States and cities are “falling off a cliff” as the economic crisis sets in

The next economic crisis is the one that will hit states, cities, and towns.

In September, Phoenix celebrated a milestone: All of its public libraries were open on a Sunday for the first time in a decade. Library hours had been cut during the Great Recession, during which the city was slammed, and restoring them was a small but important marker in its continued recovery.

Now, Phoenix is staring down a crisis yet again.

“The last recession felt like running down a hill,” said Phoenix Mayor Kate Gallego. “This one feels like falling off a cliff, it happened so quickly.”

Before the coronavirus outbreak, Phoenix was projecting a $28 million surplus for the upcoming fiscal year. Now, it’s anticipating a $26 million deficit. Arizona expected a $1 billion surplus and is now staring down a $1.1 billion deficit.

The global pandemic and accompanying economic crisis have knocked states and cities across the country back on their heels. States are hemorrhaging money to stand up medical systems and field unemployment claims while watching their revenue plummet. People have been ordered to stay at home, meaning sales tax revenues are way down, and as layoffs take hold, revenue from income tax is falling as well. Tax Day for 2019 filings has been delayed until July, another blow to state budgets. Lost tourism seasons represent money lots of places won’t get back.

Governors and state lawmakers, many of whom are faced with constitutional balanced budget requirements, are going to have to make big cuts fast, unless the federal government does more to step in.

“Whether it’s tax increases or spending cuts, states tend to take money out of the economy during periods of stress, and that is not only financially difficult for their residents, but it also tends to delay the economic recovery,” said Josh Goodman, state economic development officer at Pew Charitable Trusts.

He estimates states missed out on $283 billion in the decade following the 2008 crisis, and state funding to education and local governments is still down across much of the country. State budget shortfalls this time around could total more than $500 billion in a single year, and cities and states across the country are sounding the alarm.

“We cut services because of that recession that we never restored,” Gallego said. “We are starting this decline already lean.”

The ways states and cities make money are drying up

About 70 percent of tax revenue for states comes from sales and income taxes, explained Michael Leachman, director of state fiscal research at the Center on Budget and Policy Priorities (CBPP). And given that economic activity has been brought to a stop across much of the country — thousands of businesses have closed, millions of people have been laid off — you can start to see the problem.

“There’s no question that sales tax revenue has completely fallen off the table, so that’s about one-third of state revenues that are completely collapsing, and then income taxes are also falling rapidly with all those people getting laid off. And with the stock market decline, that means that quarterly tax payments that wealthy people and corporations pay will be lower,” Leachman said. “That’s two major revenue sources that are in very sharp decline, much steeper than anything from the Great Recession.”

The situation varies by state. A handful of states don’t have sales taxes or income taxes, and how much they rely on different taxes varies. For example, in 2014, 45 percent of Washington’s state and local tax collections came from sales taxes; just 13 percent did for Virginia. California, New York, Maryland, and Washington, DC, are more reliant on capital gains taxes, which are going to take a hit because of the downturn in the stock market.

Other sources of revenue that will also be impacted — gas taxes, alcohol taxes, lottery revenue — vary by state as well. The drop in oil prices is doing harm in places such as Texas and North Dakota. Tourism-heavy places like Las Vegas and Florida are losing out on money they won’t get back. And then there’s the simple fact that some states and cities are being hit by the coronavirus crisis and accompanying recession more than others.

“There is no one whose budget is looking like it is fantastic, but how bad the downturn is going to be is going to depend on what taxes you rely on and what’s going on in your labor force, your economy, and your population,” said Kim Rueben, director of the state and local finance initiative at the Urban Institute. She warned that if the coronavirus crisis begins to become a bigger issue in more rural counties, “that can be fiscally devastating because some of those places are much closer to the margins.”

And while the money states take in is plunging, some costs are skyrocketing, specifically unemployment insurance and medical costs. Millions of people have filed new unemployment claims over the past month, overwhelming state systems. Unemployment insurance is funded through payroll taxes paid by employers, and when there are this many claims, it’s highly likely that states will run out of money to pay out benefits. During the last recession, dozens of states had to borrow money from the federal government to cover unemployment costs.

“States don’t have armies, but they pay for health care, they pay for unemployment insurance and a few other things, and in recessions, Medicaid bills go way up, people lose their employer-sponsored health insurance, they go on Medicaid. And at a time like now, they might need medical care even more than usual,” said Danny Yagan, an economist at the University of California Berkeley. “Unemployment insurance claims go up, further draining from state coffers, and states don’t issue their own currency or may even have balanced budget amendments, so they can’t borrow the way the federal government does.”

States and cities are starting to sound the alarm

Most states follow a fiscal year that goes from July 1 to June 30 for their budgets (Alabama, Michigan, New York, and Texas are different). For many places, the numbers were looking pretty rosy just a few months ago. Now they’re not.

Take Wisconsin. Prior to the widespread Covid-19 outbreak in the United States, the state expected to see a more than $800 million surplus at the end of the fiscal year. Now, the nonpartisan Wisconsin Policy Forum is warning that while the state is better positioned than it was before the Great Recession, it is going to be in trouble if the federal government doesn’t step in. And while the state’s towns, cities, and villages rely on property taxes as their primary source of taxation — which seems to be relatively stable for now — 68 of the state’s 72 counties also collect sales taxes, which have plunged.

“The impact on the economy is devastating, and what we’ve seen develop over the course of the last four or five weeks has really been a tidal wave coming across the state,” said Missy Hughes, who heads the Wisconsin Economic Development Corporation.

The data is still trickling in on what exactly lawmakers are dealing with, but it’s not looking good. “The numbers are hard to even wrap your head around,” Hughes said.

In Maryland, the state said it could see a $2.8 billion shortfall in the last three months of the fiscal year alone. New York state is expecting tax revenue losses of $10 billion to $15 billion.

Some states aren’t imposing cuts yet, in part because legislatures are not in session, some due to social distancing measures. But they’re going to start soon. Whatever estimates they made at the start of the year will basically have to be blown up and rewritten under much more dire fiscal circumstances.

States and cities aren’t like the federal government, which can run a large deficit. Many have balanced budget amendments, meaning they’re supposed to take in as much as they put out.

Ohio Gov. Mike DeWine has said the state would look to cut 20 percent of its spending in light of the coronavirus outbreak. Nevada Gov. Steve Sisolak has requested that state agencies start preparing for 4 percent budget cuts for the fiscal year that ends in June and cuts of 6 to 14 percent for the next fiscal year.

States have “rainy day” funds that they can dip into if they need — the 50-state total recently reached $75 billion. But those rainy day funds can only go so far — the CBPP estimates state budget shortfalls due to coronavirus and the economic crisis could total more than $500 billion.

Colorado is now looking at a potential $3 billion shortfall, which would translate to a 10 percent budget cut for the year starting in July. “By statute, we have to have a balanced budget,” said Betsy Markey, who heads Colorado’s Office of Economic Development and International Trade. “Like every state, we’re looking at making some very difficult budget decisions in the coming fiscal year.”

Some states are better-positioned to weather the storm — and some are worse off. According to data from Moody’s Analytics, about one-third of states were unprepared for even a moderate recession heading into the crisis. Among them: Illinois, New Jersey, Florida, Louisiana, and Mississippi. The same thing goes for cities.

“In the Great Recession, some places, like Phoenix, got crushed, while other places, like San Antonio, really did not. We’re probably going to have something like that if the disease spread and layoffs are as locally concentrated as we’re seeing so far,” Yagan, the Berkeley economist, said.

State and city cuts translate to businesses and people

While talking about state and city budgets can seem pretty vague, ultimately, they come down to businesses and, really, people.

Most states have imposed stay-at-home orders and have mandated thousands of businesses shut. No more restaurants or bars, no department stores or boutiques, no hair salons, no barber shops, etc. There’s no tourism. People are spending a lot of money at the grocery stores, but they’re not the end-all, be-all of business, and a lot of grocery purchases aren’t taxed.

Ian Johnson/Icon Sportswire via Getty Images

Hughes, the Wisconsin economic development director, said the state’s resources and the Coronavirus Aid, Relief, and Economic Security (CARES) Act, which allotted $349 billion to small-business loans, is a help, but there have been concerns about being able to access those funds. “As we watch this drama unfold, it’s almost a second hit that the small businesses are taking that’s a challenge to access those funds, and they’re not coming as readily as we need them to,” she said.

And it’s not just about keeping employees compensated and the bills paid. If and when businesses are given the go-ahead to reopen, they’re going to need some help, too. A coffee shop that’s been closed needs to get new inventory, get their workers back in the building, and let customers know they’re back in business. “If you think about the Main Street businesses, they’re small, they don’t need a lot, but they need an injection of energy,” Hughes said, estimating $2,500 or $5,000 would go a long way toward many businesses opening their doors again.

Of course, that’s assuming they stay afloat at all, and that the virus is under control sooner rather than later. “Businesses are saying that if this goes on for another period of time, I can withstand another 30 days, I can withstand another 60 days, but after that, I’m not going to be able to survive,” she said.

Beyond businesses, this obviously gets down to people. Workers across the country are being laid off in droves, draining state unemployment coffers. And when states and cities start looking at their budgets for places to cut, that translates to the people they employ. According to one recent survey, more than 1,000 cities are planning to scale back public services, and 600 think they’ll have to lay off workers.

“A huge percentage of what state and local governments buy [is] people’s time, and so to the extent that they have to balance their budgets and they’re making cuts, that’s going to mean layoffs and furloughs that would extend the economic part of this and the recession,” Rueben, from the Urban Institute, said.

The decisions made about budget cuts now will have lasting effects. Goodman, from Pew, said that state funding for higher education, K-12 education, and local aid are still down in many places because of the 2008 crisis. And state investment in infrastructure in the decade after the last recession was at its lowest level in 50 years.

And the worse off states and cities are, the slower the recovery if and when we get out of the health crisis end of things. Laid-off workers, shuttered businesses, and reduced services drag down the economy. “Once consumers and businesses have jumped out of the economic water, they dip their toes back in only very slowly, and the initial shock is often locally concentrated,” Yagan said.

The federal government is helping — but it needs to do a lot more

There are mechanisms in place for states and cities to get financial help as they try to ride this out, but there’s broad agreement that they’re probably going to need more.

The $2.2 trillion CARES Act provides $150 billion to state, tribal, and local governments. The package also includes $30 billion for education, $25 billion for mass transit systems, $5 billion for community development block grants, $3.5 billion for child care, and $400 million for elections. And it has the Paycheck Protection Program, the $349 billion loan program to small businesses meant to support them and keep their workers employed. The Families First Coronavirus Response Act, which was signed into law in March, temporarily increases federal funding for Medicaid.

But there are issues. The $150 billion in state funds has to be used for costs related to the virus — it can’t go toward closing budget gaps. The increased Medicaid funding will end when the health emergency does. And some small businesses are struggling to find a lender under the Paycheck Protection Program, which is already running low on money.

“That will most likely run out within the next week, and we are very supportive of Congress putting additional funds” into the PPP, said Markey, noting that Colorado has already realized nearly $6 billion in small-business loans.

The Federal Reserve has also said it will buy some municipal bonds, putting up to $500 billion into short-term loans for states, cities, and counties. But a Brookings Institution study finds that because of the program’s eligibility criteria, only 10 cities and 15 counties will be able to access it directly. And most cities with large black populations, including Atlanta, Baltimore, Boston, Pittsburgh, and Detroit, will be left out and only able to go through their states. (The researchers say the problem appears unintentional.) There are also concerns that the two-year maturity limit on the notes the Fed will buy is too short a time frame for how long the economic recession might be. Private investors seem to have moved away from municipal bonds.

On Capitol Hill, there’s talk of a second CARES Act that could provide more aid to cities and states, and the Fed could do more as well. Leachman said grants to cities and states, specifically, would be helpful, and there’s a clear need for more funds for small businesses. But the greater risk appears to be that states and cities will get too little support, not too much.

“We’re already starting to see some states … start to cut back spending and lay off people. This is exactly one of the big reasons the Great Recession in 2009 had a lot of problems, because I don’t think they anticipated how tough the states would get, and as such, it counteracted or made worse the downward plunge,” said Mike Konczal, a fellow at the Roosevelt Institute. “We are totally in a position to stop that; the question is, again, if we will have the ability to do so.”

States and cities are already bracing for a tough road ahead. In Phoenix, its first phase of proposed budget cuts, totaling $27 million, includes a hiring freeze to save $13 million, axing a $4 million transfer to its rainy day fund, and deferring a $1 million planned payment to its public safety pension stabilization fund.

“I assume that will be one of many cuts we will make, but I believe the earlier we start, the less deep we’ll have to go,” Mayor Gallego said.

Support Vox’s explanatory journalism

Every day at Vox, we aim to answer your most important questions and provide you, and our audience around the world, with information that has the power to save lives. Our mission has never been more vital than it is in this moment: to empower you through understanding. Vox’s work is reaching more people than ever, but our distinctive brand of explanatory journalism takes resources — particularly during a pandemic and an economic downturn. Your financial contribution will not constitute a donation, but it will enable our staff to continue to offer free articles, videos, and podcasts at the quality and volume that this moment requires. Please consider making a contribution to Vox today.