Prior to COVID-19, the budgets of at least a few municipalities and many states were taking on water. Today, state and local governments face an imminent fiscal tsunami thanks to COVID-19, and the CARES Act will provide little protection. The federal package will keep governments afloat, but reaching a firm fiscal landing will mean doing what seems counterintuitive and steering away from what may seem like the logical thing to do.
The outlook for state and local governments is grim. There’s the expenditure problem: Increased COVID-19 expenses will be incurred immediately. And the safety-net expenditures, such as unemployment costs, will remain throughout the duration of the predicted deep recession. Then there’s the revenue problem. There will be a deep drop in sales, income and tourism taxes. Even property taxes will be constrained.
Over the long haul, states and local governments cannot count on sustained federal benevolence as the federal government will have budgetary problems of its own. Most of those funds will already be earmarked for airport, transit, etc., with not much trickling down.
No doubt states and cities will have some painful choices to make. Making the right decisions will strongly influence the trajectory in righting their fiscal ships. So, what should state and local governments do now? First, do what might seem counterintuitive. Don’t cut spending. As long as COVID-19 risks remain and people need health-related care, state and local governments should accede to any reasonable demands of the medical community.
Governments should take advantage of any forthcoming grants by both their states and the federal government, but read the fine print. Embedded strings may render grants less attractive than they actually are.
Governments should also accept that they are probably going to have to borrow. Timing and flexibility are critical. Most state and local governments are restricted in their borrowing options by balanced-budget requirements or self-imposed policies. But if interest rates are low, there might be reason to temporarily abandon or find creative ways to circumvent these constraints.
The good news for governments is that the Federal Reserve has already signaled it may backstop certain types of municipal debt, and congressional lawmakers have indicated support for some sort of federal lending program. The expected low interest rate environment will make borrowing for capital assets even more attractive. Plans should acknowledge that fiscal health is best maintained by continuing the policies and practices needed to attract and retain both consumers and businesses.
Lastly, don’t leave the rainy-day funds dry for too long. Many governments are fortunate to have established rainy-day funds. The current pandemic is a storm of Noah-like proportions, and now is the time to draw upon them. Any long-term plans, however, should include provisions to replenish them. The current emergency in no way reduces the probability of future disasters.
What governments should not do is discontinue making their required contributions to their employees’ pension funds. Basic principles of compound interest dictate that any apparent savings today will necessitate far greater contributions in the future.
Similarly, governments should think twice about issuing long-term bonds to make up for any shortfalls in their pension funds. Such bonds, referred to as “pension bonds” were risky in the past and will be no less so in the future. Short-term relief will only bring long-term pain.
Cities and states also must abide by the old adage of “if it sounds too good to be true…” Localities should avoid the allure of complicated investment and debt-management vehicles, such as interest strips and swaps, often promoted in slick sales presentations by friendly investment bankers. The fields of municipal finance are littered with governments that chased yields but along the way tripped into a fiscal abyss.
Finally, local governments should eschew “one-shot” boosts of revenue, such as those resulting from sales of core capital assets. These almost always short-change the future at the expense of the past.
As President Franklin Roosevelt said in his first inaugural address, “Only a foolish optimist can deny the dark realities of the moment.” But with careful planning and reasoned decision-making, state and local governments can not only overcome their current fiscal challenges but ensure long-term prosperity as well.
Michael Granof is the Ernst & Young Distinguished Centennial Professor of Accounting in the McCombs School of Business at The University of Texas at Austin.
Martin Luby is an associate professor in the LBJ School of Public Affairs at The University of Texas at Austin.
A version of this op-ed appeared in the Dallas Morning News.
