Uneven Fiscal Prospects for States' Post-COVID Rebound

State lawmakers reconvene this month to map out state fiscal policy for Fiscal Year 2022 and beyond. They face massive, ongoing health and economic hardships punctuated by a year-end drop in payrolls and amped-up pandemic-driven restrictions on business—counterbalanced by a new mindset in Washington, D.C., on additional resources for states and localities. Before looking to the horizon, it is worth pausing and assessing the revenue-and-spending rollercoaster ride that states have experienced over the past year.

Fresh analyses from national experts and individual state spending and revenue reports are beginning to paint a somewhat clearer picture of what has been happening in jurisdictions from California to New York. While there are still gaping holes in our understanding of national and regional trends as well as to their implications for equity and fairness, Neal Johnson Associates provides an up-to-the-minute snapshot of where we stand and what to expect.

From Doom & Gloom to a Glimmer of Optimism?

Perhaps surprisingly, aggregate spending from state funds grew by 5 percent in fiscal year 2020, which for most states ended on June 30. Total aggregate spending from all funds grew by almost 8 percent during fiscal 2020.

An infusion of federal aid in response to the COVID-19 pandemic last spring resulted in a 14-percent jump in federal spending on states—the biggest boost since the Great Recession, according to the National Association of State Budget Officers’ 2020 State Expenditure Report. These funds were distributed through the Coronavirus Aid, Relief, and Economic Security (CARES) Act, which included targeted funds for K-12 and higher education institutions, and the Families First Coronavirus Response Act, which addressed the virus-driven rise in Medicaid spending.

Declining state revenues in the spring and early summer were bolstered by predictions of massive budget shortfalls coming from Wall Street and think tank economists, as well as from states’ economic and budget advisors. Accordingly, governors directed state agencies to prepare for substantial cuts and worked with legislators to backfill early gaps with one-time fixes such as tapping historically high budget reserves as well as transferring funds between accounts and agencies.

As fiscal 2020 general fund revenues dropped by some 3 percent or more in hard-hit states, 19 states reported implementing mid-year budget cuts, according to NASBO’s just-released Fiscal Survey of the States. And the fiscal 2021 state budget blueprints enacted amidst this uncertainty reflect the first anticipated aggregate general fund spending decrease since the great recession—a decrease of 1 percent compared to fiscal 2020, according to this survey. In recent years, the big-ticket state general-funded categories have been elementary and secondary education (36 percent), Medicaid (20 percent), and public higher education (10 percent) in the aggregate, according to NASBO.

Without question, states and their most vulnerable residents still face enormous challenges in what has been described as a K-shaped recovery, in which part of the population and certain business sectors have recovered relatively quickly, while others continue to suffer a great deal—with both economic and health risks looming. 

But recently released data are beginning to provide a bit more clarity on how diverse state economies and tax systems are differentially affecting state budgets. Better understanding of this key inflection point will enable state policymakers to more accurately gauge their capacity to provide needed services, especially to critical policy priorities such as education, health care, and worker upskilling and reskilling to survive the current crisis and prepare for a post-COVID job market.

New Shortfall Estimates: Significant Stresses with Varied State Impacts

A new U.S. State and Local Shortfall Update from Moody’s Analytics projects smaller shortfalls than its earlier estimates had suggested, when actual state spending actions, federal Medicaid supports, and a variety of new economic indicators are taken into account. Reflecting states’ “improved economic outlook” overall, the authors estimate an aggregate state general fund shortfall of between $224 billion and $316 billion in state fiscal years 2020 through 2022, depending on how much the recent surge in COVID-19 infections affects economic growth and health-related expenditures.

States with projected shortfalls of less than 3%. Focusing as we did last year on the 10 states with the largest populations—representing more than one-half of the country’s total—indicates that some states’ prospects remain relatively stable, while others are moving into greater risk of higher budget shortfalls. 

As had been the case through most of last year, Texas remains relatively well-positioned to weather continued economic turbulence, according to the Moody’s analysts—a finding consistent with recent estimates of Texas personal income growth ranging between 5 percent and 12 percent over the next two fiscal years. Among the 10 largest states, North Carolina and Pennsylvania also are projected to join Texas in experiencing annualized general fund revenue shortfalls (net of its reserve funds) of less than 3 percent. (See table, below.)

Could Georgia’s and Ohio’s annualized shortfall push past 3%? Although Georgia’s relative fiscal position has dipped somewhat from Moody’s earlier projections, as of November the state’s tax collections were running almost 6 percent or $550 million above prior-year revenues. At this writing, some legislators cautiously suggested that they might restore some portion of the $950 million that was cut from K-12 education in fiscal 2021, pending new revenue estimates and budget recommendations from Governor Brian Kemp later this month.

States with estimated shortfalls between 6% to 9%. From a position of relative strength in earlier projections by the Moody’s Analytics team, California is now estimated to experience annualized general fund revenue shortfalls of between 6 and 9 percent through fiscal 2022. Other states in this range include Illinois, New York, and Michigan.

California revenue is notoriously volatile even under normal external conditions due to a variety of factors, so it’s not surprising that, in contrast with dire predictions in the spring of major anticipated virus-driven revenue drops, California experienced a “rapid but uneven recovery,” contributing to a one-time revenue windfall of tens of billions of dollars, the California Legislative Analyst’s Office reported in late November. 

Reflecting an uneven recovery across income levels, unemployment hit low-income Californians disproportionately “while most high-income workers have been spared,” resulting in “actual tax collections and program caseloads…consistent with a more positive economic picture,” according to Legislative Analyst Gabriel Petek. Nonetheless, growing expenditures could outstrip general fund revenues by 3 percent or more as early as fiscal year 2022, according to this analysis. This is less than the Moody’s range, but significant nonetheless in the nation’s largest state and economy.

Similarly, Michigan and Illinois collected revenues significantly above consensus forecasts in 2020, according to November reports from the Michigan Senate Fiscal Agency and the Illinois Governor’s Office of Management and Budget, respectively. However, Illinois Governor J. B. Pritzker said that despite a balanced budget for fiscal year 2021, “the underlying structural deficit…has not been addressed,” with annual general fund deficits projected between $4 to 5 billion for fiscal years 2022 through 2026.

Consistent with the Moody’s Analytics projection, New York could face annual tax revenue losses of up to $5 billion over the next four years, “about a 6.7 percent inflation-adjusted decline across the period,” according to the independent Tax Foundation’s recent report on data from the New York Department of Taxation and Finance.

Might Florida’s shortfalls exceed 9%? Of the 10 largest states, Florida is the one state the Moody’s Analytics team projects to experience average annualized general fund revenue shortfalls (net of its reserve funds) of 9% or more in fiscal years 2020 through 2022. This may represent one of the most prominent differences between the Moody’s forecast and the state’s internal projections.

While noting that “the continuing risk to the forecast is still high due to the pandemic-induced economic effects on Florida’s tourism-sensitive economy,” in late December Florida’s legislative revenue estimating conference restored almost 40% of the $5.4 billion revenue reduction it had projected in August—"a two-year combined increase of $2.1 billion.” The conference based its improved outlook on improving state gross domestic product data between July and September, with concomitant gains in sales and corporate income tax collections.

Uncertain Revenues, Escalating Safety Net Demands

State policymakers enter the new year facing an often-perplexing mix of positive and negative trends, specific to each state’s economy, population demographics, and success tackling COVID-19. While some analysts have boosted anticipated GDP based on new expectations of additional economic stimulus from a Democratically-controlled Congress, others remain less sanguine.

“We’re seeing more evidence that the pandemic and economic disruptions have seriously hurt state and local budgets,” says fiscal expert Scott Pattison of the Multistate Tax Commission. “But at the same time, there is a growing sense in some states that it may, in fact, be a manageable fiscal problem.” 

Clearly, further unforeseen crises could put substantial downward pressure on revenues and escalate demands for health care, unemployment insurance, and other elements of the social safety net. “Without additional federal assistance,” says Dan White of Moody’s Analytics, “we project states and local governments will be forced to raise taxes or cut spending by between $171 billion and $301 billion over the next year and a half.”

Neal Johnson Associates will continue to report on the impacts of these historic fiscal shocks to the states and capture best practices in fiscal and policy actions that support all residents—but especially the most vulnerable.

Read U.S. State and Local Shortfall Update, Dan White, Emily Mandel, and Colin Seitz, Moody’s Analytics, December 2020. (Free registration required.)

Summary: 2020 State Expenditure Report, National Association of State Budget Officers, November 20, 2020.

Summary: Fall 2020 Fiscal Survey of States, National Association of State Budget Officers, December 23, 2020.

See The 2021-22 Budget: California’s Fiscal Outlook, California Legislative Analyst’s Office, November 18, 2020.

Watch California Legislative Analyst Gabriel Petek discuss his team’s analysis of California’s 2021-22 budget with members of the press after the November 18, 2020 release of the LAO's report.

Monthly Revenue Report, Michigan Senate Fiscal Agency, November 2020. 

Illinois Economic and Fiscal Policy Report, Governor’s Office of Management and Budget, November 13, 2020. 

Taxes and New York’s Fiscal Crisis: Evaluating Revenue Proposals to Close the State’s Budget Gap, Jared Walczak, Tax Foundation, December 8, 2020.

Executive Summary, Florida Revenue Estimating Conference for the General Revenue Fund, December 21, 2020.

Florida: An Economic Overview, The Florida Legislature Office of Economic and Demographic Research, December 30, 2020. 

Goldman Sachs Research Raises U.S. GDP Growth Estimate, Goldman Sachs, January 8, 2021.