Saving Government for the Next Crisis
Using Federal Aid to Spur the Governmental Reform We Need
This is the second of Civic Way’s series on reconstructing American government (you can read Part I here). The author, Bob Melville, is the founder of Civic Way, a nonprofit dedicated to good government, and a management consultant with over 45 years of experience improving governmental agencies across the U.S.
Highlights:
If we fail to use bailouts to secure meaningful government reform, our federal, state and local governments will lack the capacity to manage the next crisis
Republicans should channel their concerns about waste into genuine reform and Democrats should support efforts to modernize government, but both should demand immediate fiscal aid for state and local government
State and local governments face a fiscal apocalypse, including service cuts, credit downgrades, higher borrowing costs, unstable pension funds and insolvency, but this threat will provide fertile soil for reform
Any government stimulus package should include three components: 1) a short-term aid package, 2) a stimulus program for future crises and 3) a long-term initiative for reforming state and local government
Introduction
In the face of dire projections about state and local government, our national leaders have resumed their familiar roles in another partisan skirmish. The Democratic House has passed a $3 trillion aid package for state and local governments, but Senate Republican leaders have expressed reservations. The truth is that many jobs—teachers, police officers, firefighters and nurses—will be lost without another stimulus package. While the optimum amount is debatable, state and local governments need help and need it now.
We can do better. Republicans should channel their concerns about waste and debt into genuine reform, Democrats should support efforts to modernize government and both should demand immediate fiscal aid for state and local government. We should survive today’s crisis and prepare for tomorrow’s. If reform does not follow relief, our federal, state and local governments will lack the capacity to manage the next crisis.
Reexamining Federalism During a Pandemic
President Trump’s unconscionable behavior has caused unnecessary pain, but also exposed the inadequacies of Federalism. Our system of federal, state and local governments may, with some notable exceptions, have served us well during our formative years, but it was not designed for the global challenges of the 21st Century.
Our patchwork of state and local governments has grown a lot and with little notice. From 1977 to 2017, per capita direct general state and local expenditures increased by 88% from $5,022 to $9,449. It now comprises 50 states, the District of Columbia and over 90,000 local governments, 57 percent of which are special districts, many with obscure missions, unaccountable boards and uneven oversight.
Our system of state and local governments has many attributes, but adaptability is not one of them. With its dependence on volatile income and sales taxes, it is vulnerable to economic slumps. It also suffers from hidebound legal forms, overlapping roles, irrepressible service demands and burdensome legacy costs. Public pension plans, a key driver of legacy costs, are fragmented, under-funded and saddled with arcane accounting rules.
State and local governments spent an average of $9,449 per capita in 2017, but spending varied widely by state. In 2017, DC had the highest per capita state and local spending at $19,053 followed by Alaska at $17,200 and Wyoming at $15,339. The states with the lowest per capita state and local government spending were Idaho ($6,766) and Georgia ($6,865). State government per capita spending also varied widely from $13,639 in Alaska to $3,838 in Florida. Such spending variances are driven by many factors (e.g., geography, demographics and service levels), but they also reflect dramatic differences in capacity.
The differences among cities are even more profound. Some cities are flourishing, especially in the South and Southwest. Others, mostly in the Northeast and Midwest, face declining population, sagging economies, rising tax rates, failing public schools, unreliable services and decayed infrastructure. Without critical assets like a civic-minded corporate employer or renowned research university, their prospects for future viability remain uncertain.
The Pandemic Will Change State and Local Governments Forever
The Covid-19 pandemic is unprecedented in its scale and pace. Nearly 40 million have applied for unemployment benefits. Unemployment, which the CBO projects to peak at 15.8 percent, could surpass Great Recession and Great Depression levels. Many economists fear a slow and long recovery. And state and local governments will likely contend with flat revenues, soaring service demands and feeble capacity for many years.
State and local governments face a fiscal apocalypse. Taxes and fees have plunged. States and localities have furloughed or laid off 981,000 workers (for perspective, Great Recession job losses totaled 750,000). More government job losses are likely, especially without federal relief. Worse yet, when state and local governments fail, other sectors suffer. For instance, the non-profit sector, the nation’s third-largest economic sector, depends on government for one-third of its funding.
The Center on Budget and Policy Priorities (CBPP) projects an aggregate state budget shortfall of $765 billion for FY20-FY22—a total budget gap of $590 billion net state reserves ($75 billion) and federal aid ($100 billion). This gap, which excludes local governments, easily exceeds the Great Recession gap. Moody’s Analytics believes that states will be hit much harder than during the Great Recession. Many states expect project budget gaps of at least 15 to 25 percent. Ultimately, the pandemic will weaken state capacity, trigger credit downgrades, increase borrowing costs and put more pension funds at risk. Worse, states could impede the recovery.
Many local governments will be insolvent. The National League of Cities and US Conference of Mayors expect most local governments to incur significant revenue losses, slash spending and lay off workers. After exhausting stop gap measures, they will eviscerate vital public services, including police, fire, schools and health care. Small jurisdictions (urban and rural) with fragile economies and tax bases will not recover quickly—if at all.
State and Local Governments Cannot Survive Without Federal Help
It may not be common knowledge, but our state and local governments lack the capacity and tools to navigate a crisis of this magnitude. During most downturns, state and local revenues fall and service demands rise, but not like this. We may not want them to be so dependent on the federal government for survival, but they are. It is one of the enduring gifts of Federalism.
Unlike the federal government, state and local governments can neither print money nor carry budget deficits. 49 states and the District of Columbia require balanced budgets. Due to long-term budget commitments like tax incentives, earmarks and safety net programs like Medicaid and unemployment, state budgets are harder to cut than ever. And discretionary items like higher education, which absorbed some Great Recession cuts with tuition increases, will be much harder to cut this time. Ironically, the easiest item for states to cut—local government aid—is the very item that will hurt local governments (and the recovery) the most.
Since the Great Recession, many state governments have accumulated modest fiscal reserves. However, fiscal reserve policies vary widely and even the largest reserves are no match for this crisis. When the pandemic hit, most state and local governments were prepared for a mild economic recession. In FY19, aggregate state reserves exceeded those of FY07. However, state reserves cover only about ten percent of anticipated shortfalls. And, due to withdrawal and repayment red tape, rainy day funds can be difficult to access. With their dependence on state aid and other limitations, local governments were even less prepared.
Restructuring tools available to the private sector, like bankruptcy protection, have limited utility for government. Federal bankruptcy law precludes state filings. A few large insolvent cities like New York City and Detroit have used bankruptcy, but most distressed cities are limited to state takeovers (e.g., Atlantic City). Unfortunately, not all states do takeovers well—Michigan’s takeover of Flint is a cautionary tale—and those that do will likely be distracted by their own fiscal problems during this crisis.
We Can and Must Save State and Local Government
The Great Recession was a great teacher. First, it taught us that recessions are ruinous, today and for years. Second, we learned that a sluggish fiscal response to a recession can slow our recovery. Third, our nation’s automatic stabilizers (i.e., programs like unemployment insurance, Medicaid and food stamps that mitigate economic disruptions) are relatively anemic. Fourth, without a permanent federal stimulus program, economic downtowns persist longer, economic recoveries take longer and federal politicians have more opportunities to fail us (during the Great Recession, authorization for extended unemployment benefits lapsed five times).
There are valid long-term concerns about federal debt, but most economists believe that our nation has adequate fiscal capacity to mount an aggressive stimulus program. Since 2001, the debt-to-GDP ratio has increased, but our interest rates should remain low. The CBO, Federal Reserve and International Monetary Fund believe we have adequate fiscal capacity for a massive stimulus effort (i.e., we can increase federal debt without suppressing investment, overheating the economy or triggering a debt crisis). In short, the long-term risks of more debt are far outweighed by the short-term risks of neglecting state and local government.
The initial $2.2 trillion federal stimulus program (the CARES Act), while impressive, gave short shrift to state and local government. It included $150 billion in direct aid for states and large cities (over 500,000 residents), but forbid the use of those funds for budget relief. And most CARE measures are scheduled to sunset long before the pandemic will end. For instance, the enhanced unemployment benefits will expire July 31st, even though the CBO expects a 16% unemployment rate that quarter.
Congress has done a lot, but not enough. The CBO does not expect the unemployment rate to fall below 9.5% by 2022 without more aid. Bipartisan groups like the National Governors Association and National League of Cities urge more federal aid (including a higher Medicaid matching rate) to offset state and local revenue losses. The amount is debatable, but, without more federal aid, state and local governments will have to gut vital services, close facilities and lay off more employees, including front-line workers like police officers, teachers and nurses.
Linking Aid to Reform
The next stimulus package should address the short-term needs of state and local government and the long-term risks of public deficits. This won’t be easy, but it will be a lot more productive than endless political squabbles about the size of government. The recommended state and local government stimulus package should include three inextricably linked components: 1) a short-term aid package, 2) a structured, but flexible stimulus program for future crises and 3) a long-term reform initiative for reforming state and local government.
The short-term state and local government relief package should be designed to maintain vital services and jobs, surmount obsolete stabilizers (like the broken unemployment insurance system), minimize human hardship and galvanize the recovery. Direct aid should be driven by objective metrics and federal debt levels should be closely monitored against key economic indicators.
The new federal stimulus system should replace episodic relief packages with robust automatic stabilizers linked to economic indicators (e.g., unemployment rate). The program should include direct aid, mortgage and rental protection, small business support, loan guarantees and prosperity-based repayment plans. Automatic stabilizers are expensive, but far more efficient than the staccato stops and starts of our current approach. And they would reduce the uncertainties of our dysfunctional political system.
The government reform initiative should be a precondition for short-term aid. A federal commission should reimagine government at all levels, assess potential reforms and develop a plan for restructuring federal, state and local government. It should craft model constitutional amendments, charters and laws for guiding implementation. The new federal, state and local government system should be designed to reduce costs, prevent and manage risks, strengthen global competitiveness and prepare for the next big crisis.
Closing
The national debate over state and local government aid is futile. It obscures the reality that state and local government need short-term relief and long-term reform. With 17.3 million employees (11 percent of the total workforce), state and local governments are a vital part of the national economy. Failing to save them will hurt people and impede the recovery. Failing to reform them will cripple their ability to confront the next crisis.
Gregory Mankiw, who once chaired President George W. Bush’s Council of Economic Advisers said, “There are times to worry about the growing government debt. This is not one of them.” The growing public debt and our uneven pandemic response are worrisome, but these concerns should not delay direct state and local government relief. We should neither turn our backs on government nor reward the status quo.
Linking the stimulus to government reform will attain two goals. First, it will enable state and local governments to weather the storm and support the recovery. Second, it will eventually produce a new public sector model, one that revitalizes federalism, fosters global competitiveness, improves public services, reduces costs and strengthens our ability to meet future challenges. From prior crises—like the Great Depression and World War II—emerged a sense of solidarity and communal purpose. Why not now?