February 15, 2021
By Michael Lucci, Senior Policy Advisor at State Policy Network, and Marc Joffe, Senior Policy Analyst at Reason Foundation
State and local governments entered 2020 in a solid financial position. A decade of economic growth resulted in healthy budgets and growing rainy day funds, with general purpose state and local governments accumulating over $200 billion in rainy day funds and unreserved fund balances. However, the coronavirus pandemic’s economic devastation caused state and local tax revenues to plummet right as public expenditures rose. Prudent states were bolstered for this crisis with robust rainy-day funds, while mismanaged states saw their pre-existing financial problems exacerbated.
Most state governments abide by some form of balanced budget requirement. As a result, rapid revenue losses can lead to equally rapid reductions in spending on government payroll and services. As states managed their finances and drew down on their rainy-day funds, the federal government provided multiple packages of aid that included direct and indirect support to state and local finances.
The Pandemic’s Impact on State Tax Revenues
State and local governments are expected to experience $140 billion in revenue losses through the first six quarters of the pandemic recession, from Q1 2020 through Q2 2021. This estimated revenue loss is based on a review of Census data for the first three quarters of this period and an updated forecast published by Stan Veuger and Jeffrey Clemens at the American Enterprise Institute.
The revenue loss estimate compares revenues currently being collected with a reasonable expectation of what states and local governments would have collected had the pandemic not caused state and local revenue reductions relative to projections. Year-on-year revenue declines between Calendar Years 2019 and 2020 show a similar result and have been minimal: around one percent at the state level according to a recent Reason Foundation analysis of state revenue reports.
The Budget Impact of Additional Medicaid Enrollment
States are also incurring additional expenditures due to increased Medicaid enrollment. As workers lost their jobs at the beginning of the pandemic, many needed to join Medicaid to replace their employer health insurance. Between March and September 2020, about 5.8 million individuals joined the Medicaid rolls, resulting in an estimated $30 billion in additional state expenditures during the pandemic.
However, we expect that this added cost will be more than offset by increased federal Medicaid support. Congress raised the Federal Medical Assistance Percentage (FMAP) for each state by 6.2% for the duration of the health emergency. The Biden Administration recently provided guidance suggesting that the FMAP enhancement would continue through the end of Calendar Year 2021even though mass vaccinations are likely to curtail the pandemic sooner.
Increased federal matches are not an unalloyed fiscal benefit for states. While accepting the additional Medicaid assistance, states are prohibited from removing individuals who cease to meet eligibility requirements from the Medicaid program. But as individuals regain employer-based health insurance, many can be expected to reduce their use of Medicaid-funded health services.
Against own-source revenue losses and mixed Medicaid impacts, state and local governments have received or are eligible to receive about $400 billion in various forms of federal aid, mostly from the CARES Act and the Consolidated Appropriations Act passed by Congress in December.
While much of the federal aid is earmarked for specific costs, such as vaccine distribution, a significant portion of the money can be used to cover expenses that would otherwise be funded by state tax collections. For example, we estimate that the CARES Act and Consolidated Appropriations Act provided a total of over $88 billion for public schools, colleges, and universities. Since most states subsidize these institutions, states could reduce their own-source revenue contributions.
As noted at the outset, state and local governments entered the pandemic recession with over $200 billion in rainy day and other unreserved fund balances as a cushion against financial distress. In short, there has already been a great deal of financial support to help state and local governments weather the financial storm. Nearly every single state has received more in federal aid than it has experienced in revenue losses.
When is enough federal aid enough?
In the long run, state and local governments need to adjust to an economic pie that economists now expect to be smaller than was projected before the pandemic recession. If state and local governments continue to grow at the rate they anticipated prior to the recession, they will become a bigger slice of a comparatively smaller economic pie—an outcome without a clear policy justification. In fact, state and local governments should avoid drastic layoffs and service reduction, yet they should also economize their resources and prioritize core services so as to minimize the tax burden placed on beleaguered private sector firms and households that fund state and local governments.
Furthermore, excessive aid packages will erode fiscal federalism and reduce the incentive for states to prepare for future recessions if the federal government continues to support pre-recession spending projections for state and local governments.
As the research below will show, federal aid has already done the work of bolstering state and local finances, and in most cases even exceeds revenue losses experienced in the states. State and local governments have received substantial federal aid on top of their own robust pre-recession fund balances, and now need to adjust their finances for a different economic reality than existed pre-pandemic. Federal lawmakers have provided state and local governments with more than enough aid and should focus their efforts on policy changes that will effectuate stronger economic growth.
Federal Aid in Excess of State Tax Revenue Shortfall
The latest revenue projections show that states are not experiencing as much of a shock from lost revenues as anticipated. The projected $140 billion in lower revenue is more than made-up for with approximately $400 billion in various form of federal aid to state and local governments. In fact, 48 out 50 states received more federal aid than anticipated revenue lost.
Vaccine Funding Allocation by State
The Consolidated Appropriations Act allocated $4.29 billion to state, local, and territorial governments for the procurement and distribution of COVID-19 vaccines. This map shows the dollar amount going to each state.
The Consolidated Appropriations Act indicates that $4.29 billion will be allocated to state, local, and territorial governments based on the Public Health Emergency Preparedness (PHEP) formula. State Policy Network attained the 2020 PHEP grants from the Centers for Disease Control (CDC) website and applied the same allocation proportions to the $4.29 billion total.
About This Data
The revenue projections for Q3 2020 through Q2 2021 are based on an updated analysis published by American Enterprise Institute on February 2, 2021. Authors Stan Veuger and Jeffrey Clements forecast an overall state and revenue loss of $130 billion for the five quarters from Q2 2020 to Q2 2021. One third of this revenue loss—about $43 billion—was attributable to Q2 2020. The remaining $87 billion is their expected revenue loss for Q3 2020 through Q4 2021, which is equivalent to the 2021 State Fiscal Year in most states. Since first quarter of this fiscal year are available from the Census Bureau, projection is based on three quarters of the state fiscal year or $65.25 billion. The projected loss was allocated across states using proportions obtained from an analysis published by the Cleveland Federal Reserve last May.
Data Sources: Download a full list of data sources here.