Shrinking revenue from sales, income and gasoline taxes could cost state and local governments billions of dollars in the coming months, potentially cutting already stretched services and leading to a prolonged recession without sufficient federal support.
State officials reported earlier this month that the fiscal year general fund and school aid budgets ending on Sept. 30 could see a $1 billion to $3 billion shortfall, a result of the public health measures taken to prevent the spread of the coronavirus. The higher range is a decline of more than 10 percent. Next fiscal year, the deficit could be up to $4 billion. Yet those are just estimates at this point, and it’s difficult to predict the ultimate effect of the pandemic on the budget.
“My own guess is it might be worse than that,” said Tim Bartik, senior economist with the Kalamazoo-based W.E. Upjohn Institute for Employment Research. He noted not just the parts of the economy shut down because of the virus, but the effect it will have on small business bankruptcies and investing confidence among businesses and consumers.
The state’s estimates are based on “initial modeling” and “various scenarios, showing the wide range and uncertainty of the situation and we can state our hope that federal dollars will ultimately be allowed for replacing lost revenue,” said Michigan Department of Treasury spokesperson Ron Leix.
He said on April 7 that data were not yet available to determine how the revenue shortfalls would be broken down, and that the estimates are subject to change: “There are a lot of unknowns right now.”
Based on state estimates in January, sales and income tax revenue was expected to total $19.2 billion this year. The state also has $1.2 billion in its rainy day fund, and Gov. Gretchen Whitmer and top GOP lawmakers agreed on $80 million in cuts to the current fiscal year budget.
Quick recovery ‘unlikely’
While the $2.2 trillion federal CARES Act signed by President Trump on March 27 directs $150 billion to states, the funding is limited to new COVID-19 related costs that weren’t already budgeted. Michigan’s share is $3.87 billion.
It’s unclear whether and how much funding may be directed to states in an anticipated next stimulus phase, but local officials and economists say it should help governments recoup inevitable budget shortfalls.
In an April 6 op-ed for The Hill, Bartik and two other Upjohn Institute researchers noted that the general fund revenue among all U.S. state and local governments totals $2.4 trillion. A 10-percent decline would mean at least $240 billion is needed from the federal government. The $150 billion given to states in the latest stimulus that was limited to new COVID-19 funding “does nothing to fill this revenue hole,” Bartik said, adding that aid for U.S. states should be at least $250 billion.
The Upjohn Institute researchers say recovery over the next few years will be “seriously harmed” if states and local governments are forced to cut spending, lay off teachers and other workers, which will cascade through the economy and lower consumer and business confidence.
“You go on and on. The economy is interconnected,” Bartik said, anticipating “very large effects” on state and local budgets. “So far the federal government has really not come close to adequately responding to that. If every state and local government is making spending cutbacks, that in turn changes spending and will depress the U.S. economy.”
Meanwhile, the full effect of the coronavirus remains unknown. Bartik said a “V-shaped” economic recovery with a quick decline and quick rebound is increasingly unlikely due to the ongoing health concerns. Additionally, the $350 billion federal small business loan program included in the CARES Act is “too convoluted, too slow and too small,” he added.
“This could be a very prolonged recession that lasts a few years,” he said. “I think it’s unlikely it’ll be a V-shaped recovery.”
Doug Rothwell, president and CEO of Business Leaders for Michigan, said potential shortfalls would hit state and local budgets when there’s already “not a lot” of room to cut.
“We’ve known for a long time the General Fund doesn’t have a lot of elasticity to it,” he said. “This is going to make that even more severe. … The federal funds should help in the short run, but the question is just how long the recovery will take.”
It’s difficult for state and local officials to give precise estimates since revenues were hit in the second half of March, said Chris Hackbarth, director of state and federal affairs for the Michigan Municipal League.
But the next two months should offer a clearer picture. The state’s revenue estimating conference is next month, and constitutional revenue sharing from the state sales tax — which makes up local governments’ second-largest revenue stream behind property taxes — is distributed to municipalities in June.
Twenty-four Michigan cities also have a local income tax, yet unemployment income is not taxable at the city level, Hackbarth said.
The MML is backing efforts by the National League of Cities in pushing for the next stimulus package to include “direct aid” to communities that could provide budget relief. The organization also is calling for a stabilization fund for municipalities, converting federal loans to grants and a prioritization on infrastructure projects, among other provisions.
But potential business closures and falling tax revenue will cause “major ripple effects,” Hackbarth said, adding that local governments have yet to recover fully from the 2008 recession.
“That’s where you’re going to see if we have an extended slowdown of the economy,” Hackbarth said. “If we end up in another situation with property values falling and no ability to grow, you’re going to see a major issue with local governments in Michigan being able to stay solvent.”