With Washington Deadlocked on Aid, States Face Dire Fiscal Crises

Local officials are slashing funding for everything from education and health care to orchestra subsidies.

Alaska chopped resources for public broadcasting. New York City gutted a nascent composting program that could have kept tons of food waste out of landfills. New Jersey postponed property-tax relief payments.

Prisoners in Florida will continue to swelter in their cells, because plans to air-condition its prisons are on hold. Many states have already cut planned raises for teachers.

And that’s just the start.

Across the nation, states and cities have made an array of fiscal maneuvers to stay solvent and are planning more in case Congress can’t agree on a fiscal relief package after the August recess.

House Democrats included nearly $1 trillion in state and local aid in the relief bill they passed in May, but the Senate majority leader, Mitch McConnell of Kentucky, has said he doesn’t want to hand out a “blank check” to pay for what he considers fiscal mismanagement, including the enormous public-pension obligations some states have accrued. There has been little movement in that stalemate lately.

Economists warn that further state spending reductions could prolong the downturn by shaking the confidence of residents, whose day-to-day lives depend heavily on state and local services.

“People look to government as their backstop when things are completely falling apart,” said Mark Zandi, chief economist at Moody’s Analytics. “If they feel like there’s no support there, they lose faith and they run for the bunker and pull back on everything.” 

States and municipalities are also crucial employers and spenders that keep the economy moving. “We run the risk of descending into a dark vicious cycle,” Mr. Zandi said. 

State and local governments administer most of America’s programs for education, public safety, health care and unemployment insurance. They also provide a wide variety of smaller services, such as outdoor recreational facilities or highway rest stops, that improve the quality of life. The costs of many of these programs have spiraled because of the pandemic, which has at the same time caused an economic slump that has driven down tax revenues.

Collectively, state governments will have budget shortfalls of $312 billion through the summer of 2022, according to a review by Moody’s Analytics. When local governments are factored in, the shortfall rises to $500 billion. That estimate assumes the pandemic doesn’t get worse.

When the lockdowns started in March, state and local governments quickly cut 1.3 million jobs. But then they paused, waiting to replace it. 

Lawmakers soon passed the $2 trillion CARES Act, which authorized one-time stimulus payments and temporary supplemental unemployment payments, which buoyed consumer spending and helped states’ sales-tax revenues. The law also allocated about $150 billion to states for expenses directly attributable to the pandemic, in areas ranging from education and health care to the operation of nearly empty airports. But the rules for what expenses that money can cover have kept much of it from being spent, according to the Treasury Department. New York State, for example, has been sent about $2.9 billion that it can’t put toward other uses.

Although states’ budget challenges would be eased if Congress relaxed those rules, that still wouldn’t be enough to fill the gap.

Gov. Andrew M. Cuomo has warned that without further relief New York will cut $8.2 billion in grants to local governments, a blow he said had “no precedent in modern times.” The cuts would hit “nearly every activity funded by state government,” including special education, pediatric health care, substance abuse programs, property-tax relief and mass transit, he said.

No two states have tackled the budget crunch the same way. Several have torn up their annual budgets and are doling out money to programs one or two months at a time. Some have earmarked cuts but not yet carried them out.

Delaware has decided to issue less debt, and a bond issue that was supposed to fund clean-water projects has been shelved. In California, people who go to court without lawyers — an estimated 4.3 million a year — will continue to deal with confusion because the state has scrapped plans for “court navigators” to shepherd them through. Nevada said it would forgo the penalties and interest it normally charged tax cheats, hoping to coax them and their unpaid millions up from underground. In Maryland, the Baltimore Symphony Orchestra will lose a $1.6 million state subsidy.

Some states are trying to save cash on their pension contributions. Kentucky has delayed its payments to the state workers’ pension fund, already one of the most poorly funded in the country. Colorado and Maryland are among the states planning to reduce their contributions. Some, like California and New Jersey, had recently committed to raising their contributions to cover past underpayments — but now can’t afford to do so.

Without further federal aid, some of the biggest cuts will be to education and health care. California says it will send its school districts $12.5 billion in I.O.U.s if Washington doesn’t step in, and it will be on the schools to figure out how to fund themselves in the meantime. Preschool programs are being cut in many states; so are free-tuition college programs. State university systems are slated to lose billions of dollars in state funding, although some states say the cuts will be quickly reversed if enough federal money arrives.

And many states say they will reduce their outlays for Medicaid. The health care program for low-income people has been growing rapidly in the pandemic as millions have lost their jobs along with their employee health benefits. States are struggling to find a way to pay for all these additional people. Some, like Colorado, are increasing the co-payments that their Medicaid patients must pay for doctor visits, pharmaceuticals and medical transport.

State officials say they have little choice but to keep cutting if more aid doesn’t arrive. All but one state, Vermont, are legally bound to balance their budgets every year, and Vermont does so voluntarily. They can’t borrow their way out of a cash crunch, the way Washington can, because they have laws limiting how much bond debt they can carry. If they veer too close to the limit, lenders will start demanding higher interest rates and the rating agencies will downgrade them. 

In May, the Federal Reserve offered to buy states’ bonds if terms in the municipal bond market become onerous. But most states think the Fed loans cost too much and have to be paid back too quickly to be of much help. So far only one state, Illinois, and one state authority, New York’s Metropolitan Transportation Authority, have taken the Fed up on its offer. New Jersey and Hawaii are exploring deals, according to the National Conference of State Legislatures, which tracks the states’ fiscal plans as they develop. 

Public pensions have been a central point of contention in discussions over additional federal aid.

In April, with economic activity at low ebb, Illinois lawmakers sent a detailed wish list to their state’s congressional delegation that included $10 billion for the coming year’s pension contribution. They also asked for $9.6 billion for Illinois’s cities, which needed the money to “fund retirement systems for the police, firefighters and other first responders providing emergency services during this Covid-19 outbreak. 

The request drew scorn in Washington.

On a syndicated radio show, Mr. McConnell said Senate Republicans would “certainly insist that anything we’d borrow to send down to the states is not spent on solving problems that they created for themselves over the years with their pension programs.” 

Glenn Hubbard, an economic conservative who was chairman of the Council of Economic Advisers under President George W. Bush, said he agreed that federal money should not be used to prop up failing state pension funds. But he acknowledged that the states’ cash needs were becoming urgent and said there wasn’t time for a complete overhaul of troubled state pension systems.

For the sake of speed, Mr. Hubbard said in an interview, Congress could send the states money with a simple, and probably breakable, rule that it not be used to reduce taxes or bail out pensions. Public pension reform, which would be grueling, could come later.

Or, as Mr. Hubbard said in an online seminar hosted by the Economic Policy Institute last month, “if an overweight person comes to the E.R. with a heart attack, you treat the heart attack before you lecture him or her about weight.”

Mary Williams Walsh is a reporter covering the intersection of finance, public policy and the aging population. She previously worked for The Wall Street Journal and The Los Angeles Times, mainly in foreign bureaus. @marywalshnyt • Facebook

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