UPDATE: May 22, 2020
Based on the latest Congressional Budget Office forecast, I now estimate the total budget problem for state and local governments to be $899 billion through end of 2021, an update to my prior estimate of $959 billion.
May 8, 2020
A few weeks ago, I projected state and local budget problems that will arise because of the coronavirus pandemic. Since then, however, economic forecasts have turned more pessimistic. The pandemic has remained persistent, and this is likely to lead to uncertainty, which in turn will reduce business investment and major consumer purchases. Collectively, these are likely to have large negative effects on the economy in 2020 and 2021.
On April 24, 2020, the U.S. Congressional Budget Office (CBO) provided an updated economic forecast. Even for 2021, the agency expects the national unemployment rate to average 10.1 percent, dropping only to 9.5 percent by year’s end.
In the near term, for the second quarter of 2020, CBO expects the national unemployment rate to average 14.0 percent. Given that the U.S. Bureau of Labor Statistics (BLS) announced on Friday, May 8, that the April 2020 unemployment rate hit 14.7 percent, the CBO forecast is probably optimistic. In addition, BLS’s May 8 report notes that some persons in the April survey may have been incorrectly classified as employed rather than unemployed, so the 14.7 percent figure may understate the unemployment rate by 4.8 percentage points.
What does this mean for state and local budget problems from the “Pandemic Recession”? With more pessimistic forecasts, these state and local budget problems will be larger.
These problems will not only harm state and local public services, they will also slow down national economic recovery. If the federal government wants to help avoid these damages, flexible federal aid to state and local governments should be provided to meet a large share of state and local fiscal needs. With a more pessimistic forecast, the need for federal aid is greater.
In the table below, I provide revised projections of state and local budget shortfalls for each calendar quarter from now through 2021. These fiscal need projections are based on an unemployment rate forecast that combines CBO’s forecast with the April 2020 unemployment estimate by BLS; details are in the table note. As I did in my previous projections, I assume, based on research, that each additional 1 percentage point in the unemployment rate over the 2019 level yields $45 billion in budget problems, on an annualized basis, for state governments, and $22 billion in budget problems for local governments.
Over the seven calendar quarters between now and the end of 2021, I estimate a total budget problem for state and local governments of $959 billion. A little over two-thirds of this shortfall is for state governments, with the rest for local governments.
These shortfalls represent large shares of budgets. Depending on what calendar quarter you pick, the collective deficits could exceed 25 percent of state budgets and over 20 percent of local budgets. These numbers are more pessimistic than some current reports from state and local governments, but it is unclear whether state and local budget officials have fully caught up with the more recent, downwardly revised economic forecasts.
One might ask: Aren’t all these economic forecasts uncertain? Yes, they are. Maybe the economy will do better than this forecast. Maybe the economy will do worse.
That is why the best policy course may be to provide monthly federal assistance to state and local governments, based on each month’s unemployment number. If unemployment goes up, then the federal payment goes up. If it goes down, the federal aid goes down.
For example, based on the April 2020 unemployment rate of 14.7 percent, if the federal government decided to fully meet state and local budget needs, then aid to state and local governments in May would total $61 billion. That amount would then rise or fall in subsequent months based on economic need.
Congress will soon debate the need for federal assistance to state and local governments. Policymakers should understand that the need is large. The economic consequences of a failure to provide sizable federal aid would also be large.