The pandemic’s impacts on state budgets – and what may still be to come

February 8, 2021

By Shelby Kerns, executive director of the National Association of State Budget Officers and external advisory panel member, GFRC.

Before the COVID-19 crisis hit, states were expecting general fund revenue growth of 2.9 percent in fiscal 2020 and 3.0 percent in fiscal 2021. But NASBO’s Fall 2020 Fiscal Survey of the States, released in December, shows a sharp reversal of fortune. 

After nine consecutive years of growth, states saw revenue decline in fiscal 2020, despite three strong quarters of revenue collections prior to the onset of the pandemic. Greater declines are forecasted for fiscal 2021, leading to enacted budgets for fiscal 2021 calling for the first general fund spending decrease since the Great Recession.

Such a steep revenue loss in just over a one-year period is noteworthy, particularly since federal stimulus measures, including enhanced unemployment compensation, the Paycheck Protection Program, checks to individuals, and other measures, were in place that helped prop up the economy – and state revenues – during much of this time. 

It’s also important to remember that state tax collections, particularly from income taxes, usually lag economic downturns, so seeing such a drastic loss of revenue so early gives us a great deal of concern for what is yet to come. With states facing two consecutive years of general fund revenue declines in fiscal 2020 and fiscal 2021, there is a great deal of uncertainty about how long it will take for state budgets to recover. 

After the Great Recession, even though revenues began to grow again in fiscal 2011, it took until fiscal 2013 for state general fund revenue to surpass its fiscal 2008 levels without adjusting for inflation. States did not see revenue restored to fiscal 2008 levels in inflation-adjusted terms until fiscal 2018. 

While actual general fund spending for fiscal 2020 did increase, it was 1.7 percent below the level that states expected to spend prior to the COVID-19 crisis. The pandemic and ensuing economic impacts hit late in the fiscal year, making it hard for states to rely too much on spending cuts to close budget shortfalls. 

However, this decrease from expected levels for general fund spending speaks to the severe, rapid impacts the COVID-19 crisis has had on state budgets, given that there is typically a lag between the start of an economic downturn and state fiscal stress necessitating budget cuts. 

States’ enacted budgets for fiscal 2021 are projected to reduce general fund spending by 1.1 percent compared to preliminary actual fiscal 2020 levels, marking the first time states enacted a net spending decrease in more than a decade. 

Compared to governors’ budget proposals for fiscal 2021, released by most states just a few months earlier, states’ enacted budgets show a 5.5 percent reduction in general fund spending. 

K-12 education saw the largest reduction, and higher education, transportation and all other government programs saw net decreases as well. Medicaid and public assistance saw sizeable increases in spending, reflecting rising caseloads and spending pressure for services as a result of the pandemic and economic downturn. 

States continue to be judicious in their use of rainy day funds, which were at an all-time high coming into this crisis, to ensure they are available to smooth out budget cuts over the course of the economic crisis. While total rainy day fund balances as a percentage of general fund spending declined from 9.1 percent in fiscal 2019 to 7.9 percent in fiscal 2020, the median rainy day fund balance did not yet record a decline. 

Looking ahead, there are reasons for optimism about the state fiscal outlook such as recent vaccine developments and news of improved revenue projections and collections from some states. However, challenges remain for states in effectively distributing vaccines, controlling the spread of the coronavirus, and meeting rising spending demands from the uneven economic recovery. And, of course, an improved revenue outlook compared to the catastrophic predictions of the spring and summer does not translate to a positive, or a return to the pre-covid, outlook. 

We’re also seeing that the effects of the pandemic on state revenue have been uneven. Energy producing states, and those dependent upon tourism and with higher unemployment rates, have experienced greater impacts. States with economies more reliant upon services are being hit harder. Tax structures and virus transmission levels also affect the impact on state revenue. Due to this unevenness, the aggregate numbers we report can mask some states thatER are experiencing dire revenue shortfalls.

The federal aid package passed in December will offer some help to state budgets through its economic stimulus, and additional federal stimulus is likely.   If direct flexible fiscal relief to state governments is not included, more spending cuts and/or tax increases will be required at the state level, leading to a slower and more uneven economic recovery.