When legislative sessions ended last year, governors and state lawmakers were braced for a prolonged recession caused by the COVID-19 pandemic. They’d frozen hiring for government jobs and cut funding for services such as education, expecting tax revenue to plummet along with the economy.
But the recession lasted just two months. State tax collections came in so much higher than expected last fiscal year—and are expected to grow so much this year—that lawmakers were able this session to restore past cuts, save money for future emergencies and spend more on everything from housing to income tax reductions.
The bonanza doesn’t stop there. States are receiving more than $195 billion in additional money from the American Rescue Plan, the COVID-19 aid package signed by President Joe Biden in March.
Now, rather than fretting about a downturn, state budget writers are wondering how long the boom can last. Some lawmakers worry new spending and tax cuts this year went too far, with criticism falling along familiar partisan lines.
In Idaho, for instance, Democrats say the state may not be able to afford income tax cuts approved this year by the Republican-controlled legislature. “This perception that we’re so flush and have these record surpluses has driven some revenue reductions that I think can actually cause long-term problems,” said state Rep. Ilana Rubel, the assistant minority leader.
In California, Republicans say the state will struggle to pay for new programs enacted by the Democratic-controlled legislature, once federal relief dollars dry up. “The budget is not sustainable,” said Assembly Member Vince Fong, vice-chair of the Assembly Budget Committee.
Forty-eight states have enacted a budget so far this year, according to the National Conference of State Legislatures, an organization that advises state legislators. Most states begin their fiscal years July 1. Lawmakers are required to pass balanced budgets in every state but Vermont.
State budget writers nationwide scrambled to match spending with expected revenues this year. The economists who advise governors and legislatures kept revising their revenue forecasts as summer approached.
“This recession didn’t look like past recessions, at least so far, and I think that has surprised us,” said Colorado state Rep. Julie McCluskie, a Democrat and vice-chair of the Joint Budget Committee. “I think it’s such an unprecedented moment that trying to predict and project has just been very difficult.”
Most governors released budgets in December, January and February, when COVID-19 cases were high and the economic recovery seemed fragile. Governors at the time estimated fiscal 2021 revenue would come in, on average, at 2.7% below pre-pandemic projections, according to the latest survey from the National Association of State Budget Officers, a membership group.
But as budget negotiations continued into the spring, the national COVID-19 vaccination campaign ramped up, business activity rose and budget analysts released new reports anticipating more economic and tax revenue growth.
The March COVID-19 relief package may be sending states more cash than they can easily spend, said Jared Walczak, vice president of state projects at the Tax Foundation, a conservative-leaning Washington, D.C., think tank.
“For most states, the fiscal relief in the American Rescue Plan Act is the very large cherry on top,” he said. “The cherry they don’t know what to do with.”
An Unprecedented Moment
Tax revenues declined in about half the states from April to December 2020, according to the Urban Institute, a left-leaning Washington, D.C., think tank. States with tourism-dependent economies, such as Nevada and Hawaii, were hit particularly hard by business shutdowns and travel restrictions. Energy-producing states such as Alaska and Wyoming were pummeled by low energy prices.
But overall, state budgets fared better than analysts expected. And some states experienced huge increases in tax collections.
“We really didn’t, at any point during COVID, see a drop-off in our revenue,” said Alex Adams, Idaho’s chief budget officer and head of the state Division of Financial Management.
Idaho’s fiscal 2021 tax revenues came in 24% higher than the prior year’s, he said. “That makes that the single largest revenue growth year in state history.”
California collected 20% more in personal income, sales and corporation taxes last fiscal year than it did the year before, according to the state legislative analyst’s office, which advises the state legislature.
“Such growth would have been extraordinary in a normal year, let alone during a pandemic,” office analysts said in an article discussing their May revenue outlook. They expect California to have $7.2 billion more to spend this year than in the prior fiscal year.
Tax revenue grew because the COVID-19 recession wasn’t like past downturns. It primarily affected workers with low incomes. High earners, who pay the lion’s share of income taxes, mostly kept their jobs. Stock prices rose. In California, tech companies rushed to make initial public offerings, further enriching the state’s elite.
Meanwhile, Congress pumped trillions of dollars into the economy, from small business loans to stimulus checks. That helped people pay the bills and splurge on new purchases. Some laid-off workers who went on unemployment actually increased their incomes, thanks to expanded benefits.
Recent tax revenue gains—and a rosy outlook for this fiscal year—allowed lawmakers to spend big on a slew of priorities this session.
Idaho lawmakers put $263 million into the state rainy-day fund and invested in transportation, education, workforce development and broadband. They also approved $220 million in income tax rebates and $163 million in ongoing tax cuts for individuals and businesses.
California lawmakers increased spending on child care, affordable housing, health care, schools and higher education. They approved $12 billion in tax rebates for middle- and lower-income residents.
And Colorado lawmakers restored cuts made last year, boosted budget reserves to a record 13.4% of the state budget, and announced $800 million in additional economic stimulus spending. “Colorado, as far as I know, has not had reserves that high in decades,” McCluskie said.
Even struggling states such as Nevada were able to increase spending this year. Although Nevada Gov. Steve Sisolak, a Democrat, in January proposed slashing $187 million from the state budget, by May economic projections showed the cuts were no longer necessary.
“Basically, the budget had to do a 180,” said Nevada state Rep. Maggie Carlton, a Democrat and chair of the Ways and Means Committee. The final enacted budget avoided most cuts—some were made, mostly to reflect a drop in caseload for certain social services, Carlton said—and included half a billion dollars in new education spending.
A Huge Influx of Federal Aid
The American Rescue Plan further boosted state budgets.
Among other things, the behemoth $1.9 trillion federal law extended pandemic unemployment benefits, issued additional stimulus checks to middle- and low-income families, provided schools with more funds to support in-person learning and set aside $350 billion in flexible funds for states, localities, tribes and territories to use to recover from the pandemic. States get $195 billion of the cash.
States where the unemployment rate has grown by more than 2 percentage points since February 2020 will receive their entire share of the funds this year, while the rest will get half this year and the rest in 2022. All states get $500 million plus additional money based on their unemployment situation.
The money can be spent on efforts to decrease the spread of COVID-19, replace lost government revenue, help people and businesses that are struggling economically, and upgrade water, sewer and broadband infrastructure. It can’t be used to pay for pensions or tax cuts.
For less populous states, it’s a stunning windfall. Wyoming is getting federal aid equivalent to over 22% of total state spending in fiscal 2020, according to research by The Pew Charitable Trusts. (Pew also funds Stateline.) Nevada, New Hampshire, North Dakota, South Dakota and Vermont will receive funds equivalent to more than 14% of their fiscal 2020 spending.
But governors and legislators have until 2026 to spend the money, and many aren’t in a rush to do so. For one thing, the funding arrived at an awkward time. The U.S. Treasury Department adopted its interim final rule on how the money can be spent and invited states to request funds in May—when lawmakers in many states already had finalized their budgets for the next fiscal year.
That’s what happened in Colorado. “We recognized that with the money coming in so late, and the Treasury guidance coming in even later, it was difficult to spend the money in that responsible way when we weren’t totally sure what we could spend it on,” McCluskie said.
She added that while lawmakers spent some of Colorado’s almost $4 billion allocation this session, more than a billion dollars have been set aside for spending next session. Lawmakers plan to focus on three key areas, she said: affordable housing, workforce development and behavioral and mental health services.
In Idaho, lawmakers went home for the year two days after the Treasury announcement. They’ll make most American Rescue Plan spending decisions next year, said state Rep. Rick Youngblood, the Republican chair of the Appropriations Committee. He said lawmakers likely will focus on rural broadband and water and sewer upgrades.
Youngblood noted that some of his colleagues wanted to reject the federal money. “We’re a very conservative state, and there was a lot of discussion of just sending the ARPA funds back,” he said. Ultimately, he said, lawmakers concluded that keeping the money in Idaho was a better option.
Idaho’s Republican-controlled legislature did reject some components of the American Rescue Plan and past federal relief packages, such as funds for COVID-19 testing in schools and for early childhood education. Some conservative lawmakers feared the early childhood funds would go toward teaching social justice concepts, the Idaho Post-Register reported. Others argued that young children belong at home with their mothers.
Before their legislative session ended in June, Nevada lawmakers passed a law outlining guidelines for spending their state’s $2.7 billion allocation. Sisolak and lawmakers on the Interim Finance Committee will begin approving funding under the law this summer.
Many states’ leaders want to use the federal funds to shore up their unemployment insurance trust funds, which are funded by taxes on employers. The funds were drained when unemployment spiked early in the pandemic. Many states had to borrow money from the federal government to keep paying benefits.
By using federal relief dollars to rebuild their funds, states can avoid raising business taxes. Kentucky lawmakers have used about a quarter of the state’s $2.2 billion allocation to refill the state trust fund, for instance. Indiana, Louisiana and Washington state leaders also have set aside hundreds of billions of federal relief dollars for their trust funds.
California lawmakers haven’t done the same, which Fong said is misguided. “Not one dollar has been allocated to that,” the Republican said of paying down California’s $22 billion federal unemployment insurance loan. “That’s been a huge frustration to me, and to the broader business community.”
State Rep. Phil Ting, a Democrat and chair of the Assembly Budget Committee, said that because the business tax increase won’t kick in until 2023, it made sense to prioritize other issues. “We had more immediate needs.”
California lawmakers have so far spent billions of relief dollars on small business assistance, affordable housing projects, broadband expansion, housing for people experiencing homelessness, and much more, according to the National Conference of State Legislatures, which tracks how states spend federal relief funds.
In states that had revenue shortfalls during the pandemic, such as Nevada, lawmakers plan to use federal dollars to fill past revenue holes—including to replace state tax dollars that had been used to restore cuts to state services this session.
That’ll free up state money to spend on other priorities, from infrastructure improvements to rebuilding the rainy-day fund, Carlton said.
The New Normal?
Budget writers and analysts nationwide expect to have surplus tax revenue to spend in next year’s budget, too. But they’re not sure how long the good times will last.
“The growth trajectory—it’s higher than we expected,” said Adams of Idaho’s Division of Financial Management. “I don’t anticipate that it will continue at this pace. I don’t think anyone does, frankly.”
Kate Watkins, who leads the team that prepares revenue forecasts for the Colorado legislature, said she expects Colorado’s revenue growth to flatten out.
“In many cases,” she said, “we’re still waiting on data to validate what the story is moving forward, whether or not this is really kind of a blip or if it really is a sustainable growth trajectory.”
The federal government’s move to delay tax filing deadlines due to the pandemic may have skewed recent revenue numbers. Additionally, changes to state tax codes this legislative session may impact collections moving forward.
And it’s unclear whether recent state tax revenue growth is a product of underlying economic conditions or a result of the federal government temporarily putting more into people’s pockets.
That’s a big source of uncertainty, said Lucy Dadayan, a senior research associate with the Urban-Brookings Tax Policy Center at the Urban Institute. “Once the federal stimulus money runs out, we don’t know how the state fiscal picture is going to look.”