States may still have time to make crucial budget decisions in the next few months, amid a slowdown in new bond issues as well as revenue and spending pressures due to the coronavirus.
That was the message delivered by a senior Pew Charitable Trust officer during a Wednesday webinar. States should be taking four steps — conducting budget stress tests, building reserves, improving responsiveness to the crisis and avoiding unsustainable budgeting such as cutting taxes, said Josh Goodman, Pew senior officer.
“Many states have used the relative prosperity of the last few years to implement some of these four strategies, others are less prepared,” Goodman said. “But even as states appear to be on the brink of budget emergencies, there is still time to act on many of these ideas. The next few months will be crucial.”
Pew began its research late last year into ways states can prepare for crises, but did not know states would soon be facing widespread strain due to COVID-19. The virus has been detrimental to municipalities’ revenues as the economy has drastically slowed down. About 95% of Americans are under stay-at-home orders and unemployment numbers have skyrocketed.
“Today states face their greatest test to their budget since at least the 2007-2009 recession and perhaps in modern history,” Goodman said. “The coronavirus is an unexpected event, but history shows that states need to prepare their budgets for the unexpected.”
Matt Fabian, partner at Municipal Market Analytics, said COVID-19 will slow down states’ borrowing plans, if not curtail them altogether. New money bond projects will slow through the end of the year and perhaps into 2021 as well, he said.
“States like people, states tend to take on less debt when their financial prospects get harder, so that’s what happened with the virus,” Fabian said. “So it’s likely they’ll put off projects instead of pushing through and borrowing on things that are nonessential like projects that they need to do like replace important facilities that are part of ongoing financing.”
Goodman recommended states conduct budget stress tests and said a handful of states have already done so. Some states require regular stress testing, Goodman said.
During a downturn, personal income and sales taxes stagnate or decline and demand for programs such as Medicaid increases, Goodman wrote in his associated research.
“This combination creates a gap between the cost of government programs and the money available to pay for them,” Goodman wrote. “By estimating how large these shortfalls could be, stress tests help policymakers plan for the potential need to close them.”
States should also build reserves as they are their best line of defense, Goodman said.
During the recession in late 2007, reserves played a crucial role in softening the blow to state budgets, but still weren’t impactful enough. States had to approve large spending cuts and tax increases, but since many states have redoubled their efforts to build strong reserves, Goodman said.
Kansas, Kentucky, Illinois, New Jersey and Pennsylvania have fallen behind in their reserves. Illinois has zero days they could operate on reserves while Kentucky just has four, according to Pew.
The Government Finance Officers Association recommends that governments should maintain an unrestricted budgetary fund balance in their general fund of no less than two months.
States should also distinguish between recurring and nonrecurring revenue. Governments often face budget challenges when they use one-time money for ongoing expenses, Goodman said. For example, if a state uses a short-term spike in tax collections to hire more workers, it may struggle to continue that commitment.
“To Pew’s point, the problem comes in when states use nonrecurring budget solutions when times are good because there is, for the most part, a finite number of recurring budget solutions that any government has access to,” Fabian said. “So if you use them up when times are good, you don’t have them when times are bad.”
