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The Wrong Way to Help

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eye on the news

The Wrong Way to Help

Instead of encouraging reform, Washington’s new bailout bill rewards states and cities for bad fiscal practices. May 26, 2020
Covid-19
Economy, finance, and budgets

The latest Democratic stimulus plan, the massive, $3 trillion Heroes Act, sets aside about a third of that total sum for aid to state and municipal governments. That’s on top of the hundreds of billions of dollars these governments have already received from the CARES Act and other measures, including money for additional Medicaid costs, mass-transit subsidies, and direct aid to budgets. Most of the new money allocated in the legislation, passed by the House of Representatives, comes in the form of unrestricted aid—cash that local governments can use as they see fit to address their budget concerns amid the Covid-19 lockdown. The National Governors Association has called for $500 billion for state governments alone to meet “budgetary shortfalls that have resulted from this unprecedented public health crisis.”

The Republican-controlled Senate has balked at these huge numbers, and with good reason. The amount that officials are seeking is likely well beyond the estimated total cost of the current recession for states and municipalities. The huge funding requests, moreover, essentially assume that the entire recession is a function of the virus and that governments deserve to be made whole for any losses, even though fiscal analysts have warned for years that another recession was coming and many states were unprepared for it. As the parties negotiate in Washington on a compromise plan, we need a realistic, focused approach that sends more aid where the virus has had a direct impact—such as on mass transit—and ties further aid to reform proposals that recognize how local government policies have created many of the financial problems that officials now blame on the virus.

The Heroes Act includes sending new rounds of stimulus checks to Americans, forgiving student debt for “economically distressed” borrowers, funding the arts and humanities, and repealing the $10,000 limit on state and local tax deductions. While those elements of the package have generated attention and controversy, the bill also sets aside upward of $1 trillion for states and cities. Added to the money that states and cities have already received, their total stimulus would surpass $1.5 trillion if the legislation passed as the Democrats proposed it. The Heroes Act is especially generous when it comes to unrestricted aid, which alone amounts to about $900 billion, to be distributed based on population, unemployment figures, and number of coronavirus cases. Based on population figures alone, states and cities would divide about $667 billion, according to the Tax Foundation. California state and local governments would share about $73 billion of that money. Texas would get $51 billion, New York and Florida $33 billion each, and Illinois $24 billion.

Consider those numbers compared with local government revenues. Last year, states collected about $1 trillion in taxes. That means that the Governors Association’s request is for aid equaling half of one year’s tax collections. In the Great Recession of 2008–2009, state tax collections declined in one year by about 9 percent, from $784 billion in 2008 to $713 billion in 2009. Then collections slumped slightly again to $705 billion the next year. When all was said and done, the cost was around $250 billion in forgone tax revenues.

What can we expect this time? Moody’s has estimated, based on what states themselves are projecting, that revenue could decline next year by 15 percent, or $150 billion. Local government revenues, which amounted to about three quarters of a trillion dollars last year, will also fall, but at a slower rate at first because municipalities rely more on property taxes, where changes in valuations are phased in over time. If the economy does not recover rapidly, the cost of this downturn over four or five years could reach $500 billion. That’s a lot, but not out of line with what analysts were predicting the next recession would bring, even before anyone had heard of Covid-19.

A study by Moody’s published in October 2017, for example, estimated that the “fiscal shock” of the next recession—if it was severe—could cost states about $137 billion in the first year, not far from what a virus-accelerated recession may cost next year. As Moody’s observed: “One of the few great inescapable facts in the field of economics is the business cycle. No matter how high-flying an economy might appear, another recession is coming sooner or later.” Another study from 2019, looking just at California, calculated that a severe recession could cost that state alone up to $170 billion in revenues over four to five years. The state is facing a $54 billion deficit next year, but in 2008, it had to contend with a $40 billion budget hole that had nothing to do with the virus. Some states, moreover, were already facing a deficit. In January, for example, New York governor Andrew Cuomo projected a $6 billion budget gap—the result of years of soaring costs—during what was still an economic expansion. When you consider those numbers within the context of what state and local officials are asking for now, it’s clear that they are essentially angling to be held harmless.

The $1 trillion for state and local aid is way beyond the stimulus that Washington provided after the Great Recession. That legislation included about $50 billion in direct aid to public schools to avoid layoffs and about $100 billion in infrastructure spending—much of it designed for “shovel-ready” local projects—to boost employment. The Obama stimulus also targeted $86 billion in new federal money to support Medicaid, the joint federal-state subsidized health-care program. But the stimulus provided no direct, general aid simply to support budgets. Giving such aid now would set a new precedent and encourage states to overspend in the future. They’d have less reason to control their budgets, to cut inefficient programs, and to try to save money.

Many states face extreme fiscal problems now because they’ve continued with bad budgeting practices for years, refusing to initiate reforms even after the fiscal pressures created by the 2008 recession. For 15 years beginning in 2003, for example, ten states—including Connecticut, Illinois, New Jersey, Massachusetts, Kentucky, Maryland, New York, and California—consistently spent more money than they took in, according to a Pew analysis. They employed gimmicks, some in violation of their own constitutions, rather than restrain the growth of their budgets. Other states continued handing out extraordinary employee perks, well beyond what’s typical of the private sector, even after accumulating huge deficits a decade ago. California still pays workers for unused vacation days, piling up some $3.5 billion in debt on that score alone. In New Jersey, one of the least fiscally stable states, local governments owe workers $1.9 billion in unused sick time. Massachusetts has one of the worst-funded state pension systems, but it also continues to dish out cash to retirees for sick time.

There is certainly justification for aid to states, and some of it has already left Washington in the form of money to support hospitals, to bolster state Medicaid programs, and to provide disaster relief. The latest stimulus proposal includes more money to help in the fight against Covid-19, including for protective gear and for boosting pay of front-line health-care workers. Washington could do more—for example, directing more aid toward mass-transit systems, which have been hard hit by the economic slowdown and by fears of disease. States and cities are looking to staff up with armies of contact tracers and will almost certainly need help from Washington. The federal government will likely also need to direct some aid to public schools to help them get ready for the fall semester with additional safety and sanitation tools.

Some fiscal experts have warned that if we don’t bail out states or big cities that were already distressed before the lockdowns, their failure could harm our entire financial system. But our worst-managed states and cities have consistently resisted sensible reforms that would put them on a path to solvency. Merely pouring money into their problems now would only forestall their financial crises. One example is the nation’s growing public-sector pension debt, which has developed over years of bad practices that the current downturn will only worsen. Two of the nation’s lowest-funded pension systems are in New Jersey and Illinois, but the governors of both states have blocked efforts to cut costs or restructure the systems.

The only acceptable federal aid to these states should be tied to reform. Pensions are a perfect example of a bargain that Washington might make to states and cities. Aid should only come in the form of low-cost federal loans in exchange for changes that end the unlimited liability that taxpayers face from open-ended, defined-benefit public pensions. One approach, utilized by Utah after the last recession, capped the state’s liability for any workers in the state’s pension system at between 10 percent and 12 percent of salaries. Workers who wanted to remain part of Utah’s defined-benefit plan would have to bear any additional costs brought on by market losses themselves. Another idea, proposed by a New Jersey pension commission but never enacted, would close the state’s defined-benefit pension plan and migrate workers to a new, hybrid system that provides workers with a modest predetermined annual sum, combined with a 401(k)-style savings plan where workers could accrue additional retirement funds.

The purpose of any additional aid to states and cities should be primarily to ameliorate the direct impact of the virus itself, and secondarily to motivate states to enact sensible reforms that make their budgets more resistant to fiscal shocks. Underwriting their bad budget practices, by contrast, will only prolong the financial pain.

Photo: lucky-photographer/iStock

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