The Great Recession that began December 2007 and ended in June 2009 preceded one of the weakest economic recoveries on record, with both wages and employment stagnating well into the following decade. The public sector in particular—local, state, and federal employment—failed to rebound to pre-recession levels for many years after the recession ended, and in some parts of the country was still below 2007 levels when the COVID-19 pandemic began.
In California, as in the United States as a whole, public sector employment has never recovered when accounting for population growth. Inadequate federal stimulus, significant state budget cuts, restrictions on local revenue options, and overall stagnation of employment and wages throughout the economy, all affected California’s economic recovery.
This persistence of public sector declines after the Great Recession should inform state and local policy responses to the job and revenue losses driven by COVID-19 in order to avoid a weak post-pandemic recovery. Although private sector employment grew strongly after 2009 (12% from peak to peak—December 2007 to February 2020; 18% from the February 2010 trough), economists have characterized the post-recession period as much weaker than previous recoveries. Wages stagnated, precarious (part-time and informal) employment ballooned, and the share of labor force participation lagged well behind previous eras, despite a historically low official unemployment rate. This weak recovery can be attributed to many factors, but the insufficient public sector recovery is an important one.
This brief summarizes the Great Recession’s impact on public employment and the public sector job losses driven by the COVID-19 pandemic in 2020. Our analysis points to the importance of focusing on the public sector as policymakers respond to the COVID-19 crisis. The key takeaways from our analysis include:
- The Great Recession, which was more sharply felt in California than nationally, was followed by a weak recovery. The economic expansion of the past decade was characterized by widening inequality and increasingly precarious economic status for many workers.
- From 2008-2013, 163,500 California public sector workers lost their jobs. These losses were in addition to furloughs and other earnings reductions across state and local governments.
- California’s public sector, although it finally surpassed pre-recession employment at the end of the 2010s, has fallen far behind the state’s population growth.
- Since February 2020, more than 150,000 state and local employees in California have already lost their jobs. As local governments adopt 2020-21 budgets that account for dramatic revenue losses from COVID-19, we expect to see those losses climb significantly.
- The public sector continues to be a path to the middle class for Black workers, who are more likely to work in the public sector than all other racial groups. Data from the Great Recession suggests that public sector budget cuts disproportionately impacted Black women.
Read full brief at the UC Berkeley Labor Center site:
Published May 14, 2020 as part of the UC Berkeley Labor Center’s Covid-19 Series: Resources, Data, and Analysis for California.
The economic consequences of the COVID-19 pandemic have been severe: at least 30 million people have lost their jobs and millions of others have seen their incomes decline. Governments are spending billions of dollars on public health and the safety net. As state and local governments grapple with the revenue loss and spending increases associated with the pandemic, the specter of significant cuts in public spending threatens the livelihoods and employment of public sector workers in a second wave of economic contraction. State and local governments will need an estimated $1 trillion to avoid massive cuts, according to the federal government’s own economic projections.
On May 14, the Governor of California released his revised budget proposal for 2020-21 projecting a revenue decline of 22.3% and a $54.3 billion shortfall. Many cities, counties, and school districts have already begun budgeting for the coming fiscal year and face similar deficits. How will these fiscal impacts affect California’s economic recovery?
In this post we examine the likely impacts of the pandemic on local budgets, the factors still unknown, and the principles that must guide California’s response to this ongoing crisis.
The Factors Shaping Local Budgets
The timing and severity of the fiscal impacts from COVID-19 on local governments will depend on several factors that are difficult to estimate, adding significant uncertainty to the local budgeting process:
- The public health crisis will drive both public health expenditures and the length of economic shutdown; its evolution will depend on the development of treatments and vaccines, testing capacity, and the behavior of the virus in coming months. California’s reopening roadmap will guide county modifications to stay at home orders.
- The long-term economic effects of the pandemic: business survival and reemployment rates, consumer purchasing power, individual and corporate debt burdens, and many other factors will shape the economic recovery. Many experts have dismissed the possibility that the economy will completely bounce back in a “V-shaped” recession: a short and sharp shock followed by a return to previous levels of employment and economic growth. Instead a U or L-shaped recovery looks more likely.
- Federal aid to state and local governments: this could take the form of direct allocations, lending, increased categorical funding (e.g. for medicaid or education), or other means. The CARES Act funding for state and local governments is only the beginning of what’s needed. The California Legislative Analyst’s Office (LAO) has analyzed COVID-19 funds flowing to the state. Democratic policymakers have proposed $1 trillion in federal aid to state and local governments.
- The California state budget: the legislature must adopt a budget by June 15, 2020, but given revenue uncertainty this will likely be a “baseline budget” for 2020-21, with possible revisions in August after sales and income tax revenues are fully known. The Governor’s budget proposal of May 14 includes significant program cuts, 10% pay decrease for state workers, some new revenue sources (including temporary suspension of some tax breaks), as well as borrowing and drawing on reserves. It will take several months to know the impacts of the state’s budget on local governments, the number of public jobs and income of public workers.
- Finally, state and local policy choices made in the coming weeks and months will determine whether the public sector helps California’s economy recover or holds it back. After the Great Recession, California’s public sector lagged the private sector in job recovery, creating a drag on the economy and exacerbating poverty and inequality. Fiscal policy that invests in the public sector—rather than cutting services and jobs—will be important for the state’s long-term recovery, particularly given the importance of public health infrastructure to permit reopening of businesses, schools, and other facilities.
How California Revenues will be Affected
The LAO publishes a comprehensive guide on California’s tax system. Here are some basics about how different jurisdictions are funded:
- California’s state revenues come from personal income taxes (67%), sales and use taxes (18.4%), corporate income taxes (10.4%), and other sources (fees etc.; 4.2%). (2020-21 proposed budget). Half of California’s personal income tax revenue comes from the top 1% of earners.
- Cities rely on sales and use taxes, gross receipts taxes, property taxes (including property transfer taxes), business license taxes, hotel taxes, and utility user taxes. Cities can also levy parcel taxes for specific purposes.
- Counties: the bulk of county programs are funded by intergovernmental revenues including state and federal funds. Local sales and use taxes, vehicle license fees and property taxes are the primary sources of funding for programs that are not funded by state or federal funding sources (although these programs may be governed by state mandates even if locally-funded).
- School districts receive most of their funding from the state budget (58%), local property taxes (22%), other local funding (including parcel taxes; 10%), federal funding (9%), and state lottery proceeds (1%). Most districts receive a calculation of revenues from the Local Control Funding Formula (LCFF) which is partially need-based. The amount the state distributes through LCFF depends on the state’s overall budget (Prop 98 guarantees schools a percentage of the state budget). The state also provides districts with earmarked funds for specific activities (e.g. special education) based on need. Federal funding is also need based. A small number of “Basic aid districts” are funded entirely from local revenues, with limited supplemental funding from the state and federal sources. The Governor’s May budget includes a 10% cut in LCFF funding, with some preservation of special education categorical funding.
- Special districts typically rely on service-based revenue streams (e.g. bus fares, bridge tolls), but some (e.g. fire and hospital districts) may get a share of property taxes.
- Higher education receives state funding, fees for tuition and student services, and some federal funding. UC is the most dependent on tuition and fees; community colleges receive more state support per student, similar to K-12. UC and CSU are particularly dependent on revenues associated with student activity: housing revenues, meals, athletic events, and parking.
Here’s how these different revenue sources have been or will be affected by the pandemic:
- Consumer purchases have fallen sharply because of lost income and shelter in place orders—sales tax revenues will fall sharply for the 3rd and 4th quarters of fiscal year 2019-20, continuing into 2020-21. There is a time lag between when businesses collect sales taxes and when they send those funds to the state, so we don’t have clear estimates yet. The Governor also gave small businesses a 12 month grace period to send taxes of $50,000 or less. The nature of this public crisis—with mandated business closures—may result in more dramatic suppression of consumption than in previous recessions, particularly for certain retail sectors such as restaurants. For example:
- Los Angeles County projects $1 billion in lost sales tax revenue through June 30, with another $1 billion lost in 2020-21.
- UC Davis estimates that gasoline sales tax revenues have fallen 75% a week, as gas prices fell and driving ground to a halt.
- California personal and corporate income taxes for 2020 will be significantly lower than the state’s original projections due to widespread job and income loss. The Congressional Budget Office projects 14% unemployment in the second quarter of 2020, and a 12% decline in GDP. 2019 income tax revenue will not be affected, but because the state delayed filing from April 15 to July 15, income tax revenues cannot be accurately projected until after state and local budgets for 2020-21 have been adopted. We have already seen a decline in payroll tax collections. California’s reliance on taxes on the highest income earners and capital gains will cause a steeper drop in income tax revenues than other states if the financial markets close significantly lower in 2020. Recovery of income tax revenue will be driven by the economy; income tax collections typically recover more slowly than sales taxes.
- We have already seen enormous drops in tourism-related revenues—such as car rental excise taxes and transient occupancy taxes. Some of these revenues will remain at nearly zero while hotels are closed and nonessential travel generally prohibited. For example:
- San Francisco projects a 32% drop in hotel taxes for FY 2019-20
- San Diego projects a 14% drop in transient occupancy taxes in FY 2020-21
- Reduced economic activity will cause declines in income from fines and fees (e.g. new businesses opening, new licenses, construction permits, bridge tolls, etc.). This is particularly affecting revenues tied to transportation—parking tickets, bridge tolls, gas taxes, transit fares. This drop will last through shelter in place orders, with recovery dependent on the nature of returning to work and broader economic recovery.
- There has been no delay in property taxes due April 10, On May 6 Governor Newsom issued an executive order that suspends until May 2021 the ability of county assessors to levy late fees for property tax payments. Reduction in the number of property transactions will drive a drop in property transfer taxes, at least temporarily. A lengthy recession (which most local governments are treating as a worst-case scenario) could reduce property values (which we are already seeing in the commercial rental market), sparking downward assessments and reductions in sales prices.
- Lost revenues for governmental activities that are self-sustaining in normal times (e.g. after school care, school meal programs, and collegiate athletics) will create shortfalls that must be covered by general funds.
All recessions are accompanied by increasing demand for safety net expenditures; this crisis is no exception, although the magnitude of need has already outpaced the Great Recession. The pace of job loss is much faster and the number of unemployed significantly higher.
Equally important, unlike previous recessions, the pandemic has increased the need for high levels of spending on public health, housing, and other measures to prevent virus spread. CSU reported $50 million in COVID-19 related expenditures as of May 12; California projected $7 billion in such spending through June 30.
Throughout 2020-21, the additional cost of providing public services—everything from transit to K-12 education—while complying with public health directives will be significant. Only some of these expenditures will be offset by federal relief. The state is also spending significant amounts of money on Unemployment Insurance (UI) benefits and MediCal as people lose their jobs and health insurance, although both programs have their own funding structures separate from the state’s general fund.
The contributions that local governments are required to make to public pension plans may also increase if investment returns fall short of targets. As of March 31, CalPERS returns were at -4.1% for the fiscal year, well off from its 7% target for the fiscal year (this predates the April and May market rally, so it’s possible some of that loss will be recovered). Jurisdictions with their own plans may also face increases in annual required contributions. School districts already faced ongoing increases in state-mandated contributions to CalSTERS.
California will enter the 2020-21 budget year with an estimated $20 billion in rainy day reserves. School districts are required by state law to demonstrate minimum reserves, but actual reserve levels vary widely; large districts typically have well under 10%. Cities and counties adopt their own reserve policies. Many local governments are entering this downturn with greater reserves than the last recession, although school districts and some cities were already significantly fiscally stressed before COVID-19.
General fund reserves can help jurisdictions bridge revenue shortfalls and emergency expenditures, but will be quickly exhausted if local governments do not receive external funding. Local jurisdictions will likely be exploring ways to access or borrow against restricted funds and reserve balances as the crisis wears on.
Local governments generally cannot engage in long-term borrowing for operating expenditures (most debt that governments carry is related to capital expenditures approved by voters). While state and municipal governments are not generally permitted to borrow for operating expenses, local governments (particularly larger units) often carry short term debt—revenue anticipation notes (RANs) or revenue anticipation warrants (RAWs)—to cover cash flow when revenues lag expenditure needs. More units will need this ability with state delays in tax collection and distribution. The Federal Reserve announced its willingness to purchase short-term debt for states and large cities as a means to ensure access to capital markets.
Unlike the Great Recession, financial markets have not collapsed, so we are not seeing the debt-related problems that faced local governments in 2008-09, although some governments will see borrowing costs increase if their credit ratings are downgraded. Moody’s has already downgraded one California school district and the City of Sacramento.
School districts can borrow against future revenues from county boards of education, which will be necessary for some districts as the state has delayed its June apportionment payment until July, straining districts with low reserves.
Principles for Responding to Fiscal Crisis
There is still much unknown about how state and local budgets will be affected by the COVID-19 crisis in the next year and until we achieve a full recovery. In the short-term, local policymakers have limited tools for raising revenues, although borrowing and accessing reserves and other local assets may help bridge budget shortfalls. State policymakers have more flexibility in terms of revenue measures and access to capital.
The recovery from the Great Recession, a decade after its official end, was incomplete and inequitable. Although unemployment was low and the stock market setting records, incomes had been stagnant for most workers, employment was part-time and precarious for many, inequality was widening rapidly, and public service levels were significantly below 2007 and 2000, the years before our two previous recessions.
As we consider the impact of fiscal shortfalls on the California economy, four key principles must guide the state’s response:
- Provide additional federal aid to states and local governments. There simply is not sufficient fiscal capacity in the states to maintain services without federal aid. The CBPP estimates that states face $650 billion in lost revenues over the next three years. Governor Newsom has said that $1 trillion in federal aid to states is needed. The federal government must use its ability to borrow and deficit spend in order to stave off catastrophe for our state and local public sectors. The Democratic proposal made May 12—the HEROES Act—could provide the level of economic stimulus needed to avoid a severe depression and dire economic consequences for American households.
- Restructure state and local revenues to provide more equitable and stable funding. Many essential state functions were severely underfunded going into this recession, and experts have long agreed that California’s tax structure is volatile and full of tax breaks that benefit those most likely to maintain prosperity through this crisis. A measure on the November 2020 ballot would phase-in a return of market-rate assessments for commercial property taxes, with funding to go entirely to local governments and K-14 education. States may want to consider progressive wealth taxes or improving taxation of multinational corporations.
- Build a robust public health infrastructure. Our economy’s ability to reopen and rebound will depend on a public health system capable of testing Californians, tracing contacts, isolating outbreaks, and housing and treating those who lack adequate healthcare. A federal jobs program approach to public health (which California is likely to attempt in part) could provide much-needed economic stimulus.
- Find ways to avoid the public sector job losses of the Great Recession. California should not repeat the mistake of allowing cuts to the public sector to drag down the economic recovery. Public sector jobs have been a pathway to the middle class for African-Americans and women in particular. Public jobs are an important source of stability for many communities, especially those already hit hard by this pandemic. Low-wage workers are especially reliant on public services such as transportation, child care, and public school programs, and will suffer if those services are cut. Preserving public jobs—through job sharing, new revenue sources, borrowing against public assets, and targeted salary reductions instead of across-the-board cuts—is a crucial piece of the economic recovery puzzle.
I spoke with an sfgate.com reporter recently about how the COVID-19 crisis could impact Bay Area local governments. As always, there is a lot I said that didn’t make it into the article so here’s a bit longer ramble. I’m working on updating the numbers and data underlying these thoughts, so this is just some general concepts we should be thinking about.
How is this recession different from all other recessions?
The short answer is that every recession is different from every other recession—people (ahem, economists) tend to greatly overestimate our ability to predict how recessions and recoveries will unfold based on previous experience. The recovery from the Great Recession was quite different from previous recoveries (tl;dr: terrific stock market performance but very unsatisfying labor market performance from the perspective of workers).
People with far greater expertise in labor economics / macroeconomics have already discussed how this crisis may unfold, although I think we really are in some uncharted territory here. The key differences I see as relates to local government impacts include:
1. The impetus
The immediate trigger for the current slowdown is a public health order that has forced businesses across the economy to abruptly cease or reduce activity, regardless of their economic soundness. The Great Recession had several drivers, including inflated property values, complex financial instruments, stagnant wages suppressing actual consumer buying power, etc.—this all came to a head when financial markets famously collapsed in 2008, but many local governments had been seeing revenue slowdowns in the preceding months. In the current recession, the impetus is much more abrupt and steeper, although some of the underlying economic factors may impact the depth of recession and the recovery. The overall stagnation / decline of consumer power and labor market precarity is higher by some measures than before the Great Recession, but the immediate impetus for the slowdown is a public health order, which means that revenues will drop *very steeply* and that many businesses which were fundamentally sound and prospering in February will not exist in June or whenever the economy reopens. The consumer buying power that drove their revenues won’t have evaporated, but the businesses themselves simply won’t have the cash flow to stay alive. This all has implications for the timing of revenue losses and when / how we should expect to see revenues recover. (And of course, people work for those businesses, so the cycle of unemployment and business failure will repeat itself over the coming months.)
All recessions bring uncertainty about when the end will come, what recovery will look like, how people and firms and governments will respond, and how those responses will weave together and feed off each other. In this case, the uncertainty is also driven by scientific uncertainty: how quickly a vaccine can be produced. These scientific and behavioral and social uncertainties add a level of complexity specific to this circumstance.
3. The spending impact:
In any recession, the biggest challenge governments face is declining revenues at a time when governments should be spending more money: on unemployment insurance, food aid, income supports, etc. COVID-19 has perhaps made this doubly true: we have unexpected costs managing a public health crisis, paying for scarce medical supplies, setting up temporary hospitals, closing up public parks, policing public health orders, housing vulnerable residents, along with all of the income support and other spending that accompanies an economic downturn. These spending imperatives to protect human life and health are atypical, and the federal government’s inaction (along with our complex healthcare system) make it very hard to estimate the total volume and distribution of this spending.
4. The role of geography:
In part because of the housing market’s relationship to the Great Recession, geographic impacts were fairly uneven, depending on economic diversity, fiscal structure, and other factors. Cities that had experienced huge growth driven by inflated property values (e.g. Las Vegas), and whose employment base was heavily concentrated in construction (e.g. California’s Central Valley) were hit particularly hard with unemployment and foreclosure rates (which translated into property values plummeting and unpaid taxes). Other cities rebounded much more quickly, including (famously) the Bay Area. The current crisis is nationalized to a much greater degree, although the impact of the virus itself may be more uneven, leading to divergent recovery rates. Economic diversity still matters a lot (can most of your businesses transition to work at home? Or is your town dominated by a meat supplier that just closed down?), but the impacts on workers and industries will be different than previous downturns, because they’re at least initially driven wholly by the public health emergency and the government’s determination of “essential” businesses and workers.
Which cities will be hit the hardest? Some of that is a public health question: New York City and State, if left on their own, would be the most devastated if current trajectories hold (obviously other viral waves will pop up in different places). We can expect that federal aid will mitigate some of that disparity, but perhaps not much of it. Some of that is an economic question—which businesses survive?—and some is a revenue mix question—which places were better prepared for a fiscal downturn? In the short term, cities that rely particularly on tourism-related revenue sources (e.g. San Francisco, as stated in the article) will see a steeper falloff in revenue. It would take some deeper analysis to predict which cities are most vulnerable in the long-term, but revenue mix and the ability of cities to adapt fiscally (i.e. by raising taxes, borrowing, or shifting money around) will matter a lot.
Here are some more detailed thoughts on a few of these items:
Local governments rely on several sources of revenue, some of which they control absolutely (e.g. revenue sources that are collected by local governments and absorbed into their general fund), some of which are locally-raised by earmarked (e.g. ”soda“ taxes), some of which are collected and redistributed by the state (e.g. property taxes), and then intergovernmental sources (state and federal funding – sometimes called “aid” but that’s a bit of a misnomer). Here’s how the revenue impacts may differ from previous recessions:
Local governments are already experiencing an abrupt drop in sales tax revenues driven not (only) by reduced consumer power caused by income loss, but by the fact that people can’t leave home to spend their money, or are feeling hesitant about their economic prospects. Some households may not be reducing consumption much, but the spending may shift to different jurisdictions and activities. Others will postpone spending, and still many more households will simply not have as much to spend in the coming weeks and months because of lost income. Much of the essential spending consumers are still making is exempt from sales taxes. Much of the spending that isn’t happening now will never happen, so it’s safe to say that sales tax revenues for the 2019-20 fiscal year will be significantly below the projections on which budgets are based. Sales taxes also dropped quickly in the Great Recession (followed by income and property taxes, which are more time-lagged), but the drop-off was not nearly as steep as it is now. California relies heavily on sales taxes for state revenue, as do cities and counties (disproportionately when compared to other states, because they have so much less flexibility on property taxes).
We have seen unemployment numbers after just a few weeks exceed the numbers for an 18 month period in 2008-09, and there are predictions that the number of new unemployment claims will increase by as much as 25%. In California, the unemployment rate statewide and in our large cities hit about 12% over the Great Recession; we may see twice that rate by summer, although it may bounce back more quickly. These employment impacts have enormous implications for lost income tax revenues and huge federal and state expenditures on unemployment insurance (expenditures is my next post…). This is a compacted impact on income tax revenues that we haven’t seen before; some of that loss will be realized when taxes are filed in early 2021, but keep in mind that much of that income tax is withheld from paychecks every month—this means we can estimate some of the impact, but also that the state will realize that dip in its cash flow in the very immediate term. Predicting the total loss of state and federal revenue from income-based revenues alone will be a sobering task (and that also includes paycheck withholding for social security, state paid leave programs, etc.). States working on their 2020-21 fiscal year budgets will need to include that in the revenue projections they’re making now. Local governments need to plan for reduced state support and reduced state spending.
California’s income tax structure depends heavily on very very rich people having a lot of income. People have warned for years that this leaves California vulnerable to recessions and market downturns: we’re about to live that reality. The stock market could close 2020 as much as 10% below where it started; in fact, that seems all but certain. It’s unclear yet how the stock market impacts will differ from the patterns in the Great Recession, but it seems likely that many of California’s wealthiest taxpayers will have no capital gains in the 2020 tax year. Given the impact on businesses already, we can also expect that California’s corporations will be reporting much lower taxable incomes for all of calendar year 2020.
In the wake of the Great Recession, property tax revenues fell soon after sales and income taxes did, as the value of properties fell through reassessments or sales (commercial owners in particular are quick to demand reassessments downward); property transfer taxes, which Oakland and San Francisco both rely on heavily, fell much sooner and more steeply. Unlike property taxes, which are collected twice a year based on existing assessments (which means their decline takes longer to appear in city budgets), transfer taxes are paid at the time of sale. When the property markets froze up in 2008-09, those revenues fell immediately. We don’t know yet how COVID-19 will affect property values, although transactions have declined already, that could theoretically rebound when shelter in place orders are lifted.
The longer term impact on property values is less clear. Commercial real estate will likely be impacted far more, and more rapidly, than residential property, particularly in the Bay Area as restaurants and retailers go out of business and other companies reduce the amount of office space they need through teleworking. The distribution of property taxes in California is incredibly complex, but in general this will hit counties, special districts, and particularly school districts.
Fees and fines
Many local jurisdictions (cities, counties, and special districts) also rely on fees and fines extensively (license fees, transit fares, bridge tolls, court fines). These have plummeted very quickly for some entities (especially in transportation), and more slowly for others (court fines, license fees, construction permits). Some agencies can expect federal support until revenues rebound, but we can expect a slow climb back to normalcy depending on (1) the depth of overall economic decline (for which previous recessions may be informative) and (2) the effect of ongoing social distancing on things like commuting and public transit (more difficult to predict). The short version is: revenues will drop precipitously, and for some entities this will be catastrophic without aid.
There are other cash flow impacts beyond these differences in time frame. Governor Newsom announced a one-year reprieve for small businesses to pay sales taxes. State and federal income tax returns are now due July 15, rather than April 15. This means both refunds and payments are delayed (although filers expecting refunds may have filed earlier anyway). States and the federal government are able to manage cash flow issues much more than local governments; how Newsom manages the delay in sales taxes (much of which goes to city and county governments) remains unclear. The Federal Reserve announced last week a program to buy up short-term municipal debt for large cities (more on that in the next post).
There has been no postponement of the April deadline for property tax payments (and unlike income and sales taxes, property taxes are mostly paid in two lumps), but many counties will not collect late payment fines. Landlords who aren’t evicting tenants for lack of rent payments may not pay property taxes; homeowners who get mortgage payment breaks may also forego escrow payments. Of course, some of this happens during any recession, but again the abruptness and depth of the shutdown, along with the prohibition on eviction, will produce a different outcome.
Revenue mix and fiscal flexibility (aka fiscal policy space):
The reporter asked me specifically about California’s history of setting fiscal policy by proposition and whether that would hurt the state’s ability to adapt. The article highlights one issue: California’s reliance on capital gains taxes. I’m going to write about this in another post—I do want to emphasize that taxing the very wealthy proportionally is desirable, for many reasons. But designing tax structures that leave your state overly vulnerable to economic cycles (particularly to the stock market) exposes you to significant revenue volatility. (Not necessarily a bad strategy, as long as you bank the upswings in a reserve). Allowing voters to constrain your fiscal options is also undesirable: Proposition 13 constraints local autonomy, depresses the tax base, and creates enormous inequities between taxpayers. It’s one reason California is more dependent on the more cyclical sources of revenue (income and sales taxes). There are other propositions that constrain the state legislature’s spending options, reducing flexibility.
State and city relationships
What happens at the local level will depend a lot on what the state and federal government do in the next few days, weeks, and months. On a webinar last week about the funding in the CARES act available to local and state governments, one of the presenters said: “Now is not the time to have arguments between city and state government.” This sentiment sounds great, but is very complicated in reality. I’ve written a lot about the dynamics between cities and states in times of fiscal crisis. We’re lucky in California that there is not a clear anti-urban bias at the state level: in fact our largest metro areas wield a great deal of power at the state level and the Bay Area has produced the two most recent governors (Jerry Brown was the mayor of Oakland; Gavin Newsom was the mayor of San Francisco). We don’t have the same ideological battles that have dominated Wisconsin and Michigan for example, or the many states whose legislatures have preempted local government policies such as minimum wages or paid sick leave.
That said, states often find it impossible to resist or avoid passing their own fiscal troubles onto cities. In the interview I said that Jerry Brown was hard core about making local governments absorb some of the state’s revenue losses; his elimination of redevelopment agencies* and other locally-controlled tax breaks was but one measure for doing that. It’s hard to know at this point what Newsom’s strategy will be.
After the Great Recession, we saw a resurgence of both municipal bankruptcies and of state control over municipal finances (through a variety of tools), Detroit being the most extreme example of both.
* The article says that Brown cut funding for redevelopment agencies; this simplifies things quite a bit—redevelopment agencies allowed local areas to capture tax revenue increases and use those funds for a variety of things. The state backfilled those revenues for counties and school districts, in part. Eliminating the redevelopment agencies saved the state a lot of money.
In general, states and cities cannot deficit spend (unlike the federal government, which can borrow and/or print money to do so). But states and cities do have some flexibility in how they prepare for fiscal downturns. One of the biggest variations in state fiscal context is whether are permitted to accumulate surpluses, such as California’s rainy day funds. Many states and local governments built up higher reserves after the Great Recession, including California. This is likely to insulate California, and therefore California’s local governments, significantly more than other states.
School districts in California, on the other hand, are on the whole much worse off in terms of reserves than they were going into 2008. Most school districts are barely achieving the state-mandated 1-3% reserve 3-years-out (1% for larger districts), and have been deficit spending for several years. There is simply no capacity at the local district level to absorb a fiscal shortfall like this.
I saved a few things for next time:
- Debt and other obligations, including public pensions: this was a big part of the story in the Great Recession. What role will debt, municipal debt markets, and related entities play in the crisis and recovery?
- Expenditures: obviously a big variable in whether any entity can withstand lost revenue is how much expenditures can be reduced. For many government entities, the ability to downsize spending is very limited, and the need to spend more (see above) may outweigh any discretionary spending cuts.
- Federal stimulus: how does the federal government’s response in 2008 and after compare to the federal response to date?
SFGate: ‘San Francisco is particularly vulnerable’: Expert explains how COVID-19 may hurt city budgets
“In every recession, it’s true that you’re losing revenue at the same time as you want to be able to spend more money,” Hinkley says. “Counties and cities have to be spending more on public health, on housing people, on emergency equipment, on ensuring that people are staying at home. It’s difficult to manage spending in the short term when you know that there is additional spending that you have to deal with. I don’t know what other options local governments really have at this point.”
See full article on the SFGate