States are flush with cash, which could soften a possible recession

Los Angeles is one of the large US cities that have directed more money to rainy-day funds. (Photo: AP)
Los Angeles is one of the large US cities that have directed more money to rainy-day funds. (Photo: AP)

Summary

Rapid recovery, federal stimulus leave state finances in historically strong shape

States are Flush With Cash, Which Could Soften a Possible Recession

BY DAVID HARRISON | UPDATED 2月 05, 2023 05:30 凌晨 EST

Rapid recovery, federal stimulus leave state finances in historically strong shape

State governments are entering 2023 with record-high reserves, which could help the overall economy weather a recession this year.

The rapid economic recovery from the pandemic combined with an influx of federal stimulus money has filled public coffers, allowing governments to squirrel funds away for emergencies.

States will hold an estimated $136.8 billion in rainy-day funds this fiscal year, according to the National Association of State Budget Officers, up from $134.5 billion a year earlier, when they represented 0.53% of gross domestic product, the highest in records going back to 1988. This year’s figure would represent roughly 12.4% of their total spending.

Unlike the federal government, most state and local governments must balance their budgets every year. That means that a fall in tax revenues must be offset, most often by cutting spending and laying off workers, which exacerbates economic downturns. Healthy reserves could make such cuts unnecessary.

On Wednesday, Federal Reserve Chairman Jerome Powellsaid state and local governments “are really flush these days," which could support economic growth this year.

Moody’s Analytics estimates 39 states have the reserves necessary to offset all the revenue expected to be lost in a relatively mild recession. Four more are within striking distance.

City and county governments have also been able to pad their reserves thanks to recovery and stimulus programs. Comprehensive data on local government finance isn’t available yet, but New York City boosted its reserve funds to $8.3 billion in fiscal year 2023, or 11.1% of revenues. Both figures are the highest ever. Los Angeles and Chicago have also directed more money to rainy-day funds.

State and local governments together make up 11% of total spending in the U.S. economy. They account for about 13% of total payrolls, more than manufacturing, construction, retail, or leisure and hospitality.

Rainy-day funds are designed to maintain state services when revenues drop unexpectedly or to keep money flowing to local governments for services such as public schools. States on average cover almost half of public-education costs.

A broader measure of state reserves, which includes all unspent funds, whether stored in specified rainy day funds or not, will amount to 24.7% of total spending this fiscal year, down from 31.7% in 2022, according to NASBO forecasts. By contrast, states held just 8.9% on average between 2000 and 2020. Most state fiscal years run from July 1 to June 30.

“It’s really kind of eye-popping compared to the numbers we saw a couple of decades ago," said Tracy Gordon, a state budget expert at the Urban-Brookings Tax Policy Center.

Economists surveyed by The Wall Street Journal see a 61% probability that the U.S. enters a recession this year. On average, they expect a recession to be shallow and short-lived.

“If [states] wanted to use their reserves and not adjust their budgets, it looks like those reserves would be there to cover most of these potential losses in a shallow recession," said Geoffrey Buswick, government sector lead at S&P Global.

But whether to tap into a rainy-day fund is a political decision that state governors and legislatures will have to make, he added. Some states might choose to cut spending instead. Roughly a dozen states are considering tax cuts this year, according to the Tax Foundation, which could limit the amount of reserves on hand.

Before the Covid-19 recession, states held about 9% of their expenditures in rainy-day funds. Some states used those funds to offset revenue declines early in the pandemic in 2020. But states still reduced spending because they expected a long and deep downturn. State and local government employment fell by 8.1% between February and May 2020 and remains roughly 2.5% below the prepandemic peak. Budget cuts aren’t the only factor for that shortfall. Some employees quit, changed jobs or retired early, leaving shortages such as of teachers in some places.

In 2007, right before the financial crisis, states held less than 5% of expenditures in rainy-day funds. That was one reason they had to make deep cuts during and immediately after the 2007-2009 recession.

There are two main reasons for the states’ upbeat outlook this year. First, the strong economic rebound in 2021 and 2022 following the pandemic-related shutdowns boosted tax revenues more than expected. In the 2022 fiscal year, revenues exceeded forecasts by 20.5%, according to NASBO.

Second, multiple rounds of federal fiscal stimulus directed almost $900 billion to state governments, according to the Committee for a Responsible Federal Budget, of which about 20% remains unspent. States have until 2026 to spend the money.

In Kansas, officials slashed their revenue forecasts in 2020 anticipating the pandemic would trigger a deep recession, said Adam Proffitt, the state’s budget director. Based on those forecasts, the state cut spending by 3.4% in the 2021 fiscal year.

“But as we well know, looking back, it was among the quickest recoveries we’ve ever seen," he said.

Revenues have exceeded forecasts for 28 of the last 29 months, he said, allowing the state to shore up its reserves.

Kansas directed $1 billion to its rainy-day fund in 2022 and this year plans another $500 million deposit, Mr. Proffitt said. All told, the fund would then amount to roughly 15% of the state’s annual general-fund revenues, he said.

“When the economic downturns happen, revenues become more scarce, but the need for services also increases so we want to make sure we have the resources available to provide those services when they’re needed," Mr. Proffitt said.

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