The State of State (and Local) Finances


State and local finances remain a matter of concern. Detroit and Puerto Rico have grabbed headlines, as, to a lesser extent, have Illinois and Chicago, but even apart from these notorious examples people generally worry precarious state of states and cities when it comes to money. People point to unsustainable union contracts, corruption, and grossly underfunded pension obligations among other concerns.

Most of their worries are well founded, if not every single one of them. It will take a long time indeed before state and local finances deserve favorable descriptors. In all likelihood most people working today will not live to see such a day. Children yet unborn will not likely live long enough to see such an event. But if state and municipal finances are still far from strong, they have nonetheless improved. Strains are less acute than they were not too long ago, allowing states and cities to begin rehiring the tens of thousands they laid off earlier in this recovery, a trend that, among others, should help quiet the recession fears that periodically arise in the investment community.

The most difficult period for state and municipal finance occurred during the great recession and early in the recovery. Between 2008 and 2009, state and local tax revenues from all sources fell 4.5 percent in nominal terms and more than 6.5 percent in real terms. Because the recovery proceeded so slowly by historic standards, tax revenues came back only slowly, growing a mere 3.0 percent in dollar terms in 2010, and 5.0 percent in 2011, not much growth in real terms. Federal grants-in-aids rose in Washington’s effort to relieve the revenue shortfall, especially as part of the massive 2009 stimulus program. These expanded a whopping 23.5 percent in nominal terms during that year and 10.3 percent in 2010. Federal transfers became so important that they rose from 14.4 percent of all state and local revenue in 2008 to fully 25 percent in 2010. But even with this help, growth in total receipts remained subdued, rising at only a 2.3 percent average annual rate in 2009 and 2010 in nominal terms, about flat in real terms.

Circumstances forced spending cutbacks. States and cities responded with layoffs among fire, police, and by far the largest segment of their payrolls, teachers. From a peak of 5.2 million employees in January 2009, state payrolls fell 140,000 or 2.8 percent to July 2011. At the local level, where most of the employment is, payrolls dropped by over half a million or 3.6 percent during this same time. By then, tax revenues had begun to pick up, albeit slowly with the slow pace of the economy, growing 4.8 percent in nominal terms in 2011, and a heftier 6.8 percent in 2012. But still, the layoffs continued, in part because budgets still needed repair but mostly because the federal government had by then begun to withdraw its support. Between 2010 and 2012, dollar flows of federal grants-in-aid to states and cities fell 12.1 percent so that overall revenues grew at a paltry 1.5 percent annual rate in nominal terms, a clear decline in real terms. And so the layoffs continued for almost two more years, troughing in mid-2013 fully four years into the economy’s general recovery and almost 750,000 below the combined state and local employment peak in 2009.

Since, states and municipalities have had at last had the ability to contribute to the economy’s general recovery, as they did in past recoveries. Tax revenues since mid-2013 have grown in dollar terms at a still slow 2.4 percent yearly rate, barely in real terms and disappointingly slow by broad historic standards. But the federal government has ceased its cutbacks so that grants-in-aid have stabilized, even grown slightly, allowing total receipts to expand nominally at a 3.5 percent yearly pace, hardly robust by broader historical standards but at least positive in real terms. The change has at last allowed the rehiring to begin. From their lows in 2013, state payrolls have increased more than 80,000 to October this year or more than 1.5 percent. Local payrolls, mostly teachers, have increased by more than 170,000 or about 1.5 percent. Combined, they nonetheless remain more than half a million below their 2009 highs, about 2.5 percent.

The present state of affairs suggests three things about the future. First, because state and local hiring and therefore spending, remains subdued, there is little reason to fear the overextension that has worried some. Second, there is, as a consequence, every reason to expect the improving trend to continue, albeit at its subdued pace. Third, state and local governments should therefore contribute, as they have not until relatively recently, to the overall economic recovery, not sufficiently to propel rapid growth but enough to lessen the likelihood of a recessionary turn.

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