Are State and Local Governments in a Strong Fiscal Position?

The U.S. government spent a tremendous amount of money responding to the COVID-19 pandemic and its associated economic fallout: The first four federal relief acts alone, passed by Congress in March and April 2020,The four pieces of legislation were the Coronavirus Preparedness and Response Supplemental Appropriations Act, Families First Coronavirus Response Act, CARES Act (short for the Coronavirus Aid, Relief and Economic Security Act), and Paycheck Protection Program and Health Care Enhancement Act. increased spending and decreased revenue enough to elevate the federal deficit by $2.4 trillion. These four laws and later fiscal actions, measured relative to the size of the U.S. economy, put the federal COVID-19 response on the same scale as Franklin D. Roosevelt’s Great Depression-era New Deal.My July 2021 Regional Economist article, “How Recent Fiscal Interventions Compare with the New Deal,” provides back-of-the-envelope calculations analyzing the size of the U.S. COVID-19 policy response relative to FDR’s historic New Deal.

Notably, many of these federal dollars were channeled through state and local governments. For example, in addition to funds supporting state and local governments’ response efforts, the March 2020 CARES Act provided $31 billion in grants to states and local education agencies like school districts. A year later, the American Rescue Plan allocated $362 billion for a program funding state and local fiscal recovery.

This blog post looks at whether the fiscal positions of state and local governments have returned to pre-pandemic trends following the outlays in these programs.

The following FRED chart plots federal grants-in-aid to state and local governments from 2003 to 2023. The figure shows two large spikes due to the above acts and that, following those two spikes, grants-in-aid remain elevated relative to the pre-pandemic period.

States’ Surplus Balance Projected to Shrink in 2024

Focusing momentarily on state governments, a state’s total balance in a given fiscal year is the sum of its rainy-day funds and its general fund ending balance in that year. As such, it equals the accumulation of the state’s past surpluses. The figure below plots this amount summed across all states as a percentage of the corresponding fiscal year’s total expenditures.

Combined State Government Total Balances, Fiscal Years 2003-23

SOURCE: National Association of State Budget Officers, Fall 2023 Fiscal Survey of States.

NOTE: Fiscal year 2023 values are preliminary.

Total balances as a percentage of expenditures were roughly in the 10% to 15% range during the years immediately preceding the pandemic. This value increased dramatically during the pandemic, peaking at 38% in 2022. It then fell to 34% in 2023 and is expected to decline further to 23% in 2024, a projection based on states’ enacted budgets. Thus, states as a whole retain a strong surplus.

State and Local Government Spending Remains above Trend

Total expenditures by state and local governments also dramatically increased following the start of the pandemic and remain well above trend. The figure below plots these expenditures from the first quarter of 2003 to the third quarter of 2023 (solid line), as well as the linear trend (dashed line). As seen in the figure, current expenditures are roughly 9% above the trend as of the third quarter 2023, the most recent observation.

State and Local Government Expenditures, 2003-23

SOURCE: National Income and Product Accounts.

Such high expenditures into 2023 may appear surprising, given that federal COVID-19 aid was part of legislation enacted two or more years previously. For example, the most recent COVID-19-related fiscal injection, the American Rescue Plan, was signed into law in March 2021, with additional federal support for state and local governments through the November 2021 Infrastructure Investment and Jobs Act. However, as is often the case with discretionary federal fiscal assistance, spending can occur over a prolonged period.For more on this topic, see my March 2020 On the Economy blog post, “How Quickly Does Fiscal Policy Get Implemented?”

In addition to past federal aid bolstering expenditures and savings, a healthy U.S. economy has contributed to state and local governments’ robust fiscal position through greater revenue from income taxes and sales taxes.

At least in the near term, the overall fiscal position of state and local governments will likely remain strong, as it has been over the past several years.

Notes

1. The four pieces of legislation were the Coronavirus Preparedness and Response Supplemental Appropriations Act, Families First Coronavirus Response Act, CARES Act (short for the Coronavirus Aid, Relief and Economic Security Act), and Paycheck Protection Program and Health Care Enhancement Act.
2. My July 2021 Regional Economist article, “How Recent Fiscal Interventions Compare with the New Deal,” provides back-of-the-envelope calculations analyzing the size of the U.S. COVID-19 policy response relative to FDR’s historic New Deal.
3. For more on this topic, see my March 2020 On the Economy blog post, “How Quickly Does Fiscal Policy Get Implemented?”