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Crisis Economics: States Need Financial Assistance Soon

Congress has passed three separate emergency fiscal stimulus bills totaling a record of $2.8 trillion. But the federal response has come up short in providing financial aid to state and local governments.

The decision not to include financial support to states in the initial stimulus bills might at first appear to be good politics, but it makes for bad economics.

Politics aside, this is crisis economics. The economic fallout from the coronavirus crisis has wreaked havoc with state budgets as tax receipts have plummeted due to the collapse in sales and record unemployment. The main idea behind the stimulus measures is to "build a bridge to the other side" so there is a sufficient business structure in place for the economy to recover. Congress needs to include states in their "build a bridge" strategy. A Big Hole in an All-Out Policy

Faced with an unprecedented economic crisis emanating from the pandemic coronavirus Congress responded in record speed and scale to cushion the fallout in the economy.

The first line of support focused on providing federal aid to workers and businesses in the form of stimulus checks to individuals, an increase in unemployment compensation, and emergency aid to small businesses. That made sense, as the early causalities from the crisis, were small businesses forced to close and record number displaced workers in hard-hit industries such as travel, lodging, entertainment, and restaurants.

Some have argued that these initiatives were overly generous. In some cases, people could potentially earn more collecting unemployment benefits that they did in their regular job. Also, federal loans to small businesses were “forgivable” (i.e., free money) if companies meet “soft” criteria guidelines.

Generous or not the same standards or scale of financial support has not been afforded to state and local government. In the second emergency stimulus bill, Congress did appropriate $150 billion, with strict restrictions, to help state and local governments to help pay for health care costs associated with coronavirus crisis.

But no federal funding has been appropriated for regular operating expenses that pay for a wide range of public services. Two-thirds of state and local revenue comes from the taxes levied against personal and corporate income and retail and business sales. The abrupt and sharp drop in sales and employment resulted in a record drop in tax revenue.

The cash crunch is so severe for some states and municipalities that a few might not be able to meet their payroll and other operating expenses for the budget year that ends on June 30.

Opposition to providing federal financial aid to states comes from the view that the fiscal management of states is poorly run and a few operate with large pension deficits. The latter is a fair criticism, but not the former as all states operate with a balanced budget mandate. Any federal legislation for state aid would come with strict restrictions on the use so the argument about states using new aid to secretly fund public pensions is a non-starter.

Even with federal aid spending cutbacks and layoffs at the state and local governments are going to occur. In 2009, following the Great Financial Recession Congress appropriated an unprecedented $150 billion in financial aid to states and local governments. Still, over the next several years real state and local spending fell roughly 10% and 800,000 public sector jobs were eliminated.

States are facing budget deficits that are two or three times larger than what occurred during the Great Financial Recession. Spending cutbacks and layoffs will far exceed that of the prior downturn. The state and local government sector amounts to 10% of Nominal GDP and employs nearing 20 million people so contractionary fiscal actions will be seen and felt in the general economy.

It is hard to predict how much financial support for state and local governments is “politically feasible” after Congress has already spent nearly $3 trillion. The National Association of Governors has requested $500 billion in aid.

It’s a high price tag, but it is less than the $650 billion of forgivable loans (free money) that has been appropriated for small businesses. Congress should be hard-pressed to justify denying or providing less assistance to help fund essential services of states while not applying the "essential versus non-essential" test in its loan program for small businesses.

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