Business owners might be relieved if they get to the end of 2020 with a revenue drop of just 7.4%. Some popular restaurants and other businesses have already announced they are shut for good.
But the 7.4% drop in revenue now expected for the state of Minnesota, announced last week by the state’s finance department, could be a problem that ripples beyond the confines of state government.
Declining state and local government spending really can make an economic downturn worse. And the recession we are in right now is bad enough already.
The damage done to the economy by the COVID-19 pandemic is nothing close to a normal downturn, of course, with sharply slower consumer spending and a level of job loss that has been just stunning, as confirmed by Friday morning’s jobs report.
More than 20 million American jobs disappeared, at least temporarily, just in April. Among the losses were nearly a million jobs in government, mostly in public education.
The Great Recession of 2007 to 2009 wasn’t exactly normal, either, the worst in decades and followed by a very long and slow climb out.
Once adjusted for inflation, state and local government spending across the nation kept declining even after the economy officially started growing again, with spending slipping at least through 2012.
To understand why state and local spending matters, start simply with payroll. Nearly 700,000 state and local government jobs across the country disappeared during the Great Recession and just after, contributing to the painfully slow recovery of the jobs market.
As of March, more than 400,000 people in Minnesota worked for the state or for local units of government, including those working in education. That’s about 14% of all nonfarm jobs.
That’s why it might be useful to set aside political arguments right now over the right role or effectiveness of government and just think of it as another really big part of the economy. Its payroll checks are funding consumers who buy cars, plants from the garden store, restaurant take out food and groceries.
A lot of what government doesn’t spend directly on payroll still flows to people doing work, maybe even all the way down to a small nonprofit that’s using some grant money to pay people to serve their town or neighborhood.
Because of the way an economy works, a worker spending their paycheck is providing income to someone else, and then they are in turn spending some of it with more people, and so on. Cut spending and take some of that income away, and overall economic activity slips.
One of the striking things in the state forecast released last week is the wide range of possible courses for the broader economy to take, which of course suggests a lot of uncertainty for state finances as well.
The most pessimistic scenario in the broader economy outlook that the state uses to build its forecast is really disheartening: a nearly 15% inflation-adjusted drop in gross domestic product this year as the unemployment rate climbs to levels last seen in the Great Depression.
State governments don’t have all that much flexibility when confronting something like that. They are restricted on what they can borrow, have balanced-budget rules, or both, as Minnesota does. That’s why state financial health goes up and down with the broader economy’s.
Minnesota is one of those states that gets a lot of revenue from an income tax system that’s set up generally to be progressive, for instance, and thus revenue generally goes up as Minnesotans’ incomes do. Of course, the reverse happens in a downturn.
“It’s sort of a cruel irony of the impact of the business cycle on state government that because we have to balance the budget we can’t deficit finance a fiscal stimulus like the feds can,” Laura Kalambokidis, state economist, told me in an interview last week after participating in the budget forecast announcement.
“And economists would argue the role of stimulating the macroeconomy is rightly at the federal level. They’re the ones that can borrow to replace whatever spending the states would otherwise have to pull back on,” she added.
While this approach rarely seems to be carried off perfectly, the right thing to do is to have Congress vote to stimulate the economy through hard times to help both households and organizations and then back off when the economy is really cooking.
That’s why the question of further financial help to the states remains on the table, even though Minnesota and other states entered this downturn in better financial shape than they were the last time.
The political give-and-take that could lead to this kind of broad federal assistance, which is never easy, seems even more challenging now.
You can easily imagine the reluctance of Washington policymakers to fund states that would just direct some of the money at chronic problems that state governments have long neglected, like their employee pension systems.
Yet the whole strategy of the federal government’s response so far, through the CARES Act provisions like the Paycheck Protection Program, is to try to keep as many jobs as possible through the worst, first phase of the COVID-19 pandemic. That hopefully makes it easier for the economy to recover once the health crisis eases.
And policymakers should remember that a lost job is just another lost job, no matter what kind of employer issued the layoff notice.