In 2020-2021, the federal government sent half a trillion dollars to state and local governments to help them survive COVID-19. Public health experts worried that the pandemic would be bigger than anything since the influenza outbreak of 1918, which struck one-fourth of the U.S. population and killed 675,000 people.
COVID-19, economists projected, would surely produce a big economic downturn. There was a sudden stall as things shut down early in 2020, but the economy began recovering almost immediately. State and local governments brought in more revenue than anyone expected. Many of them got hooked on the federal cash, and now that money is drying up, revenues have softened and lots of state and local governments are facing big deficits. The relief plan ended up blowing a hole in the federal budget, digging the country deeper into debt and luring many state governments into a fiscal hole.
Now they are making the largest spending cuts since the Great Recession. “The big sugar high from all the money that went into the economy during COVID is running down,” says William Glasgall, senior director of public finance at the Volcker Alliance.
How did a good idea turn out to be such a problem? And what’s the lesson for the federal government in inevitable future crises?
It’s not as if we weren’t warned that something like this was going to happen. Bill Gates had predicted in 2016 that a major pandemic might be the biggest problem the U.S. was likely to face. Then, in a February 2020 article in the New England Journal of Medicine, just as COVID-19 was taking off, he warned that it had “started behaving a lot like the once-in-a-lifetime pathogen we’ve been worried about.” The World Bank headlined that COVID-19 was going “to plunge the global economy into the worst recession since World War II.”
So it seemed like a sensible idea to get out in front of the crisis: Commit the federal government’s borrowing capacity to shore up state and local governments before they fell over a fiscal cliff. Policymakers took the predictions of a devastating public health crisis, worries about a deep economic downturn and the federal government’s earlier stimulus to counter the Great Recession of 2008-2009 and decided to pump money into state and local budgets to forestall the worst.
That is the new playbook: Pre-empt crises for state and local governments by pouring in federal cash — early and often.
However, even though the recession didn’t last, states started spending freely. From 2021 to 2023, 26 states slashed personal income tax rates or corporate tax rates — or both. The Tax Policy Center counted 48 states and the District of Columbia cutting taxes in some form. State budget writers faced the end of the federal government’s temporary cash just as policymakers locked in permanent tax cuts.
Arizona, for example, replaced its graduated income tax, which previously topped out at 4.5 percent, with a flat-rate tax of 2.5 percent. The state expanded its school voucher program, which provides an average scholarship for students of $9,700. Gov. Doug Ducey said, “This tax relief keeps Arizona competitive and preserves our reputation as a jobs magnet and generator of opportunity.”
But Arizona legislators returned this year to face a $1.3 billion deficit in 2024 and 2025, which forced a spending cut of more than $1 billion to deal with fiscal 2025’s budget of $16.1 billion. Opioid settlement money, aimed at reducing deaths from that epidemic, ended up in the Department of Corrections. Big spending cuts are coming in highways, community colleges, and water infrastructure. Analysts predict that the COVID-induced budget hole will only get bigger over time.
In Minnesota, a reduction in personal income tax rates is projected to produce a structural deficit by 2026. New York lawmakers are considering raising taxes after cuts last year. Illinois, perennially struggling because of its big pension shortfall, faces even bigger problems on the spending side of its budget. Many states are reluctantly dipping into their rainy-day funds, which are at historically high levels, to deal with these deficits. Financial advisers are warning against digging into the funds when the economy is healthy, out of concern that the money won’t be there when it’s not.
The structure of the COVID-19 relief money made some of these problems inevitable. State and local governments must spend their money by the end of 2026, so the use-it-or-lose-it requirement coupled with an economy that didn’t collapse encouraged them to fund the favorite programs of state policymakers.
There were alternatives, of course. The feds could have waited to see how bad things got before acting, but that would have risked a long delay in pumping out needed aid. They could have set an automatic trigger, with aid delivered as soon as state economic circumstances hit a threshold, but no one wanted to set up a robo-relief plan that wouldn’t have delivered political credit, even though in retrospect it would have been the most sensible alternative.
So we ended up with a relief plan we didn’t need, tempting state governments into budget problems for which taxpayers are going to have to pay twice: Once to bail out the state budgets, and once to pay the long-term costs of the federal borrowing. That’s the painful if hidden cost of long fiscal COVID-19.
Governing’s opinion columns reflect the views of their authors and not necessarily those of Governing’s editors or management.
