health care, it would still free up other state revenues for pension bailouts or other uses—while also adding a layer of federal micromanagement and state verification requirements.

Perhaps the best option would be to calculate future state aid as a specific share of each state’s revenue shortfall—perhaps 60 percent. That way, states will need every bailout dollar just to finance current program commitments, with no extra money available for pension bailouts. And if a state still wants to use fungibility to bail out its pension system, that will come at the expense of shortchanging its own current state programs—which any state could have done in normal times, with its own tax dollars. The best way to avoid the diversion of federal aid is to ensure that states are not overly subsidized. Federal aid in the form of loans to states, rather than grants, to be repaid gradually when the economy recovers may make states more careful in how these funds are spent.

Pessimistic projections that states and cities need more than $500 billion in federal aid may turn out to be accurate, but it would be fiscally irresponsible for Washington to commit that sum, or even more, before knowing the depth of the need. The combination of state government savings and federal legislation freeing up past pandemic funds can buy time to assess the economic and fiscal situation at the state level and ensure a more responsible funding package.

Photo by Chip Somodevilla/Getty Images

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