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Introducing Project SAFE (State Action in Fiscal Emergencies)

Posted on Apr. 27, 2020
Daniel Hemel
Daniel J. Hemel
David Gamage
David Gamage
Gladriel Shobe
Gladriel Shobe
Darien Shanske
Darien Shanske
Ruth Mason
Ruth Mason

Gladriel Shobe is an associate professor at Brigham Young University Law School; David Gamage is a professor of law at Indiana University Maurer School of Law; Daniel J. Hemel is an assistant professor of law at the University of Chicago; Ruth Mason is the Edwin S. Cohen Distinguished Professor of Law and Taxation at the University of Virginia School of Law; and Darien Shanske is a professor at the University of California, Davis, School of Law (King Hall).

Shobe is the principal drafter of this essay and is thus listed first; Gamage, Hemel, Mason, and Shanske are additional authors and are listed in alphabetical order.

In this installment of Academic Perspectives on SALT, the authors discuss Project SAFE, an academic effort to help states weather the COVID-19 fiscal crisis by providing policy recommendations.

State and local budgets are in crisis. The sudden decline in economic activity brought on by COVID-19 has dramatically reduced state and local tax revenues, creating extreme financial pressures for state and local governments. States are already evaluating ways to close their budget gaps, including tax hikes, social service cuts, and layoffs. This is especially troublesome because layoffs and cuts to services will exacerbate the economic crisis by taking money out of the economy when it is most needed. Even worse, such cuts will be coming at the worst possible times for the employees as well as residents who depend on public services.

This essay introduces Project SAFE (State Action in Fiscal Emergencies), an academic effort to help states weather the COVID-19 fiscal crisis by providing policy recommendations backed by research. This introductory essay will discuss the scope of the problem faced by state and local governments and the limitations of the recently enacted federal legislation providing aid to state and local governments. It will soon be followed by a series of essays, with different sets of primary authors, offering suggestions for how the federal, state, and local governments can best address state and local budgetary gaps while minimizing harmful consequences. The University of Virginia School of Law hosts Project SAFE’s website, with links to this essay and others to come.

State and Local Budgets and COVID-19

During ordinary recessions, states face declines in tax revenue and increased demand for state services.1 Because state governments generally operate under balanced budget constraints, they cut spending and increase taxes to balance their budgets during economic downturns.2 During the Great Recession, state spending cuts fell primarily on education, health, and social services, and almost all states reduced employee compensation.3 These spending cuts deepened the economic crisis and undermined the federal government’s efforts to restart the economy.4

This is no ordinary recession. The COVID-19 pandemic has already caused a breathtaking decline in state revenues. Nonessential business closures and social-distancing efforts have decimated sales tax collections, which normally generate about one-third of total state tax revenues. While people are still buying essential goods, such as groceries, these goods are generally subject to little or no sales tax. Income tax revenue, which normally generates about 35 percent of total state tax revenues,5 has plummeted as unemployment has soared. New York estimated a $15 billion decline in revenue for 2021, and Michigan estimated declines of up to $3 billion in 2020 and $4 billion in 2021. Virginia expects revenue to drop by $1 billion in the final quarter of 2020 alone.6

As revenues collapse, expenses swing in the opposite direction. States bear substantial shares of the costs of both unemployment and Medicaid. In the four weeks leading up to April 11, 2020, 22 million people — about 13 percent of the U.S. labor force — filed for unemployment benefits.7 Also, state Medicaid applications have risen rapidly, with Utah, for example, experiencing a 46 percent increase compared with this time last year.8

States are cutting costs to address budget shortfalls. Pennsylvania stopped paying about 20 percent of state employees.9 Ohio Gov. Mike DeWine (R) asked state agencies to cut spending by 20 percent.10 New York Gov. Andrew Cuomo (D) put it bluntly: “We have no state revenues to speak of. We are going to have to dramatically cut spending. You can’t spend what you don’t have.” Localities feel a similar crunch. New York City Mayor Bill de Blasio (D) plans to cut at least $1.3 billion from the city budget at a time when the city is facing a public-health catastrophe. And Cincinnati furloughed about one-fifth of its workforce, affecting almost 2,000 employees.11

COVID-19 Federal Relief Funding

The federal government has taken initial steps to help states and localities remedy their budgetary shortfalls. In light of increased state Medicaid expenditures to treat COVID-19, the Families First Coronavirus Response Act provides that the federal government will temporarily increase its share of Medicaid costs by 6.2 percentage points.12 Under the Coronavirus Aid, Relief, and Economic Security (CARES) Act, signed March 27, 2020, the federal government will reimburse states for half of the states’ share of unemployment benefits paid by states through December 2020. The CARES Act also provides for a $150 billion Coronavirus Relief Fund to be distributed among states and eligible localities to help cover direct COVID-19 costs.13

These federal aid programs are an important step, but they are dangerously inadequate. Congress attached strings to the $150 billion it approved for states in the CARES Act. States and localities may use the funds only for “necessary expenditures” incurred before December 31, 2020, that (1) resulted from the COVID-19 public-health crisis, and (2) were not accounted for in the state or local government’s most recent budget. The intent behind these restrictions — to prevent states from using the funds for non-COVID-19 purposes — is understandable, but the bill fails to address the true issue states are facing. The state economic crisis is primarily attributable to sharp declines in state tax revenue, not new COVID-19 expenses.14 If the purpose of the bill is to relieve states from the devastating economic effects of COVID-19, then states should be permitted to use the funds to fill budget gaps caused by the sharp and essentially unpredictable drop in tax revenue, not just new COVID-19 expenses.

Moreover, $150 billion is not nearly enough to cover urgent state and local needs. Comparing the COVID-19 crisis with the 2008 economic recession shows the scale of the emergency. During the last recession, GDP dropped by an 8.4 percent annualized rate during the worst quarter, and state budget shortfalls totaled about $227 billion during the worst year.15 Although we cannot yet measure the full effects of the COVID-19 crisis, experts say GDP will decrease this quarter by a 40 percent annualized rate.16 It’s no wonder that Cuomo called the $150 billion federal aid package a “drop in the bucket” and the National Governors Association petitioned Congress for an additional $500 billion to offset “drastic state revenue shortfalls.”17

Project SAFE

The goal of Project SAFE is to bring together experts in state and local taxation and fiscal federalism, working with students and experts in other fields, to collectively provide a series of policy options to help guide how the federal government and state governments can approach legislative responses to the growing budgetary and broader economic crises.

Congress is already working on a fourth stimulus bill, which House Speaker Nancy Pelosi, D-Calif., and Senate Minority Leader Charles E. Schumer, D-N.Y., have indicated will likely include additional funds for state and local governments.18 This new stimulus, expected to take shape in late April or early May, presents an opportunity for Congress to implement new legislation that could provide necessary aid for states and fix the shortcomings of the CARES Act.19 Follow-up essays will propose how the federal government can and should take the lead role in filling state and local budget gaps caused by COVID-19, thereby reducing the extent to which states will need to cut budgets and thereby exacerbate the economic crisis.

However, even with federal aid, state governments will still need to play significant roles in reducing their own budgetary gaps, likely through some combination of cutting services, raising taxes, and using their rainy day funds. Some of the project’s upcoming essays will thus propose ways that states can satisfy their balanced budget constraints while minimizing layoffs and cuts to essential services.20 Further, because states vary significantly in their tax bases and constitutional or statutory restrictions on raising or implementing some taxes, our forthcoming essays discussing state-level solutions will provide options that states can tailor to their own needs (as opposed to a one-size-fits-all solution).

The project will also consider issues that the economic crisis is causing for local governments. Like state governments, local governments will need to find solutions for declining revenue and increasing expenses, and many localities have started laying off employees and weighing other options to achieve solvency. Yet localities vary from states in important ways, and therefore need proposals that are adapted to their unique positions in this crisis.21

The unprecedented nature of the economic crisis caused by COVID-19 calls for novel and large-scale thinking about how state and local governments should address sharp and unexpected decreases in revenue and how the federal government should provide states the assistance they need. The ultimate goal of Project SAFE is to provide policymakers with a roadmap of options for accomplishing these goals.

FOOTNOTES

1 See U.S. Government Accountability Office, “Intergovernmental Issues: Key Trends and Issues Regarding State and Local Sector Finances” (Mar. 2020).

2 See id.; David Gamage, “Preventing State Budget Crises: Managing the Fiscal Volatility Problem,” 98 Cal. L. Rev. 749, 754-68 (2010) (discussing the fiscal volatility problem and the nature and implications of state balanced-budget constraints).

3 Tracy Gordon, “State and Local Budgets and the Great Recession,” Brookings Institution (2012).

4 Nicholas Johnson, Phil Oliff, and Erica Williams, “An Update on State Budget Cuts,” Center on Budget and Policy Priorities (Feb. 9, 2011).

5 Patricia Cohen and Tiffany Hsu, “Sudden Black Hole’ for the Economy With Millions More Unemployed,” The New York Times, Apr. 9, 2020.

6 Jimmy Vielkind, “Coronavirus Could Cut New York State Revenue by Up to $15 Billion, Cuomo Aide Warns,” The Wall Street Journal, Mar. 24, 2020.

7 U.S. Labor Department, news release, “Unemployment Insurance Weekly Claims” (2020).

8 Shefali Luthra, Phil Galewitz, and Rachel Bluth, “Medicaid Nearing ‘Eye of the Storm’ as Newly Unemployed Look for Coverage,” Kaiser Health News (Apr. 3, 2020).

9 Charlotte Keith, “Pennsylvania Facing Up to $4 Billion Shortfall as Coronavirus Shutdown Upends State Budget,” Pennsylvania Inquirer, Apr. 8, 2020.

10 Jeremy Pelzer, “Ohio Gov. Mike DeWine Will Freeze State Government Hiring, Seek Big Spending Cuts Amid Coronavirus Crisis,” Cleveland.com (Mar. 23, 2020).

11 Bill Lucia, “Cities and Counties Make Workforce Cuts as Coronavirus Financial Toll Mounts,” Route Fifty (Apr. 2, 2020).

12 Families First Coronavirus Response Act, P.L. 116-127, section 6008, 134 Stat. 178 (2020).

13 Coronavirus Aid, Relief, and Economic Security (CARES) Act, P.L. 116-136, section 601, 134 Stat. 281 (2020).

14 Letter from U.S. Sen. Mark R. Warner, D-Va., et al. to Treasury Secretary Steven Mnuchin (Apr. 7, 2020) (Several senators and members of Congress have urged broad use of the relief funds, arguing that “unbudgeted costs can also come in the form of unexpected and precipitous revenue declines. . . . Inhibiting the use of Coronavirus Relief Funds to address revenue shortfalls is likely to lead to cuts in services and programs that otherwise can mitigate the indirect impact of COVID-19 at the state and local level; that will only make the health and economic crises worse”); Greg Allen, “For Counties, the Coronavirus Brings Major Budget Problems,” NPR (Apr. 8, 2020) (“The biggest challenge we have is the way the law was written. We cannot be reimbursed for lost revenue.”) (quoting Matt Chase, executive director, National Association of Counties); and California Legislative Analyst’s Office, “State Budget Effects of Recent Federal Actions to Address Covid-19” (Apr. 5, 2020) (“Only a small portion of the federal funding allocated to date . . . will assist [California] with the most significant source of budgetary strain that likely will result from the COVID-19 emergency: lower revenues.”).

15 See Nicholas Johnson, “Bipartisan Stimulus Agreement Contains Significant Funds for States,” Center on Budget and Policy Priorities (Mar. 25, 2020); and Jeff Cox, “Goldman Sees 15% Jobless Rate and 34% GDP Decline, Followed by the Fastest Recovery in History,” CNBC (Mar. 31, 2020).

16 Patti Domm, “JPMorgan Now Sees Economy Contracting by 40% in Second Quarter, and Unemployment Reaching 20%,” CNBC (Apr. 9, 2020).

18 Jacob Pramuk, “Pelosi and Schumer Push for Emergency Coronavirus Bill With at Least $500 Billion More in Aid,” CNBC (Apr. 8, 2020).

19 See Daniel Hemel, Ruth Mason, and Gladriel Shobe, “What States Need From Congress Now Is Cold, Hard Cash,” Time, Apr. 14, 2020.

20 For instance, drawing on prior academic work (see Gamage, supra note 2), a forthcoming essay will explain why the commonly espoused notion that states should not increase taxes during a recession is not correct, and why this crisis is a perfect illustration of why that is so. Well-designed tax hikes on those who can afford them should be part of the options considered for maintaining funding to sustain vital public services, especially during a pandemic.

21 For instance, property taxes, as opposed to sales and income taxes, make up the bulk of local tax revenue; few localities build up rainy day funds at the same scale as states; and larger localities can receive direct funds from the federal government that smaller localities cannot. See Grant A. Driessen, “State and Local Fiscal Conditions and Economic Shocks,” Congressional Research Service, at 2 (Mar. 20, 2020) (stating “there is scant evidence of rainy day fund use at the local level”).

END FOOTNOTES

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