State budgets: the good, the bad and the uncertain

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Transcription:
Caitlin Devitt: (00:03)

Hi, and welcome to another Bond Buyer podcast. I'm Caitlin Devitt, infrastructure reporter at the Bond Buyer. My guest today's Bill Glasgall, senior director of public finance at the Volker Alliance. For those of you don't know, most of you probably know about the Volcker Alliance, but for those of you, don't, it's a New York based nonprofit established in 2013 by former fed reserve board chair, Paul Volcker, it's dedicated to empowering the public sector workforce. And as part of that, they do a lot of work around public finance. Among other things, they host a series of webinars called special briefings that I personally find very informative. The panelists are usually a nice mix of academics, issuers, and muni market types who take on various public finance issues. Bill, you just mentioned that you guys are launching a podcast associated with that, is that right?

Bill Glasgall: (00:50)

Indeed. We are. The special briefings are going to continue monthly on the Volcker Alliance site and the Penn IUR site, our partner university of Pennsylvania. And, this fall we are launching a podcast which will be podcast version of the webinars boiled out a little bit and available on all your favorite podcasting platforms.

Caitlin Devitt: (01:12)

Okay, cool. We'll look forward to that. So today we are gonna be talking about state budget, state fiscal positions, and the factors affecting those fiscal positions such as work from home possible recession. We're in sort of a strange and volatile post COVID time that's proven to be a little unpredictable. We haven't been able to — well remember in 2020, we said, you know, there's a lot of, we all kind of thought the bottom was gonna drop out and a bunch of downgrades we're gonna come and ended up in fact, being a time of record revenues the last couple years. So we're gonna talk a little, Bill's gonna fill us in and talk a little bit about that. But first let's start with some news. It looks like Congress might finally pass a budget reconciliation bill, possibly even this week. If the House comes back on Friday and votes, it's expected, it's a $740 billion bill. That includes about $430 of climate and energy programs. Bill, you wanna talk a little bit about what this means, if anything, for states and states fiscal positions?

Bill Glasgall: (02:09)

Oh, I think it means it, it means a lot, somewhat indirectly, perhaps unlike the infrastructure bill that passed recently or the American Rescue Plan, there's not a lot of direct aid to states and localities, at least from what I've read with the bill, what there is, is a lot of jobs tax credits. There's a huge emphasis in this bill on the green economy, energy and climate, clean electricity air pollution, all the way down to retrofitting retrofitting homes, and in giving energy credits for that. So that means that means there's gonna be a lot of new jobs. And when you, when you add on top of that, the semiconductor industry bill that Congress passed and the president signed not long ago, we have the makings of an industrial policy here which we haven't seen in a long time. So that's what I think we have to look for on the positive side. On the negative side, this is a long term concern for energy states that really need to work on either building their reserves or building a transition to a greener economy. This is not something that's going to happen overnight, but it's something that Alaska and Texas have been preparing for for years with enormous liquid reserves by, by which I need money, not oil, right.

Bill Glasgall: (03:33)

And we have to, so we have to watch for that.

Caitlin Devitt: (03:36)

Interesting. So states that get a lot of their money from minerals, you mean, to having to make that transition and maybe Wyoming, North Dakota, those kind of places?

Bill Glasgall: (03:45)

New Mexico,

Caitlin Devitt: (03:46)

Oklahoma,

Bill Glasgall: (03:48)

Virginia, West Virginia, home of Joe Manchin. All of these, all of these are states that are undergoing a transition right now, especially away from coal, and perhaps to some extent from oil, although we're the largest oil producer in the world right now. So this is something, this is something we need to watch. The other thing we need to watch is that the structure of state taxes right now, in almost every state, motor fuel taxes, gasoline, diesel, motor fuel taxes and sales taxes on motor fuels go to go to highway funds. They go to build bridges and pay for maintenance. And as we move to hybrid and electric cars, we're going to be selling less gasoline and collecting less taxes as it is. The federal gasoline tax has been unchanged since the Reagan era, it's not adjusted for inflation, it's less productive. So will we go to a miles traveled tax or fee basis? There has to be something to replace that otherwise, otherwise all the bridges are gonna fall down. So we better figure this out soon.

Caitlin Devitt: (04:59)

And of course, a lot, those revenues cover a lot of the debt service for the bonds that have already been issued. The bipartisan infrastructure law does include, I think that pilot user fee program, right for miles per the national pilot program for vehicles, I'm blanking on what the name of the program is, but the, you know, basing it on how many miles you drive as a vehicle. So that is gonna kind of advance that a little bit. I think Oregon

Bill Glasgall: (05:29)

Oregon has had for several years, a voluntary test system of miles traveled to replace to replace charges at the pump. But this is, this is something that states and cities are going to have to figure out whether they charge by the mile, whether they charge on a toll basis as most interstates are prohibited from levying tolls. We need to figure, we need to figure this out if we're going to have a transition.

Caitlin Devitt: (05:59)

Mm-hmm interesting. Okay. So Fitch Ratings came out with a report this week that says state budgets are in a pretty strong position heading into fiscal 2023, even as economic growth, we're starting to see some slow down and inflation continues to pose challenges. I mean, this isn't news to anybody like you, and most of our listeners who have been following this closely, but what's your analysis of how states are doing as we head into this environment? And how uncertain do you think this environment is right now for states?

Bill Glasgall: (06:29)

That's a great question. I think we need, we need to look at two things. Fiscal 23, 24, and then what happens after, after the end of calendar, 2026. And let me explain why. So right now states, cities, counties, they, they literally don't know what to do with all the money. You refer to this at the beginning, this, there was $5 trillion in federal aid that went into the economy, $350 billion of it directly for budget aid. There was other program aid, there was the unemployment, the special unemployment payments, loans, you know, on and on and on. So that's around 20% of the economy. We've never seen a stimulus that large, that, that I can recall. And it came on top of an economy that before the pandemic was doing really well, we were at three and a half percent unemployment.

Bill Glasgall: (07:27)

We're back to three and a half percent unemployment now. So state rainy day funds are at a record high in nominal terms, not adjusting for inflation. States are looking for ways to give money back either through permanent tax rate cuts, moving from graduated taxes to flat taxes. Several states are doing that and then rebates, rebates galore, which are, which are a one-time action. We'll see if they, if they last, but a lot of gas, lean tax rebates, sales tax holidays, big checks being handed out in California. So states are giving that back. That's the short term. Now what happens though? When the federal, when the federal money is spent, it'll work its way through the system, states will give money back as they probably should. And then what about programs that are right now living on federal funding, like the universal Three K, it's the pre-K program in New York, which is being financed by the feds or a lot of other lot of other programs, uh, we've identified violence prevention, violence mitigation programs, lots of social service type programs that are being supported out the revenue replacement category in the ARPA.

Bill Glasgall: (08:47)

We don't know what's gonna happen with those. So is there a fiscal cliff coming? We are reminded just this week that state and local pension funds took a pretty big hit last year, down about 7%. That money has to be replaced somehow. And we're giving out, we're giving out, pay raises to public servants who God knows, deserve them because of inflation. And COVID some of those pay raises are one time bonuses. Some of those pay raises are salary increases that work into higher costs, long term, higher pension costs, higher compensation costs. How are governments gonna cope with this when the sugar high wears off?

Caitlin Devitt: (09:29)

Yeah. And hiring new workers in this tight labor market and having to attract new workers with higher wages and higher benefits, and that translating into long term,

Bill Glasgall: (09:39)

Well, governments actually are being very, very cautious state, state and local government employment. Employment is recovered from where it was at the depths of the brief COVID recession before all the money starts to flow. But state and local employment is still, has not come back to where it was in 2009 after the Obama stimulus plan did its thing and, and, and ran out. So states, school districts, counties, police, departments, all these, they're being very, very cautious about hiring. And if you look at the, if you look at the net numbers, they're really not, they're not growing. They may be, they may be replacing people. The workforce is getting old and people are retiring, but they, they may be replacing people, but they're not adding a lot. The federal to that hasn't, hasn't increased for years. The, the federal answer is to hire a lot of consultants and do it off the balance sheet, if you'll.

Caitlin Devitt: (10:43)

Yeah. And I know that some governments are saying that that they do need to bulk up hiring at least for the infrastructure. You know, as the infrastructure money starts really rolling out, if they wanna start building projects that they need to start to bulk up some hiring in that way.

Bill Glasgall: (11:01)

And that's a big problem. I was at a meeting of legislative analysts recently and inflation is one of their big concerns. We had a conversation with the Idaho budget director of maybe about a month and a half ago. And he said, you know, I have a bridge to build for $200 million and $200 million doesn't go as far as it once did. And, everything, the cost of everything is going up and people are, are hard to find. And I'm wondering, can the kind of, can Congress extend, or can the White House and Congress extend the 2026 limit on spending because they're afraid they're not gonna be able to get the money spent by by then.

Caitlin Devitt: (11:51)

Oh, that's interesting. So that's that important 2026 date, that you mentioned that I think the funds have to be obligated by the end of 2024, is that right? And then spent by 2026,

Bill Glasgall: (12:00)

Right. And obligated means, obligated is a, is a federal bureaucrats term. It means you have to have a contract for, for something. So basically, if you haven't decided what's gonna be done with this money by 2024, you may have some problems.

Caitlin Devitt: (12:21)

I mean, it's interesting. I wonder if there is gonna be a push for that to get an extension on that 2026. I'll bet it, you know, I'll bet it's gonna be the case, because a lot of these, when we're talking about infrastructure, we're talking about capital programs. I mean, a lot of these programs, we're talking five, 10 year programs. So although that's a little separate from the ARPA stimulus money. Okay. We'll be right back after this important message. And we're back talking with Bill Glasgall, the Volcker Alliance about all things, state fiscal positions. Let's talk a little bit about, you know, something that's been a massive change for all of us, in good, bad, and all sorts of ways — work from home. Can you talk a little bit about the fiscal impact for states possibly local governments on work from home?

Bill Glasgall: (13:11)

Oh, sure. I think the first impact is it's the other way around is, is kind of work from the bottom cities, cities, counties and states. The biggest impact we're just beginning to see is on commercial property, valuations assessments and what that's going to mean for real estate taxes. So Brad Lander, the New York city controller sees the city taking as much as a billion dollar hit in its tax collections because of this residential property taxes are very strong, but commercial office properties, especially the, the bigger ones are showing weakness in leasing, because, you know, we will, we need as, as much space in buildings if people are only in two days a week, we don't know yet, but billion dollars is about 1% of the New York City budget. It's not insurmountable, but it's a number.

Bill Glasgall: (14:13)

What we're seeing is that cities with really lousy commutes like New York, San Francisco, San Jose, are tending to be in the 40% occupancy range cities with easier commutes and arguably, lighter touch COVID policies like Dallas and Boston are seeing occupancy that's higher still, but in the fifties. So we don't know yet whether this is going to be a long term trend or something that starts to, especially if the economy slows, we go into a recession or stagflation jobs, maybe become a little harder to get, and people start to listen to the boss. It could have an effect on state taxes, too. Some, there are some state property taxes, but state income taxes are a big, if there's, there's a whole bunch of lawsuits right now over the domicile of employees.

Bill Glasgall: (15:17)

So if I'm based in New York and I've fled to Vermont, to my cabin in Vermont, or I bought a cabin and I'm working from there, but I'm still officially domiciled, New York, New York state is collecting, my income taxes on my New York income, is Vermont gonna come and want a piece of that? And that hasn't been worked out that, that that's gonna be up to the courts, but that's a really big issue, right now, because some states may maybe be losers, New York, New York, California, that have steeply, progressive income taxes, uh, New Jersey, Connecticut. These are states that get a very large amount of their, of their income from a very small number of people. If, if they move out of state, they move to Florida where there's no income tax, but they still have businesses in New York. Who's gonna be, who's gonna be the beneficiary of that. We don't know yet. That's a cloud.

Caitlin Devitt: (16:19)

Yeah, that's interesting. That's a complex issue. It's a part of the tax policy that I think really needs to be cleaned up, or clarified as we, you know, if we kind of stay in this environment, I know Ohio is very affected by that as well. Because if you wanna talk about on the local side, you know, if you are work in, you know, you have an office or you used to have an office in Columbus, but you lived outside and you know, now you're no longer going in. So it's sort of an interesting issue.

Bill Glasgall: (16:48)

Yeah. Detroit is very concerned about, about its personal income tax collections. This is an issue in Washington DC, and there's another market that depending on the value of office properties, the commercial mortgage back securities, the CMS market, could also be affected if leasing remains very subdued office, property, valuations come down. And the, the security for the CMBS is compromised. We're starting to hear rumbling about that.

Caitlin Devitt: (17:23)

Huh? Yeah. A lot of fall out, a lot of interesting string to pick up there. Let's go back just for a minute to this stimulus money. You were talking about, you know, states starting to use, some places using some of this money for one time uses either possibly with operations or, you know, other to fund programs. So what do you think, you guys have been doing a little bit of research into this area. You've been talking to some people about the idea of fiscal cliffs. Can you talk a little bit about, you know, what we might see there and, and who might be some of the candidates for places that we should watch?

Bill Glasgall: (18:06)

Sure. Well, we, we issued a report in the spring called the $195 billion challenge, which is on the Volcker Alliance website. If you'd like to go there and have a look at it. And that looked, that was a first pass, uh, on the state and local fiscal recovery fund money, that $350 billion that went to states of cities and counties. We looked at, we looked at the state part of this, which was 195 billion. We're doing, uh, we're doing a second take on this right now, if you want quick takes on what states are doing and cities for that matter, the national association of state budget officers NASBO, has the state, the state filings on their site and all of the state and local filings as they come in are on an enormous spreadsheet on the us treasury website. So you can, you can look for it there, but fiscal cliffs, all right, California, as of March, that's the latest numbers anybody has, California was putting $11 billion of its of its aid money into general services.

Bill Glasgall: (19:12)

So it's gone into the general fund. We're not quite sure what it's gonna be used for, but, but it's revenue replacement is a big category that has fewer, fewer restrictions on it than some of the other program categories. So that's something to watch. Illinois has $3 billion and change for public safety agencies, uh, Colorado, almost $400 million for transportation, Washington, $600 million for transportation. So these are things we wanna watch. Initially, Pennsylvania dumped its entire, uh, its entire, uh, our, our part or, or fiscal recovery fund allocation into the general fund. As did California. New York has been New York. Did that. It's been pretty good about disclosing what it's going for, but, uh, because a lot of these are continuing programs and the filings are, are oblique and not always complete. We don't know that the full truth, something we need to watch because it's, it's not like everything is going into, a specifically COVID related program. Some of these are, are funding, existing existing programs passed under laws from long ago.

Caitlin Devitt: (20:26)

It sounds like it's early. And that revenue replacement category is a pretty, it's a big kind of fat category and it doesn't necessarily mean that that's what it's being used for. There's also, you know, some lawsuits, a handful of them several, right over what you were talking about earlier, states that are possibly giving tax cuts, using some of the money to offset that,

Bill Glasgall: (20:48)

That true. That, that there's, there's about a dozen cases right now. And that's because in, to boil this down to very, in very simple terms, the law says, there's a bunch of things you can't do with your state and local fiscal recovery fund money, uh, put money into rainy day funds, put money into pension deficits to help close you. You can pay your normal, your normal costs, but not, not pay off the pension debt. And essentially you can't use this federal money directly to fund tax cuts. There's a constitutional issue there on whether Congress can tell states what to do about their, their tax policy. And then there's the issue of fungibility that has come up a lot with, I know with, with budget directors, legislative analysts, this is money is fungible states, states use cash accounting for much of what they do in their budgets in cash.

Bill Glasgall: (21:49)

In accounting, cash is king. So whether you get cash from a bond issue, federal aid, uh, it goes into, goes into a big bucket and then it becomes fungible. So the money comes in and yeah, you can't cut. You can't use the federal funds to cut, to cut, to finance a tax cut, but you can use the federal funds to pay for a road or pay for a social services program that would've come out of the general fund that frees up money in the general fund to finance a tax cut, very, very difficult to, to forensically tease all that apart. And that's, that's what this issue is gonna be about is the fungibility of money. Some states will use, will use GAAP, generally accepted accounting principles for budgeting, New York City does. And it's a little harder, it's a little harder to fool around in GAAP, although there are work arounds, but for the moment cash is cash is cash and trying to separate it out is not always easy.

Caitlin Devitt: (22:50)

Yeah, that's the reality. Well, certainly, you know, depending on what happens in the midterms, if Republicans gain control of one or both houses, we're gonna start to see a lot more scrutiny. We already, we're already, you know, of ARPA funds and, and how states and locals have used it. We're already seeing that in hearings. But we'll start to see a lot more of it. I think, if the GOP gains some power, so we don't know about a recession, we hear this, we hear that. But we can talk about, or you can tell us a little bit about what you think states could do to help prepare, if we are, if we are heading into a recession and in particular, so that we don't see a repeat of the great recession of 2009, which was this very hard, tough lesson, I think for a lot of states and local governments coming outta that.

Bill Glasgall: (23:43)

Sure. Well, we, you know, we argue among ourselves whether, whether we're in a recession or not the labor part, the, the labor participation has gone down. A lot of, lot of women, uh, have left the workforce to, to care for kids. A lot of people over 50 have decided to take early retirement if they, if they can. So the labor force is actually shrunk, but the unemployment rate is, you know, is down at a, at, at at least a near historic, historic low. So it's, it's kind of a, it's kind of an odd recession in, in that way. It may be a stagflation kind of recession. We haven't, we, we are not, uh, we're not seeing the kind of excess in the housing market that we saw in the, in the great recession where the housing market was was infinitely securitized, and then brought down, brought down the wall, brought down Lehman Brothers and, uh, threatened to bring down AIG and every other bank.

Bill Glasgall: (24:46)

And so there all the dominoes fell and we, and we, we had just a, a deep crash could be, we're certainly seeing, as rates, interest rates have risen, we're seeing a slow down in mortgages, slow down in home construction, Boise, Idaho. That was a big refuge state for Californians fleeing COVID, Boise has seen their housing market go flat. All of a sudden that's the fastest growing was the fastest growing state in the country. So, you know, you're seeing some signs there. Housing construction is very important for our economy. Drives drives furniture, appliance sales car sales car car sales are being are, are being hamstrung by supply shortages chips, especially. So there, there there's signs signs of weakness. You're not seeing it in consumer spending. You're not seeing it yet in sales taxes, which are being buoyed by inflation, partly, but also by pretty, pretty strong demand.

Bill Glasgall: (25:48)

So it's kind of a strange situation we're in now, what, what should states be doing? You know, arguably that the one thing they shouldn't be doing is giving out gasoline tax rebates, which effectively lower the price of gasoline and increased demand. We want gasoline demand to decline. It has, the prices has declined so far, not back to a dollar, a gallon, but it's certainly headed lower. States can be very careful on how they use their rainy day funds, hang onto them, hang onto them until there's a crisis. And just, don't start, don't start bleeding and try states ultra

Caitlin Devitt: (26:29)

Because, sorry to interrupt, but because we are seeing record rainy day fund, right? Generally across

Bill Glasgall: (26:34)

States. Yeah. But you know, they're gonna be, states are usually pretty careful about, about spending them and that's something to, that's something to keep in mind. So states have a pretty good cushion going in, which they didn't have in the 2007, 2009 recession when everybody was just going broke. So that's, that's remember Arizona, Arizona was, was doing sale, lease backs of all of its state properties, including the state house, every everything, but death row, to raise money. I don't think we'll see that again, but there's a, yeah, there's about, you know, 50-50 chance that we'll have some kind of a recession and then we'll, and then we'll see what, what shakes out, especially if this all occurs as the, as the, the federal aid works its way through the system

Caitlin Devitt: (27:22)

And what type of shape the federal government will be in, to not be able to help out possibly.

Bill Glasgall: (27:28)

Well, the latest bill, whatever you wanna call this act, the inflation reduction act or, or green bill that in theory, at least that has some very important deficit reduction, reduction measures in, it looks like the congressional budget office and the committee for responsible federal budget, which are normally pretty hawkish about these things, have been quite approving of this law and its effect on the deficit. The big worry and the long term deficit is that as Medicare, Medicaid, Social Security and debt payments eat up federal revenue, that there's not gonna be a lot left for everything else. And we're gonna have a credit, a federal credit squeeze, this, this bill seems to ameliorate it. Uh, but it's you tell me what's gonna happen over the next 30 years?

Caitlin Devitt: (28:26)

Yeah. Okay. Lot to think about a sort of a strange patchwork landscape. Everything's a little unpredictable as we, we all discovered in 2020, and it kind of continues to stay that way. Is there anything else that you wanted to say as the last takeaway?

Bill Glasgall: (28:44)

Yeah, I think it states and localities, to go back to infrastructure, which is where we, we started this, states and localities are kind of caught in a bind right now, from the supply side, tight labor, tight materials, inflation is raising the cost of everything and they're not gonna get as much bang for the buck from the bond market. You see all the Wall Street firms marking down their estimate of the amount of the amount of, of muni debt, especially fix rate muni debt, tax, tax exempt, fix rate, muni debt that's going to be sold in 2022. States localities provide 80% of the infrastructure funding in the United States. So $400 to $500 billion a year, which has been the pattern in recent years, that half of that more or less goes for debt service, or you've got, you've got $200, $200, $250, $300 billion available, mostly for infrastructure work. They're not gonna have as much from the debt market, at least, at least for now, if rates keep climbing, that's a concern. So states, states and cities, counties are being squeezed from numerous, uh, numerous sides. And I'm not sure there's a safety valve quite yet. Safety valve is, is billed less or build slower,

Caitlin Devitt: (30:12)

Right. And also with interest rates on the market side, you know, a lot of governments would often refinance over the last, you know, decade. We've seen that as a way to kind of alleviate some budget pressure and that won't probably be an option as much

Bill Glasgall: (30:26)

Anymore. Oh, there, and we're gonna have to wait for the next cycle because they're running out of there. There's not much 10% debt left out there, or even five or 6% debt left out there to get to dispose of. So it's another squeeze,

Caitlin Devitt: (30:45)

Another squeeze, okay. Food for thought, Bill Glasgall, the Volcker Alliance. Thank you very much for being with us today and thanks to the listeners of this latest Bond Buyer podcast. I produced this episode with audio production by Kellie Malone. And thanks again to Bill. Rate us, review us and subscribe to our content at www.bondbuyer.com/subscribe. From the Bond Buyer, I'm Caitlin Devitt. And thanks for listening.