State, local budget pain looms over economy’s future

WASHINGTON — The U.S. economy struggled to shake off the last recession, with historically slow growth and a labor market that took more than six years to recover its earlier employment levels. A big part of the reason: state and local governments that cut spending and fired workers amid widespread budget shortfalls.

The same dynamic poses one of the biggest threats to America’s recovery from the pandemic downturn. State governments are again experiencing extreme budget problems as they pay out increasing sums to cover unemployment and health costs caused by the coronavirus crisis while revenues from sales taxes and corporate and personal income tax payments plummet. States could face a gap of at least $555 billion through the 2022 fiscal year, according to one estimate.

Economists warn the long-term risk coming from struggling states could prove even more damaging this time than the last recession, from 2007-09, unless Washington steps in. Yet providing more aid to state and local governments has become one of the biggest political battles in the fight over another pandemic rescue package.

The Senate formally adjourned Thursday until early September, all but ending any chance that an agreement could be reached soon. House members had already left Washington.

President Donald Trump and top Republicans, including Sen. Mitch McConnell of Kentucky, the majority leader, warn that providing more money to states could simply bail out fiscally irresponsible governments that did not manage their budgets and their public pension plans prudently in good times. Treasury Secretary Steven Mnuchin said Wednesday in a television interview that most states had not exhausted the $150 billion that was allocated in the relief bill passed in March, although analysts say much of that has already been earmarked for certain projects.

Democrats insist states need more money and have proposed as much as $1 trillion, saying it would support needed services and help the economy recover more quickly.

While many governments entered the downturn with solid tax revenues and billions of dollars in their emergency reserve funds, those coffers are quickly dwindling. State revenues “could fall as much as or more than they did in the worst year of the Great Recession and remain depressed in following years,” according to the Center on Budget and Policy Priorities, a progressive think tank.

Nearly all states are required to balance their budgets, meaning officials will need to plug shortfalls by tapping emergency funds, raising taxes or cutting costs, including jobs.

That worries economists and Federal Reserve officials. Jerome Powell, the Fed chairman, regularly warns that state job cuts could weigh on the economy’s ability to recover, and his colleagues warn of public-sector budget pain as one of the primary vulnerabilities ahead.

“It will hold back the economic recovery if they continue to lay people off and if they continue to cut essential services,” Powell said during congressional testimony in June. “In fact, that’s kind of what happened post the global financial crisis.”

Charles Evans, president of the Federal Reserve Bank of Chicago, echoed that sentiment in a CBS interview Sunday, saying, “As you look at the economic outlook, there are some negative scenarios, and the ones that are most pessimistic involve not supporting state and local governments.” Absent that help, Evans said, “there will be employment reductions.”