Unlike the federal government, state and local governments budgets are limited by the demand for their debt. Many state governments have been in difficult financial territory for years, and the pandemic only exacerbated that unfortunate trend. However, the federal government provided relief for state and local governments to prevent widespread austerity, and the results are expected to be positive.
Many States Left in an Alarming Situation Last Spring
The immediate threat to states resulting from the pandemic was the lack of tax revenue, with 20 states needing to borrow directly from the federal government to meet unemployment insurance obligations. For reference, state income tax revenues generally decline by $40 billion per year for every 1 percentage point rise in the unemployment rate. So, when the pandemic caused an incredibly sharp rise in the unemployment rate, it led to many bleak state government forecasts.
The lack of tourism and demand for gas also targeted specific state coffers as well. Some states tax revenues, however, outperformed expectations. Those with higher capital gains tax rates took advantage of the stock market’s performance last year, like California which is predicting a budget surplus in 2020-2021.
Analysis of CARES Act Impact on State and Local Governments
The CARES Act provided over $200 billion for state and local governments, with the majority going into the Coronavirus Relief Fund. The largest portion of the fund, $150 billion, was meant to benefit states and larger local governments for the purpose of covering expenditures incurred due to the COVID-19 pandemic. Another $55 billion was provided to education and transit and $5 billion for community development grants, among other smaller provisions.
Additionally, the Federal Reserve created the Municipal Liquidity Facility to lend directly to state and larger local governments. Once again, these funds were only to be used for pandemic-related expenses. When the facility opened the market had stabilized and the rates provided by the Fed were above market rates, therefore little of the $500 billion authorized for borrowing was utilized.
Analysis by the CBO found that the CARES Act, which costed a total of $2.9 trillion, is expected to return 58 cents to GDP for every dollar spent. For the funding provided to States and local governments, the return is expected to be 88 cents in GDP for every dollar spent, much more efficient compared to other parts of the relief package.
What to Expect from American Rescue Plan
The more recent American Rescue Plan [ARP] provided $220 billion for state and tribal governments, $130 billion for local governments, and $10 billion specifically for capital projects. The majority of jobs lost by non-Federal government employees were at the local level. As a result, the local government size threshold was lowered to include more community governments, which opened the door for smaller communities to receive aid.
State and local budget forecasts have improved since the CARES Act has passed, but the ARP has provided much more in funding than its predecessor. In fact, it is more than quadruple the amount needed to plug budget holes through this summer.
Overall Stimulus Impact to State and Local Governments
Unlike the CARES Act, the ARP allows spending the funds provided to States and local governments on a wider variety of expenses. In addition to refilling unemployment coffers and stabilizing budget shortfalls, state and local governments are advised to invest the excess funds into their communities. The ARP prohibits the use of these federal funds to justify cutting taxes.
For the CARES Act, one of the most efficient uses of the funds was the bailout of state and local governments, where the workforce was hit particularly hard. The expectation is the funds spent by the ARP will provide the same or more benefits given the mandatory use of funds by 2024 and the expected investments into communities.
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