States And Cities Make A Financial Killing

Hurt severely by Covid in many ways, states and cities have nonetheless enjoyed a financial boon in the pandemic. To be sure, fighting the pandemic has cost them a lot, in lost taxes and by increasing expenses, mostly for social services. But more than compensating for these burdens is the tsunami of money Washington has laid on them. And it looks like there is still more on the way with the next Covid relief package. States and cities clearly have gained greatly the expense of the federal taxpayer.

In the runup to the pandemic, state and local government as a group were making slow progress on improving their finances.  That should hardly come as a surprise. The economy was humming in 2018 and 2019, even into 2020. Most important, unemployment had fallen to 50-year lows. The general prosperity limited the number of people burdening social services, while all those employed people and profitable businesses were paying income taxes and sales taxes on what they bought. 

Over the four quarters ended in March 2020, state and local government revenues from personal income taxes increased 4.6%, and sales tax revenues rose 3.6%. Both exceeded the rate of inflation. Housing was doing well.  Revenues from property taxes rose 3.0%. Even before special federal aid for Covid, transfers from Washington were the fastest growing component of state and local revenues, expanding 5.7% over those four quarters. All these sources of revenue outpaced current outlays which for the sector as a whole increased some 2.7%.  States and cities in aggregate still ran current budget deficits, but the differential growth rates were narrowing the gap. As of 2020’s first quarter, the sector’s aggregate budget deficit had fallen almost 5.5% from 2019’s first quarter.  

Lockdowns and quarantines last spring initially upended this improving state of affairs. Sales tax revenues dropped 11.6% in the spring quarter alone. Revenues from corporate income taxes fell 13.6%. The flow of funds from individual income taxes did not do well, but it did a lot better than people had expected. Most of the job losses occurred in lower-paying services occupations, a group that contributes relatively little to state and city income taxes (or federal income taxes for that matter.) Most higher-paid people, by far the greatest source of income tax revenue, continued to receive their relatively lavish paychecks, largely because of work-from-home arrangements. These people continued to pay taxes accordingly. Last year’s spring quarter actually saw a slight 0.7% quarterly increase in personal income tax revenues.

It was the federal government’s CARES Act that made the huge difference. Passed late in March of 2020, it more than doubled the flow of federal dollar transfers to states and cities. Grants-in-aid, as this line item is called in the official accounting, rose from a seasonally adjusted $627.8 billion annual rate in the first quarter to a $1.4 trillion rate in the second. Even with increased expenses, state and local governments had no way to spend the flow. The gap between current revenues and outlays went from an annualized $202.7 billion deficit in the first quarter to an annualized $470 billion surplus in the second.

Things began to even out during the year’s second half. The economy’s partial re-opening allowed some increase in the usual flow of tax monies. Individual income tax receipts jumped at a 7% annualized rate during those six months. Sales tax receipts rose at almost a 24% annualized rate. The flow of federal money slowed from the second quarter’s flood but remained well above pre-pandemic levels. Meanwhile states and cities kept a lid on spending, more easily done during the second half of the year because many who had been laid off during the spring months returned to their jobs and had less need of social services. Budget balances deteriorated from the fantastic surpluses that the CARES Act brought in the spring quarter, but it looks as though, when all the data becomes available, state and local governments in 2020 will have managed a current budget surplus for the first time in over 40 years. Matters should improve still more this year – from a more complete economic re-opening but mostly because the latest Covid relief legislation in Washington includes still more billions for states and cities.    

What states and cities do with Washington’s lavish use of the taxpayer’s money will no doubt vary greatly from one locality to another. One can hope that they will use the funds to improve the lot of people in their jurisdiction, make needed capital investments, for instance, or even use them to enlarge a “rainy day fund” for use perhaps in another emergency when Washington may be less generous. However states and cities use the money, it should be clear that they have done well at the expense of the federal taxpayer, though the end result is that they have become even more than before wards of Washington.