Connecting state and local government leaders

Deficit Laden Federal Finances Stir Uncertainty for Future State Aid

The trading floor of the New York Stock Exchange is shown in this photo, Tuesday, Aug. 21, 2018.

The trading floor of the New York Stock Exchange is shown in this photo, Tuesday, Aug. 21, 2018. (AP Photo/Richard Drew)

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Connecting state and local government leaders

Low Federal Reserve interest rates are a concern as well when it comes to how the nation will respond to the next recession.

With the federal budget deficit on track to exceed $800 billion when the nation’s fiscal year concludes at the end of this month, observers continue to question how much state and local governments will be able to depend on help from Washington in the years ahead.

During the past fiscal year federal lawmakers enacted major tax cuts that have reduced revenues, and also passed legislation to allow for increased spending. Congressional Budget Office estimates show the nation’s debt expanding to about $29 trillion over the next decade, at which point it would nearly equal U.S. gross domestic product.

“The long term budget deficit is enormous at the federal level and it suggests massive cuts to state aid,” Matt Fabian, a partner with the research firm Municipal Market Analytics, said during an event earlier this week at the Federal Reserve Bank of Chicago.

“States are going to downstream cuts to local governments,” he added.

Debate about how the federal government’s finances will affect states and localities is getting attention at a time when the nation is over nine years into an economic expansion, and as some forecasters are predicting that a recession could unfold by 2020.

Kim Rueben, a senior fellow with the Urban-Brookings Tax Policy Center at the Urban Institute noted that during the last recession the federal government pumped money toward expenses like Medicaid, schools and infrastructure, softening the financial blow for states.

As states prepare for the next downturn, she said, something they need to think about is “how much can they actually rely on what the federal government is going to be doing.”

“If the federal government in times of surplus is running big deficits, it means that they have less room to provide some of that backstop for state governments,” she added. “In some ways I feel like states need to be more conservative as they’re budgeting going forward.”

Route Fifty earlier this year looked in depth at how federal aid could be harder to come by in the next recession, and some experts suggested then that while the nation would not necessarily face economic roadblocks to stimulus policies, political obstacles could emerge.

But not everyone is convinced that heaps of debt, or budget gaps will scare federal lawmakers away from doling out funds during a downturn. “I’m not as bearish on the Congress side of things,” said John Hicks, executive director of the National Association of State Budget Officers.

“Just because there are big deficits doesn’t mean they won’t spend,” he added. “I think we’ve got evidence to that. And so to forecast that it won’t happen, I think, is too negative.”

Congressional Budget Office estimates predict that the tax overhaul Republicans pushed through Congress last year and that President Trump signed into law in December will increase the nation’s deficits by $1.9 trillion through 2028, after accounting for borrowing costs and the effects the law is expected to have on the economy.

House Republicans are now pursuing follow-up legislation that would extend some of last year’s tax cuts, while also making other changes to federal tax policy. That proposal, which appears to have slim odds of going anywhere in the Senate before this November’s elections, would cost about $657 billion over the next decade, according to the watchdog group Committee for a Responsible Federal Budget.

Looking beyond the leeway Congress has to enact stimulus style policies, the Federal Reserve could be more constrained than in the past in how it can help states by lowering interest rates when another recession arrives. This is because rates remain historically low.

Eric Rosengren, president and CEO of the Federal Reserve Bank of Boston, writing in an article published by The Boston Globe Thursday, notes that in most recessions the Fed reduces interest rates by 5 to 6 percentage points. But short-term rates are now around 2 percent.

“It is unlikely they will be near 5 percent when the next recession occurs,” Rosengren says.

The Fed has other tools, he adds, but “the ability to counter economic downturns with monetary policy alone may be impaired.”

Referring to similar comments Rosengren made this month, William Glasgall, senior vice president and director of state and local initiatives at the Volcker Alliance, put it this way: “The Fed is saying for states that do get affected by any recession down the road, the amount of buffer provided by the central bank is going to be very, very limited.”

Bill Lucia is a Senior Reporter for Government Executive's Route Fifty and is based in Washington, D.C.

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