Most states and localities prepared for next recession

The vast majority of states and localities are prepared for the next recession, bolstering their financial resilience to counter the next downturn, analysts said at a Brookings Institution webinar.

During a Wednesday webinar focused on state and local governments’ preparedness for the next recession, Laura Porter, managing director and head of U.S. Public Finance at Fitch Ratings, said state and local governments’ actions today show their preparedness.

“How a government manages at the time of economic recovery is hugely influential on how that government is going to look at times of economic decline,” Porter said.

Laura Porter

Fitch’s overall average state rating is AA+ and its overall state rating is AA. The high ratings mean that Fitch thinks the ability of those governments to manage throughout the economic cycle is very strong, Porter said.

Fitch looks for a government’s taxing power and control of spending and reserves, among others to determine their financial resilience. They do not see a recession happening in 2020 or 2021, though there could be an economic slowdown.

State governments’ median reserve levels are 8% of general fund spending, according to a 2019 survey from the National Association of State Budget Officers.

Since the Great Recession, many states have almost doubled their reserve levels. During the Great Recession in 2008, median reserve levels were 4.8% and in 2003 was 0.7%.

States learned a lesson during the Great Recession about the necessity of strong reserves, Michael Nadol, managing director at PFM, said during the webinar.

“Memories can be short in terms of forgetting the hard times,” Nadol said. “The effects of the Great Recession was pretty game-changing in terms of the way particularly finance officers and many responsible elected officials have approached preparedness.”

Local governments have also increased their general fund reserves, though slightly. In 2018, cities and counties reserved a median of almost 30% in reserves, while school districts were close to 20%, according to Fitch.

In 2009 median levels in reserves for counties and cities were closer to 20% and school districts were less than 15%.

States have substantial control over raising revenues and spending, and local governments have less control. Local governments tend then to have a higher level of available reserves, Porter said.

Philadelphia is among those local governments that have taken steps to combat the next recession. Mayor Jim Kenney’s administration set aside a $20 million recession reserve and set aside $55 million annually from 2020 to 2025 to prepare for potential cuts in federal aid.

If and when a recession does hit, interest rates tend to decrease leading to favorable borrowing conditions, but that doesn’t mean states and local governments will jump on the chance to do so.

Though infrastructure is at the top of the list for many governments, they will not be issuing more bonds during an economic downturn just because interest rates are low.

“It’s just not the way states have operated,” Porter said. “You don’t spend in downturns and that’s what we’ve seen pretty consistently.”

States have taken the chance now during relatively good economic times to raise gas taxes in the absence of federal infrastructure funding, Porter said. Since 2013, most states have raised or reformed their gas taxes, according to the Institute of Taxation and Economic Policy.

Public sector budgets are pressured financially anyways in good economic times due to the imbalance between spending on a carry-forward basis growing faster than revenues, Nadol said.

“So when you hit a downturn, you have to pull out all the stops to preserve services,” Nadol said. “Unfortunately, one of those stops can be to go on a debt diet, reduce your new issuance and try to not add to your prospective debt service.”

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