Erik Loualiche

State and Local Governments Face Dire Economic Times During Pandemic

Tuesday, November 17, 2020

With a major drop in revenue and increased expenditures because of the COVID-19 crisis, local governments were forced to lay off a significant number of their workers.

Assistant Professor of Finance Erik Loualiche explored these issues and more in a paper he co-authored entitled “State and Local Government Employment in the COVID-19 Crisis.” Loualiche spoke about the factors leading to this impact, how this economic downturn is different, and the pivotal role the Coronavirus Aid, Relief, and Economic Security Act  (CARES Act) played.

You found that a decrease in sales tax was the main driver of difficult budget decisions for state and local governments. Why is that? 

State and local governments rely on different taxes for their revenue: income tax, property tax, or sales tax. Some states, like Florida, lean heavily on sales taxes which closely track local consumption and declined severely during the height of the pandemic in April of 2020. 

As an individual or company, when you experience a temporary drop in your income or a sudden spike in your expenses, the typical response is to borrow to smooth out the shock over a longer period of time.

Unfortunately, state and local governments can’t do this. They are subjected to balanced budget requirement rules and the money they spend—more or less—has to equal the money they bring in. This means that they must cut expenses, and since employment is a big part of local government expenditure, this can come in the form of layoffs, furloughs, or pay cuts. 

What makes this pandemic different than other economic downturns when it comes to state and local government employment?

There are good and bad things here. First, it turns out that state and local governments were well prepared going into the crisis. That’s probably as a response to the last crisis they experienced during the great recession. States have been prudent savers in the past decade and their rainy day fund balances were at record highs going into 2020. 

On the other hand, I mentioned how sales tax revenues dropped, but the pandemic will also affect the 2021 budgets because of the fall in income tax due to the persistent drop in economic activity we are seeing. Moreover, states have been at the forefront of the coronavirus response coordinating healthcare and distributing safety-net programs such as unemployment insurance. 

What government employees were most likely to be laid off?

We find that the drop in employment was the largest in the education sector. Given the increased challenge of providing remote education, this is likely to have large negative consequences in the long run.

The sectors that were the least affected were "protective services," such as police officers and healthcare, probably due to their position at the forefront of the crisis. 

How did the CARES Act help ease some of these issues?

The CARES Act provided $150 billion to state and local governments. In our analysis of the CARES Act, we find that without an aid package, these governments would have laid off an additional 401,000 workers in April 2020 -- 40 percent more than realized. 

Only the federal government can conduct large scale deficit spending. It’s probably not the right thing for the government to be running a deficit all the time, but it is really important to have that flexibility in times of crisis, economic or otherwise. Wars, recessions, and pandemics are all examples of times when there is a large social return on public spending. 

Our findings suggest that the inability of state and local governments to run deficits forced them to scale down government employment during the pandemic. The federal government support for state and local governments helped ameliorate this but probably did not go as far as it could have. 

This article appeared in the Fall 2020 Discovery magazine

When the COVID-19 pandemic hit, Carlson School faculty experts researched a myriad of aspects of the pandemic in real time. In this edition, you'll see how state and local governments dealt with the economic downturn, how that economic anxiety was worse for some individuals and groups than others, and how the Supply Chain and Operations Department shifted its research agendas and curriculum to help educate policymakers, media, and the public on how to address these issues.

Fall 2020 table of contents