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Regulation and Compliance > State Regulation

Here's How State, Local Funding Shortfalls Could Affect GDP

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Time is running out for state and local governments to fill the gap between the revenues they collect and the expenditures they need to make as the COVID-19 pandemic continues. 

In Michigan, for example, 31,000 state employees, or nearly two-thirds of the state’s government workers, are temporarily laid off through July due to budget shortfalls.

In New Jersey, about half of the 400,000 employees comprising the state and local public-sector workforce face layoffs if additional federal aid isn’t forthcoming, according to Gov. Phil Murphy. 

“State and local governments desperately need financial support,” said Mark Zandi, chief economist at Moody’s Analytics, as part of a bipartisan conference call sponsored by the Economic Policy Institute (EPI) on the topic. 

Citing data from the Congressional Budget Office, Zandi said the state and local government shortfalls could reach about $500 billion through fiscal 2022, assuming state governments tap their rainy-day funds, which many have, and the federal government continues to pick up direct health costs related to the coronavirus.

If more federal support is not forthcoming and assuming a multiplier of 1.5, U.S. GDP between July 1, 2020, and June 30, 2021 — the next fiscal year for most states — U.S. GDP could be $375 billion lower, according to Zandi. That shrinkage is equivalent to approximately 2% of GDP, which has been the average annual growth of national GDP over the last 10 years. “That’s a lot of GDP,” Zandi said.

Cut Spending, Raise Taxes or Get More Federal Aid

Zandi also expects that 3 million state and local government jobs will be eliminated over the next 12-18 months on top of the 1 million that have already been lost if there is no additional federal aid for state and local governments.

In that case, states would have to cut spending or raise taxes which would be a “terrible choice,” said Josh Bivens, director of research at EPI. He participated in the call along with economist Glenn Hubbard, who served in the administrations of George H. Bush and George W. Bush; Gbenga Ajilore, senior economist at the Center for American Progress; Jason Furman, chair of the Council of Economic Advisers during the Obama administration and professor at the Harvard Kennedy School; and moderator Thea Lee, EPI president.

“This is like fighting a war,” said Hubbard. “You borrow to fight it.” He views more aid to states as “federal business interruption insurance … [that] is about mitigating the demand shock” from the COVID-19 pandemic and subsequent lockdowns.

There are opportunity costs to not not fighting a war, according to Hubbard, who added that the government should also consider “more automatic stabilizers and more federal spending for public health infrastructure not only within states but across states” along with a broader discussion of state and local accountability.

To those who are critical of more government borrowing to address fallout from the pandemic, Bivens said the choice is between borrowing at very low rates now or having the economy suffer even more later on, “causing a lot of human misery.”

To date, the federal government has allocated $150 billion in direct aid to state and local governments and tens of billions of dollars in block grants and school, child care funding and transportation funding costs as part of the $2 trillion-plus CARES Act. In addition, the Federal Reserve, through its municipal liquidity facility, can offer up to $500 billion in lending to states and municipalities to help manage cash flow stresses caused by the coronavirus pandemic, but there are no federal grants for states to make up for revenue shortfalls.

Another $500 billion in state and local aid is needed, according to the National Governors Association.

“Anything we can do to help the economy today will help prevent problems from multiplying and continue,” Furman said. There could be a debate about whether these policies should be permanent or short-term but not the need for them, he said.

Without more aid for states and local governments, state governments will cut their budgets, which will only add to the economic slowdown, Hubbard said.

“This is just a rescue,” Zandi said. 

Waiting for More Federal Aid

The Democratic-led House has passed another $3 trillion bill that includes $875 billion in aid for state and local governments, along with extended unemployment benefits and a second round of $1,200-per-person payments, including $1,200 for children. The Republican-led Senate has not taken up that bill, and it’s not clear they ever will. 

Senate Majority Leader Mitch McConnell, a Republican from Kentucky, said in April that rather than support federal assistance, he would favor “allowing states to use the bankruptcy route” even though state governments, by law, do not have that option; only municipal governments do. State governments cannot use deficit financing to fund operations, only capital spending.

Last Friday, McConnell said the Senate would consider a “fourth and final” economic relief bill to begin “in about a month.” He has previously said the next economic aid bill will not pass without liability provisions to protect businesses as they reopen after lockdowns.

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