While many of us may hope the worst of the coronavirus pandemic is behind us — in spite of the recent surge in new cases across the country — for the nation’s states, cities, and towns the worst is still ahead. The new fiscal year begins on July 1 for these governments, which together provide the public with schools, water, sanitation, trash collection, fire safety, emergency medical response, and infrastructure. They are facing a perfect fiscal storm of declining tax revenues, less local aid, and small business failures, coupled with risk worries among municipal bond investors that will make it more difficult to raise new funds.
Unlike the federal government, 49 states and most municipalities must balance their budgets. The economic fallout from the coronavirus pandemic hit states and local authorities hard, but they have survived so far by dipping into rainy day funds and using revenues collected during the months before COVID-19 struck. For the upcoming year, the revenue prospects are grim. Many revenue-producing businesses — such as tourism, hospitality, and big sporting events — are unlikely to return to pre-pandemic levels any time soon.
Most state revenues rely heavily on income taxes, sales taxes, and fees — all of which have plummeted. Some states are in better shape than others, depending on their financial condition before COVID-19, their mix of revenue streams, and their economies. States such as Florida and Nevada, which depend on sales taxes from tourism, will be especially hard hit. Even fiscally prudent states are in trouble. Massachusetts Senate President Karen Spilka estimates that the Commonwealth faces a budget deficit between $5 billion and $8 billion, which means that the state revenues will be 17 percent less than Governor Charlie Baker predicted last January.
For local communities, revenues from sales taxes and user charges (tolls, parking fines, hotel and restaurant taxes, and the like) have dried up. Following the 2008 financial crisis, local governments compensated by raising a range of sales and property taxes, transit fares, parking fines, tolls, restaurant taxes, and the like. This time around, the steep fall in economic activity means that these strategies are unlikely to raise much revenue and would certainly run into opposition from local businesses struggling to stay afloat.
In a bid to make ends meet, states and municipalities are restructuring their balance sheets, entering into regional recovery efforts, carefully examining operating costs, adopting job-shares, monetizing fixed assets, pruning overhead, and working closely with community banks. But these efforts alone will not be enough to prevent painful cuts in local services, even if the federal government enacts further stimulus targeted to state and local governments.
State and local governments have already laid off 1.6 million employees, most of them teachers. A further 1.5 million employees across all sectors are in danger of losing their jobs next month. A key dimension of the crisis is its impact on the Black and minority middle class. For example, 42 percent of Boston’s 17,000 city employees are nonwhite.
Thirty percent of the 27.6 million small businesses in the United States are minority-owned, but they have been closing at an unprecedented rate. According to Robert Fairlie, a professor of economics at the University of California, Santa Cruz, the number of Black businesses fell by 41 percent between February and April — twice as fast as the decline in small businesses overall. The number of these firms fell from 1.1 million to 640,000.
There are three immediate steps local governments can take.
▪ Instead of across-the-board cuts and layoffs, they should use an “activity-based” approach. This means identifying the tasks and contracts within each department and reducing those with lower priority. Convening a local control board can assist in making difficult trade-offs.
▪ Communities need to adjust the way they budget, planning at the outset for a worst-case scenario and modifying budgets using the activity-based approach as new information comes in.
▪ Local governments can work to retain access to capital markets. Mayors should engage with their investor community to show they have a plan to keep their finances under control. States can invest money in community banks. In Massachusetts, former state treasurer Steve Grossman successfully shifted $100 million in state funds from Wall Street to local community banks after 2008, which in turn helped to revive small businesses. This could be a model for states and cities this time around.
Supporting a massive investment in local communities is the single most important step the federal government can take to avert a further deterioration in the economy. As economist Mark Zandi has pointed out, studies conducted following the 2008 crisis showed that each dollar invested in local governments produced a return to the economy of $1.40. Studies also showed that the lack of sufficient federal help to states and local governments delayed recovery from that crisis by years.
So far Congress has provided some $200 billion in aid to states, as well as assistance with Medicaid and unemployment spending, but this is no match for the estimated $1.3 trillion revenue shortfall expected over the next three years ($650 billion for states and the rest for local governments). The Federal Reserve’s $500 billion Municipal Lending Facility is welcome, but it is available only to states and very large jurisdictions and must be repaid within three years. It will not help thousands of medium-sized communities that wish to issue longer-term debt to finance critical infrastructure projects that generate jobs.
In the current environment, the federal government needs to do everything possible to restore liquidity to states and localities. This includes not only federal support, but also expanding the Municipal Lending Facility to more cities and extending it over 10 years, enacting a bill to rebuild America’s infrastructure, providing direct support to prevent layoffs of front-line city workers, and direct aid to minority-owned small businesses. This is the best way to strengthen the national economy.
Linda J. Bilmes is a senior lecturer at Harvard University and a former assistant secretary of the US Commerce Department.