States benefit from conducting budget stress tests during a recession, given the competing demands for limited resources facing leaders at times of fiscal distress, according to Utah’s legislative fiscal analyst, Jonathan Ball.
Testing a range of potential economic scenarios is key: Budget stress tests help decision-makers “know how bad things will get and think about what you would do in the situation, hopefully avoiding crisis-driven decision-making,” Ball told participants in an Oct. 22 webinar sponsored by Pew.
Ball and other speakers at the event—Maddy Oritt, staff economist in Ball’s office, and Juliette Tennert, chief economist at the Kem C. Gardner Policy Institute at the University of Utah—stressed the need for long-term planning and analysis to deal with problems caused by this recession driven by the COVID-19 pandemic.
Many analysts expect that the economic fallout could last until at least the middle of the decade, which means that states will likely struggle to balance their budgets unless they are prepared to act.
The three speakers from Utah shared the fiscal management tools that the state uses to prepare for and respond to economic downturns. They discussed why Utah conducts budget stress testing, how they have adapted their methodology to the pandemic, and how the results affect the available budget balancing tools.
Budget stress testing: Why and how
By looking at a range of scenarios, budget stress tests help states estimate the budget shortfalls that could result from adverse events such as an economic downturn or a pandemic-induced recession. Tennert opened the discussion by asking why Utah does a budget stress test.
Ball said stress testing allowed Utah to gather lessons learned from the Great Recession, including figuring out what could be early warnings for the next recession. Incorporating a budget stress test into routine planning allows the state to account for economic downturns and manage business cycles. And that helps policymakers make sound long-term plans.
Once the COVID-19 recession hit early this year, Utah modified how it handled its regular tress testing. The updated stress test assumes a severe two-month economic shock to reflect the pandemic’s effect on the state’s economy, followed by a moderate recovery.
Fiscal toolkits are a helpful starting point
Ball and Oritt emphasized that the usefulness of a budget stress test lies in its ability to inform policy, but leaders must also plan for how to use that information. Policymakers in Utah knew they needed to first estimate the level of budgetary risk from declining revenue and increased expenditures. Next, they developed a series of policy options ranked by both their ability to fill a shortfall and the ease with which legislators would be able to access them. Preparation of such a “fiscal toolkit” allowed Utah to quickly mitigate the fallout from the pandemic and the ensuing economic crash while dealing with uncertainty about federal stimulus help.
According to the presenters, cataloging the order of budget actions available to state policymakers—such as tapping a rainy day fund or issuing debt to pay for projects currently financed with cash—can be beneficial, regardless of whether they perform stress tests. Many states are already making budget balancing decisions in response to the ongoing recession.
The impact of cataloging potential actions can be substantial. Ball noted that from April to June this year, Utah used a variety of tools to find over $700 million in cash flow, saving the state significantly more than the cost of the staff time to perform the stress test.
The order of use and fiscal impact in Utah’s toolkit would likely differ from those of other states because they may have other tools available, different large expenditures, or varying statutory or constitutional barriers to using specific options.
Ball said his team also found it helpful to consider political will when creating the toolkit, noting that political preferences for policy actions—such as tax increases or spending cuts—will vary state to state. Creating a toolkit helps policymakers and businesses because they would have a better idea of what to expect from legislators, he said.
Although a toolkit does not guarantee what will happen, knowing a likely path—informed by experience and careful estimation—can help guide decisions in a methodical way, rather than one driven by disasters.
“Right now, you can look at what you’re doing to survive this. And that will start to inform your stress testing after we’re out of this. Start by making a list of all the actions you’re doing to get through this,” Ball said. That kind of thinking, he added, can help policymakers be better prepared for the economic twists and turns to come.
Jeff Chapman is a director, Airlie Loiaconi is a senior associate, and Sara Estep is an associate with The Pew Charitable Trusts’ state fiscal health project.