Make Sure State Aid Lasts as Long as It’s Needed

It’s great news that the fiscal relief package being debated in Congress includes another round of support for state and local governments. Once again, however, lawmakers are failing to learn lessons of the past by not designing this relief to be more automatically dependent on economic conditions.

All states except Vermont have some sort of balanced budget rule, mandating that they reduce spending or raise taxes in an economic downturn — thereby exacerbating the downturn by constraining demand. Over the past year, for example, state governments have reduced employment by more than 300,000, and local governments (which are partially supported by state governments) by almost 1 million.

Most states have a fiscal year that runs from July to June, and as legislatures reconvene in January, they will be setting their budgets for the one that starts in July 2021. Many will face projected general revenue declines that, based on the most recent estimates, exceed 15%.

History suggests that, to offset the decline in revenue and the need to increase pandemic- and recession-related spending, states will make cuts in their two biggest budget areas: health care and education. Some states have already started. Georgia, for one, has reduced funding for K-12 public education by almost $1 billion. Higher education is also often targeted, and Tom Kane of Harvard University and I have shown that the cumulative effect of lowering state appropriations for higher education during recessions has substantially harmed the quality of public universities.

To minimize the need for these harmful steps, the federal government has often provided special state fiscal relief during downturns. In 2009, for instance, the American Recovery and Reinvestment Act included $87 billion in extra assistance through Medicaid and roughly $50 billion more through an education-related stabilization fund. Earlier this year, the CARES Act provided $150 billion in state and local funding through a Coronavirus Relief Fund. The additional package now under consideration apparently includes another $160 billion for state and local governments.

Given the deficits that states face in 2021, any such additional relief is necessary. But there is a danger that this state support will expire too soon, as it has in the past. The state and local support included in the 2009 legislation, for example, averted a significant number of job losses. But because it also ended too soon, states slowed the already sluggish recovery that followed by constraining spending.

In 2016, Jared Bernstein, who now stands to become a member of President-elect Joe Biden’s Council of Economic Advisers, coauthored an insightful analysis titled “Preparing for the Next Recession: Lessons from the American Recovery and Reinvestment Act.” In it, he argues that state fiscal relief should be designed to take effect automatically and last as long as the economy remains weak, so that it doesn’t end while it’s still needed.

The Government Accountability Office has outlined how one such system involving additional federal support for Medicaid could work. The extra aid would be triggered if 26 states experienced a sustained decline in the employed share of their populations.  And it would remain in place until the employment trend recovered.

As GAO writes:

Because the prototype formula relies on labor market data as an automatic trigger rather than legislative action, assistance would have begun earlier and extended longer than the assistance provided by the Recovery Act. The prototype formula would have triggered assistance to begin in January 2008 and end in September 2011, compared with the Recovery Act which provided [additional assistance] from October 2008 through June 2011.

Alternative systems for turning assistance on and off may have altered the precise results, but the broader point is that crucial assistance to states would be made less dependent on discretionary action.

Although 2021 currently looks promising for the economy, especially given the stunning scientific advances on vaccines, no one knows for sure how the economy will behave, how much economic scarring will occur before vaccines are widely available, and how hard state and local governments will be hit. Given that uncertainty, it would be far better if any assistance to state and local governments enacted now could come with a built-in insurance feature.

The art of the possible may not permit it, but whatever fiscal relief is provided to states will be much more effective if it is set to automatically stay in place until more normal conditions return.

“Sustained” means that the three-month average declines relative to the same three-month average in the previous year, for two months in a row.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Peter R. Orszag is a Bloomberg Opinion columnist. He is the chief executive officer of financial advisory at Lazard. He was director of the Office of Management and Budget from 2009 to 2010, and director of the Congressional Budget Office from 2007 to 2008.

©2020 Bloomberg L.P.

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