States need help closing their deficits, avoiding further disaster
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Congress is negotiating another round of financial support for a cratering economy. Help for state and local governments is central to this effort. Their budgets are getting hammered by a loss of tax revenue and rising demand for health care and other public services. Financial help to the states is thus desperately needed to maintain vital services and to avoid exacerbating the economic downturn.
Help to the states is not a reward for bad fiscal management in the past. This argument rests on an economic concept known as moral hazard. Applied to state government finances, it says that federal assistance to the states now will encourage poor fiscal management in the future since states can count on future assistance to bail them out when things go wrong. But that would assume that the next financial downturn again would impact states indiscriminately and require massive federal interventions, especially for those who overspent or, more accurately, undertaxed. Taken to its logical conclusion this argument says that states would count on another pandemic or something like it to prompt a fiscal bailout and thus would act irresponsibly.
That is obviously not how things work. States cannot count on a widespread external crisis to prompt massive federal assistance. But if there likely won’t be a trigger for future federal assistance, there also won’t be an incentive to act recklessly now. States will consequently manage their finances as prudently as possible after this crisis wanes. In fact, states beefed up their finances after the last crisis.
This post-crisis financial management, though, bears its own risk that needs to be addressed now. States will expect little additional future assistance from the federal government. Without sufficient support from the federal government now to counter the negative fallout from the current crisis, states and local governments will start to cut services and possibly raise taxes. States and local government spending, though, makes up a little over 11% of the economy, not counting transfer payments. Cuts to their services will have a measurable negative effect on economic growth. In fact, austerity budgets that enacted cuts to public services substantially contributed to the slow recovery after the Great Recession of 2007 to 2009.
Worse, those same cuts to state and local government budgets decimated the public’s ability to respond to the current health crisis. Local health departments are woefully understaffed. First responders often lack access to personal protective equipment in addition to being stretched thin handling both the pandemic and regular duties. And many unemployment insurance offices lack the people and technology to even handle a fraction of the tens of millions of Americans now out of a job. As it turns out, cutting government services is hazardous to people’s physical and financial wellbeing.
All states, regardless of their political bend or fiscal practices, are in dire need of financial help from the federal government. They face rising costs from sick and out-of-work citizens. Both income and sales tax revenues are down as people delayed tax filings, don’t have jobs and have less money and fewer opportunities to spend. Since states typically cannot borrow money to close this yawning gap, they either need cut spending or raise taxes in the middle of a crisis, unless the federal government comes to the rescue.
What does this all mean for the negotiations under way on Capitol Hill? Congress will need to act swiftly to provide financial assistance to state and local governments. Such help will provide support for people and communities where it is most needed. And that assistance will need to be large enough for governments to maintain crucial health care and public assistance programs in addition to rebuilding first critical capacity. And help to the states will need to last long enough that states and local governments will not have to enact austerity budgets again in the middle of an economic crisis. Congress doesn’t have to worry that its assistance to state and local governments will reward past behavior. Rather, it needs to worry that its lack of action will make a really bad situation much worse.