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The Next Crisis to Hit: State Budget Cuts

States of Crisis with Dan Vock
The Next Crisis to Hit: State Budget Cuts
By Daniel C. Vock • Issue #3 • View online
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Onto the news…

The Next Crisis to Hit: State Budget Cuts
The United States economy officially entered a recession in February, according to a group of economists that officials rely on to make such pronouncements. The news came as no surprise, after most of the country shut down this spring to slow the spread of covid-19. Collectively, the governors have sounded the alarm as loud as they can about the recession’s potential impact on state budgets: they’re asking Congress for another half a trillion dollars to avoid making major service reductions.
Despite the ominous signs, though, states have largely avoided the painful budget cuts. At least for now.
“Most states have delayed substantial cuts,” says Jared Walczak the director of state tax policy with the Tax Foundation. “Certainly we have seen some states postpone planned spending increases, or scale them back somewhat. But some have even preliminarily gone forward with those.”
That’s a stark contrast to the throes of the Great Recession a decade ago, when lawmakers were repeatedly summoned to their state capitols to make spending cuts to match ever-more-ominous revenue projections.
The wait-and-see approach many states may just delay inevitable cuts, or even make them worse. Lawmakers could find themselves returning to their capitols later this year, trying to scale back popular programs that teach children, provide health care to residents, enforce environmental and workplace rules and keep prisons running.
But there are several reasons governors and state legislators aren’t moving quicker to address the holes in their budgets:
  • They still don’t know how much revenue they’re losing. State leaders are just now seeing how much money they took in during April. Many states saw revenues drop by more than 50 percent compared to April 2019. California saw a drop of 85 percent. But those numbers are not very helpful for the 43 states that collect income taxes. Almost all of them followed the lead of the federal government and extended the deadline for 2019 income taxes until July 15. So states aren’t seeing their traditional April surge in income tax revenue, and it’s not clear yet how much of that is because of timing and how much of that is because people losing their jobs. “Normally you don’t know you’re in a recession until you’ve already been in it, and this time we saw it coming,” says Shelby Kerns, executive director of the National Association of State Budget Officers (NASBO). “So people feel like they should have all this data and things you can get your arms around, but you can’t, because it’s happening in real time.” 
  • The recession hit suddenly, and at the end of the fiscal year for most states. That gave governors and legislators little time to make adjustments before the books are closed on the fiscal year at the end of June. (Four states have fiscal years that normally end at other times during the year; New Jersey extended its current fiscal year from the end of June until the end of September to help manage the coronavirus crisis.) To make up the shortfalls in the current fiscal year, they would need to make big cuts in just a few months.
  • Health concerns came first. Many legislatures left town to avoid spreading the disease, and governors devoted most of their attention to the public health crisis.
  • They’re hoping Congress will soften the blow. The U.S. House has passed a $3 trillion relief bill that includes more than $1 trillion in aid to states and localities. But the bill, produced by the House’s Democratic leadership, has languished in the Republican-controlled U.S. Senate. It’s unclear how or when the Senate will take up another relief bill, but pressure is mounting, as many of the popular provisions of Congress’ earlier relief bills begin to expire.
“States are hoping for significant federal assistance, so in some ways, they have little incentive to cut. It’s helpful for them to have the largest projected deficit possible,” Walczak says. “Also they don’t want to get out in front of things and cut more than is necessary, because cuts are painful by definition. No one wants to more than it turns out they have to.”
That strategy, though, may not help their case for much longer. “It’s clear by this point that Congress is not going to provide a complete bail-out of state finances,” Walczak adds.
Slow to Cut
New Jersey Gov. Phil Murphy told Politico this week that Congress needs to act quickly because “layoffs are happening as we speak.”
So far, though, it looks as if schools, public universities and local governments are responsible for the vast majority of layoffs in state and local governments. State government employees, by comparison, have been largely spared.
Overall, states have more money in reserve – in so-called rainy day funds – than they did entering the Great Recession. But that good news is tempered by the fact that revenue drops have been bigger and faster than those in the Great Recession. Nevada has already tapped its reserves to cope with the current crisis, and several other states, including New Mexico, appear poised to do so soon.
The timing of the economic collapse has made it difficult for state officials to respond with firm plans. Thirty-three states have passed budgets for the coming fiscal year, according to the National Conference of State Legislatures. Sixteen of them actually passed those spending plans last year, as part of two-year budgets.
But a handful of states have implemented or are still considering spending cuts for the upcoming year, either through legislation or executive action.
Nevada Gov. Steve Sisolak, a Democrat, proposed monthly furlough days for state employees and a freeze on merit pay increases. That came after the state siphoned $401 million from its rainy day fund to address revenue shortfalls.
In Washington state, Gov. Jay Inslee has directed state agencies to find ways to cut their budgets by up to 15 percent next year.
Ohio’s Republican governor, Mike DeWine, cut $775 million in state spending last month, with schools, Medicaid and higher education bearing the brunt of the reductions.
Lingering uncertainty
The biggest question when it comes to state budgets, of course, is how long the recession will last.
“There’s still a lot of uncertainty because, in some ways, it’s less of an economic question, and more of an epidemiological question,” says Walczak of the Tax Foundation. “States are obviously beginning to reopen, but we don’t know how linear that progress will be… [A quick recovery] is contingent on there not being reversal in the public health sphere. And that’s just a big unknown.”
Even if the economy recovers quickly, some states could take a big hit anyway, he adds. In the Great Recession, states like California and Massachusetts that relied heavily on progressive tax schemes (ones that tax high incomes at far greater levels than low incomes) saw big revenue swings. That’s because their income tax revenue relied so heavily on capital gains taxes from wealthy individuals.
But that could happen again, Walczak warned. Individuals who sold stock earlier this year, when the stock market tanked, could write off those losses in their 2020 tax returns. But if they turned around and bought a stock that started performing well, they might not sell that stock until next year. That means the taxes on their profit from the sale of the new stock would be collected by states next year too.
Federal help so far: It’s complicated
The most significant aid that Congress has offered so far has come through the CARES Act, a $2 trillion relief measure that President Donald Trump signed in late March.
The law includes $150 billion in direct aid to state and large local governments to help them offset costs related to the covid-19 pandemic.
Those restrictions are significant, says Kerns, the executive director of NASBO.
“It’s not fiscal relief,” she says. “It’s not to replace the revenue that was already there and appropriations that were already made. It’s making new appropriations.”
Governors get to decide where that money goes.
(That said, other provisions of the CARES Act set aside money for specific types of expenses, such as education and elections. And an earlier law increased the federal match for Medicaid, the enormous public insurance program whose costs are shared between states and the federal government. Increasing the Medicaid matching rate is one way Congress can help states make up for revenue losses.)
While the CARES Act gives governors broad discretion in how to use the money, state laws differ significantly (Table 7) over whether governors need permission from legislators to spend the windfall funds from the federal government.
The dispute over control of the federal rescue money led to clashes between the legislature and governors in Alabama and Mississippi, even though both branches of government in both states are controlled by Republicans.
When Colorado Gov. Jared Polis, a Democrat, announced his plans for the CARES Act money with Democratic leaders of the legislature, Republican lawmakers complained that they were cut out of the process. “It was a shocker to me, and I reacted by saying, ‘Governor, you told us that the legislature and the [Joint Budget Committee] would be in control,” state Sen. Bob Rankin, a Republican, told a local TV station. “He said that we didn’t have time to wait for the legislature, we had to get the money out.”
By taking control of the federal money, Rankin pointed out, Polis got to decide how to spend $1.6 billion, at the same time lawmakers were working on plans to cut $3.3 billion.
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Daniel C. Vock

A pandemic. Recession. Civil unrest. State leaders are grappling with several enormous crises all at once. We explore how they're responding.

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