Governors, legislators, mayors, and other public officials across the country are bracing for the coming drop in state & local government revenue collections caused by the pandemic-driven economic downturn. Some states are sitting on budget surpluses, rainy day funds, and unemployment insurance reserves that are sizable enough to help lawmakers avoid otherwise necessary spending cuts, but difficult budget revisions will still be required in many state capitals.
“No one knows how deep or long the pandemic-triggered recession will be,” writes Alan Greenblatt, senior staff writer at Governing Magazine. “But nearly every type of government revenue, including income, sales and gas taxes, will take a hit.”
It’s not a matter of if state tax collections will fall short of projections, but the degree to which state revenue estimates will be missed.
“The question now isn’t whether previous state and local budget assumptions have been demolished — only by how much and for how long,” writes E.J. McMahon, research director at the Empire Center for Public Policy and a Manhattan Institute adjunct fellow.
The good news is states are better positioned to deal with a recession today than they were heading into the previous downturn. States ended fiscal 2019 with $72 billion in their rainy-day funds, or 7.6% of their general fund spending, according to The National Association of State Budget Officers. That compares with $33 billion in state rainy day funds in fiscal 2007, at the start of the Great Recession, which represented 4.7% of state budgets at the time.
The fact that federal debt increased during the recently-concluded decade-long expansion of the U.S. economy and stock market meant that the federal government was not as well-positioned as it could have been for the current crisis. Greater federal spending restraint over the course of multiple administrations would’ve provided resources that could be call upon during the current emergency and economic downturn.
The federal government “would have been in a much better position to handle this extra spending — and everything else that Congress has in mind — had Uncle Sam practiced some fiscal austerity in the past,” Veronique de Rugy, senior research fellow at the Mercatus Center at George Mason University, writes. This assertion is backed up by data.
From 2000 to 2018, for example, growth in federal government spending increased by 130%, which is more than double the 61% combined rate of population growth and inflation during that period. Had federal spending growth instead stayed in line with the rate of inflation and population growth during that period, the national debt would’ve decreased by 2.6 trillion instead of increasing by $10.5 trillion during those nearly two decades.
The federal government would’ve spent $1.2 trillion less than it did in 2018 had federal spending grown at the rate of population growth and inflation since 2000. That’s money that could’ve been held in reserves to be utilized for emergencies like the current one, returned to taxpayers, or both.
The states best positioned to weather the current crisis are those where state spending has not grown as rapidly as at the federal level and has been held to a sustainable clip. North Carolina, perhaps the state most well-positioned to deal with the pandemic-driven economic downturn, is a state where growth in state spending has roughly been held in line with the rate of population and inflation in recent years.
As a result of responsible budgeting, North Carolina enters this crisis operating with a budget that has a $2.2 billion unreserved cash balance, a $1.1 billion rainy day fund, and $3.9 billion in unemployment insurance reserves. North Carolina lawmakers accumulated these savings in recent years at the same time they returned billions of dollars to taxpayers through revenue trigger-enabled income tax cuts.
In addition to cutting income tax rates with the help of revenue triggers, as lawmakers in other states like Arizona are now considering, North Carolina lawmakers also flattened the state’s income tax. This gives Tar Heel State a tax code that yields less volatile revenue collections in economic downturns like the current one compared with states that collect a greater share of revenue from upper income households. States with progressive income tax codes where high earners provide a disproportionate share of tax collections are expected to take a larger revenue hit in the current downturn.
States that are overly-reliant on high earners, with revenue collections are disproportionately dependent on their wages and capital gains, include places like California, New Jersey, Connecticut, and New York. According to the Empire Center’s McMahon, New York, gets 40% of its income-tax collections from upper income households. On average, about 28% of New York’s income comes from market gains, meaning that large drops is the stock market create major problems for budget writers in Albany.
“The personal-income tax, Albany’s largest single revenue source, leans heavily on high-rolling investors who have lost fortunes in three wildly chaotic weeks on Wall Street,” E.J. McMahon writes. This challenge is not limited to New York.
“In addition to California, the states with the most financial-market sensitivity in their tax structures are New York, Connecticut, Massachusetts, and Oregon, according to a recent S&P Global Ratings report,” writes Steve Malanga, senior editor of City Journal and the George M. Yeager Fellow at the Manhattan Institute.
One take-away for governors, state legislators, and other public officials that is already becoming clear is not only the importance of saving during the good times, but also the prudence of not making government disproportionately dependent on upper income households or certain economic sectors. There will be many lessons for policy makers to learn from this unprecedented pandemic and the economic downturn it has caused. These are some of the early lessons.
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