California is flush with cash. Even after twice doling out stimulus checks to low- and middle-income Californians during the coronavirus pandemic, the state expects a $31 billion budget surplus in 2022. It’s not just California. Across the country, state governments have taken in over 12 percent more revenue for fiscal year 2021 than they did for the previous year.
Why are state and local governmental coffers overflowing after dire predictions of budgetary shortfalls during the pandemic’s early days?
Outsize checks were sent to blue-state and local governments
In an unprecedented policy response to the pandemic’s economic impact in 2020 and 2021, Congress and presidents sent some $900 billion to state and local governments across four major pieces of legislation. The most recent, March’s American Rescue Plan Act, included $27 billion in state fiscal recovery funds for California — roughly the size of the state’s projected surplus.
Before passage of the American Rescue Plan, a number of experts and analyses suggested that Congress should send state and local governments no more than perhaps $100 billion in addition to the $400 billion included in the three previous bills. State and local governments were in pretty good financial shape because of their unexpectedly strong revenue, combined with relief funds from the earlier aid packages. But the Biden administration and the newly elected Democratic Congress instead approved nearly $500 billion in funding for school districts, state governments and local governments.
Support for such massive fiscal assistance stemmed in part from lessons learned from the slow recovery following the Great Recession. In responding to the pandemic, lawmakers aimed to prevent the need for state and local budget austerity, which contributed to the Great Recession’s depth and duration. Because most state constitutions require the state and its cities to balance their budgets, low tax revenue during recessions triggers cuts to major categories of state and local spending, including for education, benefits and Medicaid payments to physicians.
Congressional politics also shaped the design of state and local aid. To allocate federal spending, Congress deploys formulas that account for states’ populations, estimates of their needs and other factors. As we explain in a forthcoming paper, Democrats chose formulas that distributed the American Rescue Plan’s transportation and general relief dollars more generously toward Democratic states than did the formulas in the earlier relief bills.
Even before the American Rescue Plan, pandemic fiscal assistance formulas were tilted toward blue states. The act’s sheer size thus further boosted funds sent to Democratic-leaning states. And because no Republican would vote for the bill, Democrats used a special budget procedure, known as reconciliation, that placed Democrats in full control of designing the package.
State legislators make big decisions. So why do they get tiny paychecks?
We see a similar dynamic in the current draft of the Build Back Better bill. The House-passed version of the bill would allow households to increase the amount of state and local tax payments that they deduct from their federal taxes from $10,000 to $80,000. Since few households pay that much in state and local taxes, most of those who would benefit are high-income taxpayers in deep-blue California, Illinois, New Jersey and New York — places with disproportionately higher state and local tax rates than is the norm in red states.
Small states have cashed in
Federal aid to state and local governments in pandemic relief bills also disproportionately benefited small states. That’s not unusual in federal spending bills. States, of course, have two senators regardless of population, and small states’ senators use that leverage to insist that formulas include a small-state minimum. In other words, Senate malapportionment drives extra dollars to small states, often beyond their fiscal need.
Our research found that having an additional senator or representative per million residents predicted an extra $670 in aid per capita summed across the four relief packages. In total across the bills, we estimate that this bias shifted around $30 billion in relief funds to small states, which are more evenly split between red and blue than often assumed. That’s equivalent to the federal funding for the development, manufacturing and distribution of coronavirus vaccines and therapeutics in the bills.
Automatic triggers can stabilize budgets during downturns
Of course, the federal government distributed an extraordinary amount of fiscal relief for the pandemic. The total spent on aid to state and local governments alone — $900 billion — is equivalent to half of state and local governments’ tax revenue from 2019. During the Great Recession, the federal government committed around $230 billion to fiscal relief for states and localities. Then and now, Congress designed its fiscal assistance packages ad hoc, which allows last-minute political maneuvering to shape the distribution of federal dollars.
If it wants to avoid such ad hoc policymaking, Congress could rely more on “automatic stabilizers,” support programs that would be triggered by downturns. Because state and local governments have access to capital markets and rainy-day funds, their need for emergency relief differs from that of low-income households. Congress can set its trigger formulas to assess the first few months of a downturn, gauge the needed aid and dispense it gradually, in a way that accounts for states’ budget cycles.
To limit partisan and political influence over the emergency formulas, automatic stabilizers could be tied to macroeconomic statistics. These are numbers such as the unemployment rate or total consumption in a state, which state governments cannot easily manipulate. Aid could also be designed to prevent states from being treated unfairly relative to one another, for example by ensuring that emergency relief is returned in boom times.
States lead the fight against covid-19. That means we all depend on Medicaid now.
Such an approach contrasts with existing proposals, which create winners and losers by divvying up stabilization funds in ways unrelated to states’ fiscal needs. Enhanced Medicaid funding, for example, was a key element of both the March 2020 Cares Act and the 2009 American Recovery and Reinvestment Act. These funds were tied to how much a state’s Medicaid program dispenses, which turns out to be very weakly related to the spending needs created by the pandemic, even within the Medicaid program itself.
Some members of Congress have shown an interest in adopting additional automatic stabilizers, but their proposals haven’t gone far. Future crises may differ from past ones in ways that make designing fiscal stabilizers genuinely difficult. What’s more, lawmakers delight in taking credit for sending aid back home as crises unfold. Nor are states complaining about their surpluses. Don’t expect much to change, for now.
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Jeffrey Clemens (@jeffreypclemens) is an associate professor of economics at the University of California at San Diego.
Stan Veuger (@stanveuger) is a senior fellow at the American Enterprise Institute.