The impact of COVID-19 and federal relief on future budgets

The COVID-19 pandemic and resulting economic downturn created the perfect storm for state and local budgets in the United States. The full extent of the fiscal problem is unknown and greatly dependent on the course of the virus.

States were generally on course for FY20 beginning July 1, 2019, through June 30, 2020, when the pandemic hit in March. State stay-at-home mandates, imposed to slow the spread of the pandemic, negatively impacted consumer spending, which significantly reduced sales and excise tax revenues. Unemployment skyrocketed, resulting in decreased state income and payroll taxes. The April 15 tax filing deadline was extended to August 15, adding further uncertainty regarding revenue.

The uncertainty and reduction in revenue came at a time when emergency response by government to COVID-19 increased state operating costs dramatically. Cities and towns were also negatively impacted with reductions in every revenue source, including property and sales tax and permit and utility fees.

Although revenue forecasts have been challenging because of the uncertainty associated with the virus, most states are anticipating budget shortfalls through FY21 or longer. Unlike the federal government, states generally cannot borrow funds because there are statutory or constitutional requirements to enact balanced budgets.

The federal government has taken several steps to address COVID-19. Starting in March, the federal government enacted several appropriation bills to address the pandemic.

The question is: will Congress pass additional legislation to address the pandemic? Congress went back in session on November 9 but agreement on Phase IV COVID-19 funding is still uncertain. Speaker of the House Nancy Pelosi and Treasury Secretary Steven Mnuchin attempted to negotiate a new COVID-19 relief bill. The Speaker proposed a $2.2 trillion measure while the White House, through Mnuchin, was willing to agree to $1.8 trillion. Before the election, President Trump said we will have a tremendous stimulus package immediately after the election, but the was seemingly based on the condition of him winning re-election. Senate Majority Leader Mitch McConnell has indicated that he will not take up an expensive spending bill. Instead, McConnell plans on moving forward with a narrow $500 billion measure.

The major sticking points are the amount of the appropriation and the level of unemployment benefits and whether the bill contains state and local aid and liability protections for business. Republican and Democratic lawmakers that are in tight election races are pushing for a deal before the election. Although there has been some progress, it is uncertain whether lawmakers will reach an agreement before the election.

Even if there is significant federal funding to state and local governments, many believe that there will still be a need for independent solutions to address budget shortfalls at the state and local level. The impact on individual states will depend on the impact of COVID-19, the amount in any state rainy day fund and how well the state pension system is funded. To impact budget deficits immediately, states will use rainy day funds, reduce services or workforce levels, raise current taxes or fees, offer early retirement programs, defer costs, or look for new tax revenue.

The states may also pursue structural changes to reduce costs. They can look to maximize COVID-19 federal funds, consolidate government or services, reorganize, and reduce unnecessary activities. State government can also use tools and technologies to create efficiencies. States will likely use some combination of budget cuts, raising existing tax rates, and introducing new tax revenue sources to close budget gaps.

Ultimately the course of action any state pursues will be driven by how long the pandemic lasts and how severe any resurgence might be, and how the overall economy responds and how quickly it recovers, factors which are exceedingly difficult if not impossible to predict.