As COVID-19 continues to slow the economy, the media has been rife with headlines foretelling revenue shortfalls and a cash crisis for battered state budgets. We look under the hood to better assess the status of the headline-grabbing states with the largest debt burdens.
Many States Had Prepared for the Unforeseen
Bond investors are right to be concerned. COVID-19 hasn’t been kind to anyone or anything, and municipal finances are no exception. When the pandemic struck, many investors expected state budget shortfalls to be as big as those of the 2008 global financial crisis and the recession that followed.
But municipal default rates have remained low through many crises, including the crisis of 2008. No state has defaulted since the Great Depression, and with today’s ample liquidity and market access, no state is even close to being in danger of a missed payment. While the strain of the pandemic may result in rating downgrades, we expect the overall credit quality of states to fare well through the coronavirus crisis.
Why has state credit quality remained so strong? To start, states came into 2020 on much stronger footing than in 2008. Municipal and state governments had used the long economic expansion since the global financial crisis to shore up their balance sheets and reserve funds. In fact, states faced the pandemic with more cash on hand than they have had in decades—on average, almost 8% of budget. And municipal debt to GDP is well below levels of 15 years ago.
Additionally, the federal government responded to the crisis by passing the initial CARES Act, which included direct disaster-related aid to municipalities of $150 billion—plus another $275 billion earmarked specifically for healthcare, education, transportation and airports.
Revenues Ahead of Expectations
Most fiscal year 2021 state budgets were proposed early in 2020, before the potential impact of the coronavirus shutdowns was fully understood. These budgets quickly became obsolete as COVID-19 costs soared and projected revenue shortfalls swelled.
However, not all feared revenue shortfalls have come to fruition. In Illinois, for example, revenues are down but running almost 10% ahead of budget. Massachusetts’ revenue received is 3% ahead of last fiscal year ($124 million), even though state officials had estimated that tax collections could fall by $2 billion to $8 billion this fiscal year. Even hard-hit New York State’s revenue is 2.9% ahead of budget for the first half of its fiscal year.
Future revenues may also hold up better than expected for states with a progressive income tax. Higher wage earners can work remotely and retain their jobs through the crisis. And thanks to a volatile but hardy stock market and strong residential real estate prices, capital gains tax revenues should remain steady. Sales tax receipts have also held up better than expected as people trapped at home have indulged in online retail therapy and home improvement projects. On the other hand, revenues from gas taxes, hotels, airports and even toll roads have plunged, as people have simply stayed home.
There’s Almost Always a Way to Make Ends Meet
When states face revenue shortfalls, they have four levers to pull. They can use fund balances and reserves, borrow, raise revenues or cut spending. Many states have used portions of their rainy-day funds. To date, only a few have borrowed. Raising taxes and cutting spending during recessions is politically difficult and can worsen the economic stress. Many states have, however, started slashing payrolls (Display, below).
