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When Precedent Isn't a Guidepost: State and Local Budgets in the COVID-19 Era

September 29, 2020

September 29, 2020

By Michael Pagano, Dean of the College of Urban Planning and Public Affairs at the University of Illinois at Chicago (UIC), Director of UIC’s Government Finance Research Center, Professor of public administration at UIC, Former Nonresident Senior Fellow of the Brookings Institution’s Metropolitan Policy Program, and Fellow of the National Academy of Public Administration.

In the months since COVID-19 hit the United States, tens of millions of Americans have lost their jobs, and only about half have returned to work. States, cities and local governments – which represent 13 percent of GDP – are under intense fiscal strain as they are being asked to do more at a time when they have less. In fact, it is estimated that the FY20-22 fiscal loss to state and local governments ranges from $500-$800 billion, a staggering sum.

As of this writing in late September, states and localities are holding their collective breaths waiting for Congress to provide fiscal relief while recognizing the unlikelihood of anything of consequence occurring in the short term…and possibly ever.

So now, six months after the shutdown, state and local governments are confronted with a once-in-a-century opportunity of adopting fiscal policies that can reflect either an austere philosophy or an experimental philosophy to governance.

The austere approach is premised on the idea that governments should jettison extraneous, non-core public functions, improve operational efficiencies, cut back on spending and learn to live with less. For example, without additional federal support, states and local governments will first follow the tried-and-true trifecta of fiscal belt-tightening:

  1. Draw down rainy day funds and other unobligated funds; responding to the unexpected is the purpose of such funds and until March of this year, reserves for states and cities were estimated to be at an historic high point.
  2. Halt capital projects and provide as much support as possible for operations and services with the savings; that said, addressing a $500-$850 billion shortfall by spending reductions would be unprecedented.
  3. Do not fill vacant positions, otherwise known as a hiring freeze.

Unlike many previous fiscal crises, COVID-19 happened overnight—depriving state and local leaders of the ability to prepare for an orderly, thoughtful, and equitable path forward. Employing these three actions provides some time to think through more significant changes: reorganization, service delivery changes, and reprioritization of services.

There are, of course, enormous variations across state and local governments in their underlying economies and in their access to fiscal tools. For some governments, especially with stronger economies and steadier revenue sources, the trifecta may be adequate. For others, the required fiscal changes could be draconian.

Already there are signs that reducing expenditures on services will mark the actions of some states and local governments. If austerity rules the day and defines the philosophical approach of a government, we can expect severe service level reduction, calls for public-private partnerships, and preservation of a limited set of existing public services.

Alternatively, state and local governments could embrace new fiscal policy experiments and a revised social compact with their residents. The experimental philosophy to fiscal choices argues that now is hardly the time to cut back just as needs are soaring and the economy is being transformed.

For example, general-purpose local governments (cities and counties), and even state governments, do not align their economic bases and engines with their tax levers. Local governments’ reliance on the property tax, for example, may no longer reflect the underlying economic bases’ productive capacity or even the distribution of wealth, as it did over a century ago.

Or, take the regressive tax-burden effects of the narrow sales tax base for a large majority of state and local governments. Services tend to be excluded, yet the consumer’s purchasing dollar buys more services than taxable goods. In other words, rather than looking for places to cut, the policy experimenters look for better, more equitable and more socially productive places to invest.

As difficult as the crisis is, it does present an opportunity to implement ideas that make good sense:

  • Consider “balanced budgets,” a concept that tends to be much more elastic when fiscal crises face policymakers. Shifting payments forward to the next year seemingly increases the current year’s cash balances, but that approach calls into question the budgetary norm of linking budget cycles (revenues and expenditures) to the earth’s rotation around the sun. A longer budgetary cycle might be an easy first step, and a few states and localities have adopted biennial budgeting.
  • Adopt accrual accounting, as recommended in a recent National Academy of Public Administration report, Building a Stronger Fiscal Foundation, to improve budgetary and financial transparency.
  • Explore collaborative arrangements with other governments to produce services at a lower cost.

The fiscal hole in state and local budgets is worse than at any time since the Great Depression. State and local officials must move quickly with creative and experimental solutions to address the fiscal crisis. There’s no time to waste.

For more information on the Academy's work with Fiscal Health, please visit the Election 2020 Action Plan for Fiscal Health and our Education Resources page.