Federal Fix Can Help States and Encourage Work

The U.S. House passed another massive spending bill on May 15 in response to COVID-19. In the unlikely event the Senate and President Trump approve it, that measure would spend another $3 trillion, including $1 trillion to aid state and local governments.

State and local governments are experiencing large drops in income and sales tax receipts, but it is premature to know how large those shortfalls will be. A Morgan Stanley analyst predicts state revenues will fall by $180 billion and localities will see drops totaling $90 billion; news outlets report Georgia’s budget might have a $5 billion gap over the next 15 months.

Small-government advocates might hope state budgets, which by law must be balanced, would have projected deficits remedied solely by budget cuts. Some cities are discussing employee furloughs to reduce spending – as is the University System of Georgia – but it is unlikely the public will tolerate budget reductions of the magnitude necessary for balanced budgets.

The focus must therefore be on how to help governments with financial hardship genuinely arising from COVID-19 while being aware of the possibility of poorly run state and local governments trying to pawn their fiscal problems onto the rest of the country. Congress must also be mindful of spending even more on top of the massive $2.2 trillion CARES Act passed in March.

Fortunately, there is a way to take a significant initial step toward helping struggling state and local governments without adding more the burgeoning deficit.

A notable provision of the CARES Act was Federal Pandemic Unemployment Compensation, which pays people receiving unemployment benefits an extra $600 per week through July. With the $600 federal benefit on top of ordinary state unemployment insurance payments, many laid-off workers get more money being unemployed than working or searching for new jobs.

One analysis by University of Chicago economists estimates 68% of unemployed workers are eligible for unemployment benefits greater than their lost earnings. They also calculate the median replacement rate is 134%, or more than one-third above workers’ normal pay. Georgia’s results are even more striking: The median-income unemployed resident would receive benefits equal to 154% of lost income.

People respond to incentives, even perverse ones created by government policy. During the Senate’s CARES Act debate, one senator warned, “We don’t want this piece of the bill to create an incentive for folks to stop working.” News reports attest to his prescience:

  • CNBC reports a spa owner in Washington state was met with a “firestorm of hatred” by her employees for obtaining a Paycheck Protection Program loan to pay their normal wages instead of laying them off.
  • NPR told of a Kentucky coffee shop that closed; employees asked to be laid off “because it would cost them literally hundreds of dollars per week to be employed.”
  • Newsweek reported on a Maryland restaurant owner whose employees did not want to return to work because they make more unemployed.

Herein lies the opportunity to help states without doing long-term fiscal damage. Congress should revisit the hastily enacted $600 supplemental unemployment benefit. Ending it after May – by which time most mandatory shutdowns will have been lifted – would end the perverse incentive against working and free up significant funds for state and local governments.

Those whose jobs are cut or in danger would still have two forms of protection. One is ordinary unemployment insurance benefits, which a different provision of the CARES Act extended for an additional 13 weeks. The second is the recently expanded Paycheck Protection Program, which gives employers forgivable loans to pay their employees.

How much would this proposal help state and local governments? Eliminating the $600-a-week benefit eight weeks earlier would save $4,800 per unemployed worker. With a staggering 36 million new jobless claims in the past two months, saving $4,800 per person would allow more than $170 billion to be redirected to struggling state and local governments.

While $170 billion may not replace all state and local government revenue lost because of COVID-19, it should cover budget gaps in the current fiscal year and allow more time to better estimate ongoing economic effects. And it is more responsible now than the House approach of $1 trillion more in funding.

Just as the federal aid restricted to direct COVID-19 response “overshot the runway,” as Georgia state Rep. Terry England recently put it, the House’s $1 trillion proposal exceeds current estimates of state and local budget shortfalls.

Another large state/local bailout is likely on top of the CARES Act. This free money approach – “Just put it on the government’s credit card” – is problematic. The federal government is already on track for an astounding $4 trillion budget deficit, publicly held debt is now roughly 80% of GDP, and interest on past borrowing already consumes a significant chunk of the federal budget. Maintaining a perverse incentive against working while adding hundreds of billions of additional borrowing is not sound policy for the present or the future.

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