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The COVID-19 Budget Crisis Makes Federal Aid To States Critical

With states’ revenue streams drying up, state employees have been laid off and core services cut. This has increased the number of residents needing aid while reducing state aid available to vulnerable people when they need it most.

Photo illustration by Elizabeth Brown.

The COVID-19 Budget Crisis Makes Federal Aid To States Critical

With states’ revenue streams drying up, state employees have been laid off and core services cut. This has increased the number of residents needing aid while reducing state aid available to vulnerable people when they need it most.


This research and analysis is part of our Discourse series. Discourse is a collaboration between The Appeal, The Justice Collaborative Institute, and Data For Progress. Its mission is to provide expert commentary and rigorous, pragmatic research especially for public officials, reporters, advocates, and scholars. The Appeal and The Justice Collaborative Institute are editorially independent projects of The Justice Collaborative.

The economic freefall caused by COVID-19 has decimated state budgets and created an unprecedented crisis. States depend primarily on income and sales tax revenue to fund services, including education and health care. But as unemployment rose at an unprecedented rate (and remains at an alarmingly high level), income tax revenue plunged. And as retail sales racked up the largest two-month decline on record, sales tax revenue has plummeted (May state sales tax revenue dropped by close to $6 billion, or 21%, compared to May 2019). 

Although it is impossible to predict the full effect of COVID-19 on state budgets, the steep drop in the national GDP is more than twice as large as the economic collapse during the Great Recession. Early estimates indicate that states will face a collective budget shortfall of approximately $555 billion from 2020 through 2022, even before accounting for pandemic-related expenditures such as increased costs for public hospitals, unemployment, and public safety. 

Because states generally operate under balanced budget requirements and do not have sufficient reserves for severe economic downturns, states either need to bring in more money or cut costs during a recession. By contrast, the federal government can engage in deficit spending, giving it the flexibility to smooth out spending when revenues decrease in a recession. The federal government can use this spending to help fill state budget gaps through aid packages, such as the $150 billion already available to states through the CARES Act for some pandemic-related expenditures. But because the CARES Act primarily targeted states’ extra expenses due to COVID-19, it did not help states make up for falling income and sales tax revenue. 

The State Budget Crisis Will Harm the Most Vulnerable Populations

When states face gaps in their budgets, they can balance them by raising taxes, cutting expenses, or a combination of the two. During the Great Recession, states balanced their budgets primarily through spending cuts. Anecdotal evidence indicates states will do the same again, laying off state employees and downsizing core programs and social services. Georgia cut $2.2 billion from its budget, including a $950 million cut for K-12 education. Colorado cut approximately $1 billion from education alone. And New Jersey cut or deferred over $5 billion in expenditures. Around 13% of the American labor force works for a state or locality. Since the start of the pandemic, state and local governments have furloughed or laid off at least 1.5 million workers—about half of whom were employed by school districts. The net effect has been to increase the number of residents needing aid while reducing state aid available to vulnerable people when they need it most.

To understand the ramifications of these budget cuts it is important to remember the broad services states provide. Over 40% of states’ expenditures go to public welfare programs funded by a mix of state and federal dollars, such as Medicaid, Temporary Assistance for Needy Families, and Supplemental Security Income. States also provide significant funding for healthcare, unemployment benefits, and education. While      states do provide services that benefit the state as a whole, such as highways, most social spending goes to aid more vulnerable residents. 

State budget cuts due to the Great Recession created an ongoing drag on economic growth and offer a warning for the current economic crisis. For example, state and local governments eliminated more than 400,000 jobs between August 2008 and February 2011—adding to already high unemployment rates in the private sector and depressing consumer spending, which lowered economic growth and sales tax revenue. In fact, many states “lost a decade” of growth to the Great Recession. Without federal aid, states will likely face the same fate, or worse, as a result of the current pandemic-induced recession. 

The drastic state budget cuts of the Great Recession also pushed more Americans into poverty by reducing aid for those most in need. During the Great Recession, 34 states cut funding for K-12 education, 29 states reduced services for the elderly and disabled, and 31 states cut healthcare spending. And 43 states reduced higher education spending, leaving public universities to close their funding gaps by raising tuition and forcing many students and their families to take on more debt or forgo college altogether. 

In sum, the lessons of the Great Recession make it clear that as states make similar budget cuts in response to the current economic crisis, those cuts will slow economic recovery and shrink what safety net currently exists when those services are most needed. 

The Federal Government’s Role in the State Budget Crisis 

The federal government should take the lead role in reducing the state budgetary crisis. Indeed, voters are in favor of this type of federal involvement. A survey conducted by The Justice Collaborative Institute and Data for Progress found that 71% of likely voters support sending federal aid to states to protect basic services, including public education, healthcare, and transportation. Only 17% opposed such federal aid. 

To be sure, states will likely need—and have already begun—to play a role in reducing their own budgetary gaps. Measures such as raising taxes on the wealthy, cutting services in a way that minimizes the impact on the most vulnerable, and using rainy day funds can be seen as states bearing a portion of the financial burden imposed by COVID-19. However, those measures can only go so far. There simply are not enough ways for states to balance their budgets without drastically cutting services for those who depend most heavily on them. 

Even though the state budget crisis spans both red and blue states, Congress remains deeply divided on further economic recovery packages. Partisan debates about how to structure state aid have become one of the greatest hindrances to proposed bills becoming law. Some politicians have expressed reluctance to bail out states that they view as being fiscally irresponsible. However, states went into this recession with a median rainy day fund of 7.8% of general fund budgets for the year—significantly more than they had saved at the beginning of the Great Recession. Like the federal government, states could not have anticipated the economic effects of the pandemic. But unlike the federal government, states do not have the tools to deal with the enormous economic impact of the pandemic without depriving deeply vulnerable people of essential services. 

The federal government can provide aid to states in myriad ways. Academics have mapped out approaches Congress could take, from sending states unrestricted aid—as opposed to aid tied to COVID-19 costs, as in the CARES Act—to expanded federal support for unemployment insurance and Medicaid. Although there is no one right way for Congress to structure state aid, sitting at a political impasse and doing nothing to fill the state budget gaps will continue harming the most vulnerable. 

Methodology

From 7/24/2020 to 7/25/2020, Data for Progress conducted a survey of 1,318 likely voters nationally using web respondents. The sample was weighted to be representative of likely voters by age, gender, education, race, and voting history. The survey was conducted in English. The margin of error is +/- 2.7 percent.

Gladriel Shobe is an Associate Professor of Law at Brigham Young University. Grace Nielsen is a JD candidate at Brigham Young University.