Should Congress pass another COVID relief package? The deliberations continue, with one of the sticking points being whether the federal government should provide additional aid to state and local governments and, if so, how much.
On balance, we see a relatively strong argument in favor of a moderate amount of further relief.
The disagreement on this point is, to a certain extent, understandable. State and local government revenues have decreased, while expenditures needs have simultaneously risen. However, Congress has already responded with non-trivial relief. It is not obvious how these factors net out.
On the revenue side, our estimates suggest that state and local governments will suffer revenue shortfalls of some $300 billion from April 2020 through June of 2021, when the current fiscal year ends for most states. On the funding side of the ledger, Alan Auerbach and co-authors find in a recent Brookings paper that federal aid so far has amounted to $250 billion. This number includes, among other things, money from the Coronavirus Relief Fund and the net effect of increased spending and federal transfers in the Medicaid program.
In addition, state and local governments entered the crisis with combined budget surpluses and rainy-day funds of some $120 billion. Put that together and you have $370 billion available—$70 billion more than the predicted shortfall. This is a greater amount than the additional expenditures (outside the Medicaid program) we expect state and local governments to incur in response to the public-health crisis.
So in the aggregate, state and local governments have probably received enough federal aid to make up for revenue losses throughout the current fiscal year—if we take rainy-day funds and pre-crisis budget surpluses into account.
However, “in the aggregate” and “the current fiscal year” are doing a lot of work here.
What happened “in the aggregate” has only so much importance since revenue sources and spending needs differ substantially across states and local entities.
As a result, while the least strained states and localities may have been made whole by federal aid, the most fiscally distressed states are now tightly bound by their balanced budget requirements. In fact, some of them have laid off significant numbers of workers. (Since the beginning of the pandemic, state and local government employment has decreased by over a million jobs.)
Moreover, some revenue losses may still be rising. The blow to transit agencies, for example, may be worse than initially foreseen, and the rise in COVID-19 cases makes it unlikely that this strain will abate in the near future. And while there are two quarters left in the current fiscal year for most jurisdictions, what will happen in the next fiscal year is becoming of crucial importance as state and local policymakers go into a new budget and planning cycle.
We see a strong case for, and a weak case against, additional state and local aid between $100 billion and $200 billion, as proposed in a recent bipartisan, bicameral relief proposal.
The case for additional aid is strong because the downside risk of doing nothing is quite real. The fact that over 1 million state and local government workers have lost their jobs is a sign that fiscal distress has had real consequences.
In our view, the case against substantial, though by no means extravagant, additional aid is weak. Opponents of further aid cite two concerns: poor incentives and future taxes. Let’s take each in turn.
The “poor incentives” argument views federal aid as a form of bailout. Bailouts encourage future profligacy when they reward poor fiscal management—“moral hazard.” Detractors of state and local government aid have been particularly fixated on the idea that aid would “bail out unfunded pension obligations.”
This argument is largely unapplicable for two reasons. First, the argument misunderstands existing proposals. We support general aid distributed to all states, perhaps proportional to each state’s population. We oppose aid that would be contingent on a state’s degree of fiscal stress or the linking of aid to holes in underfunded pension schemes.
Second, states’ current fiscal stress is only loosely related to poor fiscal management.
After the global financial crisis, the conventional wisdom was that states ought to adopt broad-based consumption taxes and eschew the volatility of progressive personal income taxes.
This view was generally sound—but the states that acted on it may actually be the worst hit by COVID-19. Consumption taxes, particularly those that include services, have been hard hit. At the same time, progressive income bases have been unexpectedly spared due to the pandemic’s pernicious effects on relatively low-paying jobs.
To be sure, many states could have done better in their accumulation of reserves in their rainy-day funds. But again, the aid we propose would neither reward nor punish states based on this particular aspect of their past fiscal performance. And overflowing rainy-day funds pose their own challenge, of course, in that they encourage wasteful spending.
Finally, while we view the “bailout” argument as largely misguided, we view future taxes as a relevant and appropriate concern. Taxes tomorrow are the cost of federal aid today, and these costs and benefits must be weighed against one another. We view additional aid between $100 billion and $200 billion as a reasonable compromise between these competing concerns.
In the short run, aid is a valuable source of fiscal stabilization. It will enable the hardest hit states to stave off additional layoffs. It can also ensure that state and local governments have the capacity to invest in vaccine distribution, which is the key to ending the health crisis as quickly as possible.
And aid passed today will also reduce the scope of any additional aid that may be required in the future. If the crisis persists or grows unexpectedly deeper, aid given today will be a down payment on aid tomorrow.