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Congress Could Extend The Recession If It Doesn’t Bail Out The States

A pandemic is an expensive thing to weather. The COVID-19 crisis has already prompted a huge drop in state tax dollars, and seems likely to cost states hundreds of billions of dollars in lost revenue over the upcoming fiscal year. That’s pushed governors to come to the federal government, hat in hand, asking for a federal bailout. But while Democrats in Congress seem eager to oblige — a new stimulus package that narrowly passed the House on May 15 includes nearly $1 trillion for state, local and tribal governments — congressional Republicans and President Trump aren’t sold yet.

There’s a tinge of moral and political outrage to this debate. Trump has repeatedly suggested that blue-state governors mismanaged their finances and don’t deserve a bailout. Senate Majority Leader Mitch McConnell, meanwhile, made headlines last month when he suggested that states should simply file for bankruptcy if they run out of money.

But experts think that doing nothing could be even more costly in the long run than bailing the states out. Without a lifeline from the federal government, states would have no choice but to start slashing budgets and raising taxes.

Recessions are never easy on state finances, since states rely heavily on tax revenue — whether it’s income tax, sales tax or property tax — and all of those sources of income tend to fall when people lose their jobs or stop buying luxuries. And because states generally have to balance their budgets — unlike the federal government, they can’t go into massive debt during a financial downturn and promise to pay it back later — they have to make up that missing revenue in other ways. In the aftermath of the 2008 financial crisis, many states took a hatchet to higher education funding and reduced their spending on K-12 education, infrastructure, local governments and their own government workforce — and raised taxes.

And states had barely recovered from the last recession when the COVID-19 crisis arrived. The Great Recession technically ended in 2009, but according to an analysis by the Pew Charitable Trusts published last year, the slowness of the recovery meant that state tax revenues didn’t return to their pre-recession levels until 2013, adjusting for inflation — much longer than in the previous two recessions. Over this period, states lost an estimated $283 billion in tax revenue. “It was kind of like falling off a cliff and then walking up a ramp,” said Donald Boyd, co-director of the Project on State and Local Government Finance at the University of Albany.

This meant that even by the time state revenues had recovered, it took longer for dollars to start flowing toward education or infrastructure. States did put more money into their rainy day funds, which they can draw on during emergencies, in case another recession hit. But that prudent instinct left them with even less cash to spend on other things. By 2018, according to Pew, nearly half of the states were still spending less money than they were a decade earlier. State funding for higher education was down 13 percent, and state infrastructure spending as a share of GDP was at its lowest level in more than 50 years.

“Think about what happens if the main breadwinner in a household loses a job,” said Barb Rosewicz, director of the State Fiscal Health project at the Pew Charitable Trusts. “There are things you stop spending money on — maybe you don’t put a new roof on your house, maybe you don’t save for your kid’s college education. Even if the head of the household gets a new job and the salary goes back to where it’s been, there are all these deferred investments you want to catch up on. And that’s how states got left after the last recession.”

And now, states are facing an even more devastating budget crisis. There is, of course, a huge amount of uncertainty about how long the COVID-19 pandemic will last, and some states are already beginning the process of reopening, which could bring lost tax money back into their coffers. But the long-term outlook still looks bleak. Analysts at the financial services company Moody’s gamed out a few scenarios in April — including one that was categorized as “severe” but looks more and more like our current reality — and found that states could see a shortfall of $172 billion over the next 15 months.

That’s because in addition to a huge decline in tax revenue, states are facing new, unexpected costs. Earlier relief bills did provide money, including $150 billion from the CARES Act, for the states to use to offset spending in response to the coronavirus, as well as some additional money for Medicaid. But there hasn’t been any federal money directed at the state-level economic impact of the coronavirus crisis, and even the money that’s tied to health costs likely isn’t enough to cover the huge influx of people who have lost their jobs and employer-sponsored health care and now qualify for Medicaid. The 36 states that expanded Medicaid under the Affordable Care Act are facing a particularly large surge of new recipients, since it’s now especially easy for newly unemployed people to get covered.

It will be very, very difficult for states to pay for all of these expenses without cutting costs or raising taxes, even if they drain their rainy-day funds. According to analysis by Moody’s, only five states have the reserves they’d need to fully float through a severe recession caused by COVID-19. Most states would need to fill gaps of at least 5 percent.

States are already facing hard choices about how to manage the giant holes in their budgets. California, for instance, is borrowing money from the federal government to ensure that it can continue to make unemployment payments. But other states are already looking to significantly reduce their spending: Earlier this month, state agencies in Georgia were asked for a revised budget proposal for next year with cuts of 14 percent.

The trouble is that because states never returned to their pre-recession levels of spending, it will be even harder to find places to trim fat. Higher education often gets slashed early in a recession, Rosewicz said, but because it now makes up an even slimmer portion of many states’ budgets, it’s harder to reap significant savings by making cuts — especially since universities are simultaneously facing potentially large drop-offs in tuition if they can’t reopen in person in the fall. Similarly, state workforces are smaller now, which means states can’t pocket as much money by laying off or furloughing workers. And with public school teachers already protesting stagnant salaries in many states, significant cuts to K-12 education could be politically dicey.

So tax hikes could also be coming — which would also make it even harder to recover from the recession even after the economy starts to pick up again. “The problem is pretty obvious — raising taxes is going to make consumers less inclined to spend money,” said Raymond Scheppach, a professor of public policy at the University of Virginia. “That will make it even harder to get the economy going again.”

But financial assistance from the federal government could still make a big difference, Scheppach and other experts told me. Studies conducted in the aftermath of the Great Recession suggested that the stimulus funds that were sent to states to help cover Medicaid costs or invest in new infrastructure helped increase employment, and general aid to state governments prevented them from slashing programs and raising taxes when those actions could have hurt the economy even more.

Of course, the stimulus funds during the Great Recession didn’t mean there were no tax increases or spending cuts. But this is another situation, Rosewicz said, where an influx of federal cash would be a good investment, if it prevents states from cutting their budgets to the bone. “Federal aid isn’t the full solution — this is an unprecedented crisis and we don’t even have a good estimate of what the need is, because we don’t know how long it will be going on,” she said. “But significant state tax increases and spending cuts will pull even more money out of the economy, and that will almost certainly prolong the recession, so in that sense federal aid is a really essential tool right now.”



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