State and Local Fiscal Conditions and COVID-19: Lessons from the Great Recession and Current Projections

State and Local Fiscal Conditions and COVID-19: Lessons from the Great Recession and Current Projections

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INSIGHTi
State and Local Fiscal Conditions and COVID-
19: Lessons from the Great Recession and
Current Projections
Updated December 7, 2020
Federal assistance to state and local governments has been a central part of the fiscal policy discussion
surrounding the COVID-19 pandemic. Economic downturns tend to depress the tax bases of federal, state,
and local governments and increase demands for certain spending programs. Unlike at the federal level,
however, most states and localities have statutory requirements to balance their budgets every one or two
years. Absent other measures, these balanced budget requirements can necessitate tax rate increases or
spending cuts that could exacerbate economic distress.
Evidence from the Great Recession
The Great Recession, which lasted from December 2007 to June 2009 as measured by the National
Bureau of Economic Research (NBER), was considered the largest U.S. economic shock since the Great
Depression, as significant disruption in the housing and financial markets generated adverse conditions
throughout the economy. At its peak, quarterly real gross domestic product (GDP) declined by 8.4% (in
the second quarter of 2008), and federal deficits averaged 9.0% of GDP from FY2009 through FY2011,
their largest values since World War II.
Trends in revenues, the portion of the budget typical y most affected by recessions, may offer some
perspective on the Great Recession’s effect on state and local budgets. Figure 1 shows the actual state
and local own-source revenues in FY2008-FY2010 relative to levels consistent with FY2004-FY2007
growth trends. Relative to FY2004-FY2007 revenue trends, the cumulative combined state and local
revenue gap from FY2008 to FY2010 was $838 bil ion.
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Figure 1. Actual and Projected State and Local Own-Source Revenues, 2004-2010

Source: U.S. Census Bureau, Annual Survey of State & Local Finances, 2004-2010.
Notes: State and local revenues are own-source revenues, which exclude transfers from other governments. Shaded area
indicates recession as measured by the NBER.
Cumulative declines in revenues from trend levels were larger for state governments ($520 bil ion, 62%
of the total) than for local governments ($319 bil ion, 38% of the total). This effect was partly due to
larger state budgets prior to the Great Recession. But it was also due to declines in consumption taxes—a
major source of revenue for many states—that are more sensitive to economic downturns than local
property taxes, which are the primary sources of revenue for local governments.
Projections of Effects from COVID-19
The Federation of Tax Administrators estimated a near-term decline in state revenues of $152 bil ion
through the remainder of the fiscal year (general y ending June 30, 2020) and $91 bil ion adjusting for
delayed tax filing. The largest source of shortfal s was from individual income taxes ($83 bil ion),
followed by $38 bil ion in sales tax revenue, $24 bil ion in corporate revenue, and $5 bil ion in motor fuel
taxes. The study estimates states have about $90 bil ion in rainy day funds.
Moody’s Analytics estimated shortfal s for states through FY2021 (ending June 30, 2021) from revenue
declines and increased Medicaid payments of $158 bil ion to $203 bil ion (17.9% to 23.0% of general
fund budgets), with the majority (14.8% to 19.5% of general fund budgets) due to revenue shortfal s.
States with the largest projected shortfal s have more volatile revenue sources (e.g., oil severance taxes or
progressive income taxes) or more affected industries (e.g., tourism, finance, and energy). The states with
the largest shortfal s as a share of their budgets were Alaska, Louisiana, and North Dakota. States are
general y wel prepared with rainy day funds but not to address a crisis of the current magnitude. States
with the largest relative shortfal s net of reserves are Louisiana, New Jersey, and New York. States wil
also increase direct spending due to the demands of COVID-19 (estimated at $150 bil ion in the analysis),
offset by funds from already enacted federal legislation—$35 bil ion from the Families First Coronavirus
Response Act (P.L. 116-127) and $110 bil ion from the Coronavirus Aid, Relief, and Economic Security
(CARES) Act (P.L. 116-136).

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The Center on Budget Policies and Priorities estimated effects for states through FY2022 at $500 bil ion,
with $360 bil ion remaining after rainy day funds and federal aid. The National League of Cities projected
a revenue shortfal of $134 bil ion for 2020 and $360 bil ion for 2020-2022 for local governments. The
Upjohn Institute projected a revenue shortfal for the second quarter of calendar year 2020 of $127 bil ion
for state governments and $62 bil ion for local governments; through end of calendar year 2021, these
amounts are $644 bil ion and $315 bil ion. The Urban Institute estimated a revenue loss for the states of
$200 bil ion through FY2021 (general y ending on June 30, 2021).
A recent American Enterprise Institute study indicates a general consensus estimate of a revenue shortfal
of around $200 bil ion for FY2021.
Recent Federal Activity
The federal government has already enacted some measures to address state and local fiscal conditions.
The Coronavirus Relief Fund, established by the CARES Act, enacted on March 27, 2020, provided $150
bil ion in payments to state and local governments, with roughly 20% distributed to large local
governments and the remaining 80% to state governments. The CARES Act also created a Municipal
Lending Facility that can provide up to $500 bil ion in direct financing for state and local debt. The
Heroes Act (H.R. 6800), which passed the House on October 1, would direct $436 bil ion in payments
within one year of enactment ($257 bil ion to states, territories, and tribes, and $179 bil ion to localities).
Author Information

Grant A. Driessen
Jane G. Gravelle
Specialist in Public Finance
Senior Specialist in Economic Policy

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