The American economy is still finding its feet. But states are doing pretty well.
The United States is emerging from the global pandemic with its economy in an unusual place: unemployment is high and a deportation crisis is looming, but consumer spending is skyrocketing and businesses are rushing to hire.
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In the midst of these baffling economic indicators, it is worth asking: what is the state of states? After all, states are responsible for providing the services citizens expect and, unlike the federal government, they must maintain a balanced budget.
According to Therese McGuire, a professor of strategy at Kellogg who studies public and local finance, despite a year of restaurant closings and increased spending, many states are doing surprisingly well. How could that be? What about states like Illinois, which have entered the pandemic already in financial crisis? And what are states and cities doing to prepare for the next economic downturn?
“The big surprise”
The decline in state and local government revenues, as for the economy as a whole, has been rapid and deep, much deeper than during the Great Recession. States had to dip into their funds for the rainy days and borrow as much as they could to cover expenses, especially in areas like health infrastructure.
âDo you remember the spring when the city of Chicago took over McCormick Place and tried to turn it into a potential hospital? McGuire said. “And then of course, at the end of May, George Floyd was killed in Minneapolis.” With the cost of additional public safety measures on top of the loss of income from closed businesses, “it was another crisis that particularly hit the big cities.”
Still, she says, “the big surprise” is that state revenues have started to rebound faster than anyone expected. Consider California. At the start of the pandemic, the state forecast a deficit of $ 54 billion. In May, the state estimated a surplus of $ 76 billion.
Part of the reversal of fortune comes from payments to individuals insured by the federal government: the increase in unemployment benefits was taxable above a certain amount, for example. But a more important factor was that the impact on sales tax revenue was not as dramatic as expected.
âPeople were worried about state and local government tax revenues because people were losing their jobs and staying at home. But a lot of people, especially the higher income folks, kept their jobs and were buying stuff like crazy on Amazon, âsays McGuire. Thanks to the 2018 Wayfair Supreme Court ruling, retailers are now responsible for collecting taxes on out-of-state purchases, essentially making internet sales in all states taxable. This has allowed revenues from the online shopping boom to ease some of the pain of struggling service sectors.
Then came Biden’s election, and with it a $ 1.9 billion spending program that expanded support for individuals and businesses, programs initiated under the Trump administration. It also provided a new dedicated funds program for states and cities.
“So these funds are coming in, and it’s not currency either,” McGuire says.
50 states, 50 state budgets
Still, it’s no secret that some states are emerging in better shape than others.
States like California have been particularly fortunate throughout the crisis, says McGuire. California has a graduated income tax, which means a large chunk of its income comes from the highest earners, the same people who have most likely kept their jobs throughout the pandemic. California also has a capital gains tax, which provided a significant source of income once the stock market came back strong.
On the other end of the spectrum, states that rely heavily on sales tax revenues have not done as well. States that rely on tourism either.
The battle to consolidate state finances – though ultimately largely successful – has taken time to win, causing unnecessary suffering for those who depend on government services.
To some extent, the same can be said of city chests. âCities are a similar story, but many cities tend to be even more dependent on tourism than the state they’re in,â says McGuire. âThe city of Chicago has suffered a greater revenue impact than the state of Illinois because the city is more dependent on tourism revenue and convention revenue than the state. “
So what about Illinois, which has entered the pandemic in crisis?
âIn the spring and last summer, Illinois was in dire straits,â McGuire says. âAt the start of the pandemic, the Federal Reserve offered to lend money to states, and Illinois was the first and only state to accept them. “
Illinois was not allowed to use the money from Biden’s recovery plan to repay those loans, as well as to use the money to consolidate the state’s unfunded pension liabilities. This put the state in a dilemma: “How are they using the one-time money to put us on a better course in the future?” “
In his opinion, the state is doing a reasonable job in dealing with the situation. Sellers are now paid on a timely basis: in 2017, the state had over $ 16 billion in unpaid invoices; it is now only $ 3.8 billion. Remarkably, with this one-time cash injection, Illinois has a balanced budget and all three major credit bureaus have recently expressed a positive outlook.
Yet, âit is a structural deficit that we face in this state. We have revenues that grow at a slower rate than expenses, âshe said. “And so we’re balancing the budget this year, but if we don’t change any growth rates, give us a few months: we’ll have a deficit.”
A better way forward
Surely you’ve heard the saying “Don’t let a good crisis go to waste”. So, are any states using the pandemic as a chance to reset their finances, act on new learning, or perhaps experiment with more innovative or equitable sources of revenue?
âI didn’t see anything,â said McGuire. âIt’s disappointing. But on the other hand, to their credit, it’s a one-off recession in a century, a pandemic-triggered recession. So maybe there was no lesson to be learned from it. this particular episode.
This is not to say that there are no broader lessons that could be applied at the federal level.
In McGuire’s view, the battle to consolidate the state’s finances – though ultimately largely successful – has taken time to win, causing unnecessary suffering for those who depend on government services. She cites research that supports the idea of ââautomatic stabilizers: mechanisms that automatically increase federal aid to states and cities as soon as the unemployment rate exceeds a specified threshold in this area without requiring political action.
âThen if another recession hits a single industry in particular, cities and states that depend on that industry are eligible for help,â she says. “I think a lot of economists would agree with this recommendation.”