As currently being discussed, the COVID-relief package delivers billions of dollars to states even though their finances are sitting pretty.
State and local governments have avoided a recessionary crunch thanks to recovering tax revenues coupled with waves of federal aid. Instead of seeing their finances crater, states are now afloat on a tide of federal cash.
And yet the coronavirus-relief proposal President Biden favors would provide state and local governments with another $525 billion of aid, which exceeds all previous federal aid during this crisis so far combined. It isn’t necessary. The federal government has provided sufficient aid to state and local governments. It now ought to stop, lest it undermine fiscal federalism.
The Biden plan would push massive new state- and local-government spending despite long-run national GDP projections being trimmed, and would thereby make state and local governments a larger slice of a smaller American economic pie, and lead to unsustainable growth in spending. On the one hand, state and local revenues have come in roughly flat compared with revenues in prior years, at most down by less than 2 percent, according to independent analyses by J.P. Morgan, Reason Foundation, Urban-Brookings Tax Policy Center, and the State Policy Network (where I am a senior policy adviser). With revenues flat year-over-year, state and local coffers are expected to collect $130 billion less than previously anticipated growth through June 2021. That means the fiscal gap that states experience is due less to revenue falling in absolute terms and more to revenue growth being weaker than would have occurred had there not been a pandemic recession. States simultaneously took on new costs to fight the deadly pandemic.
Yet any financial shortfall is more than covered by previous federal-aid packages. The federal government has provided $400 billion of support through programs such as the Coronavirus Relief Fund ($150 billion), education support ($88 billion), transit-agency support ($38 billion), and other programs such as higher Medicaid reimbursements and money for vaccine distribution. Furthermore, state and local governments were sitting on $200 billion in rainy-day funds and unreserved balances when they entered the recession. No wonder so many states are swamped in cash.
Some policy-makers point to state- and local-government job losses as a source of economic drag. However, it is unclear that government job losses are caused by revenue shortfalls rather than by explicit policy to reduce government services during the pandemic. State and local job losses are in line with private-sector job losses, at roughly -6.5 percent year over year. Yet government job losses bear no clear relationship to government-revenue losses. States such as Texas and Florida faced steeper tax-revenue losses during the pandemic than such states as California and Michigan. Yet Texas (-2.3 percent) and Florida (-4.3 percent) better preserved government jobs than California (-7.6 percent) and Michigan (-8.6 percent), probably because they remained more open and imposed fewer restrictions.
This brings us to Biden’s proposal to flood state and local governments with $350 billion in general support and $175 billion for education, effectively pouring more water into an overflowing cup. Even Democrat-affiliated economists such as Larry Summers have questioned the wisdom of the $1.9 trillion package of which the state aid is a part, pointing out that it goes far beyond replacing lost output. Moreover, $350 billion in state support is distributed by a formula that favors states with high unemployment, so it’s slanted toward blue states that enacted prolonged shutdowns. States that voted for President Biden receive $1,040 per resident compared with $900 per resident for states that voted for President Trump. It is hard to avoid the conclusion that the money is not meant to offset revenue losses, but rather to temporarily absolve financially troubled states of mismanagement that predated the pandemic.
The casualty of all of this borrowing, spending, and financial pretending is America’s exceptional system of federalism, a source of national strength and healthy internal competition. States are free to tax and spend as they please, but they are responsible for the consequences of their own decisions. And most states are required to abide by balanced-budget restrictions — an admittedly quaint idea in modern Washington, D.C., but a fundamental component of the pragmatic state approach to financial affairs. That’s why states save up for a rainy day.
Competition has admittedly taken a toll on financially mismanaged states. Businesses and families are increasingly leaving them for better-managed places. Floridians can’t build homes fast enough for all the relocating New Yorkers. And despite Texas’s embarrassing energy-system failure, Californians will continue to flow in. Some states do suffer for their mismanagement while others prosper. But that Americans stay mobile and responsive to internal mismanagement undeniably contributes to a healthy system. $525 billion of unnecessary cash tilted toward the mismanaged states harms America’s internal dynamism, removes the incentives for mismanaged states to improve, and stretches America’s borrowing capacity, which is more vulnerable than it may appear.
The state of state finances does not justify another state-aid package. States are already awash in federal cash, and money from previous aid packages is still flowing out. There’s greater risk in undermining fiscal federalism than in taking a wait-and-see approach to another round of state aid. The only viable long-term solution is for financially mismanaged states such as Illinois, California, and New Jersey to address the problems they had well before the coronavirus came along. Healthy interstate competition will encourage them to do so. But the Biden plan would undermine such progress by protecting mismanaged states from the healthy competition of their peers.