Federal Covid-19 Aid Aims to Help Cities, States Avoid Cutting Jobs and Services

Administration officials have said the money will help avoid the same outcome as the previous recession, when years of budget shortfalls forced local governments to cut spending, curtail services and lay off workers, all of which weighed on the recovery.

The failure to send enough aid to state and local governments “was a profound error,” Treasury Secretary Janet Yellen said in speech to the National League of Cities last week. Even after the recession ended in 2009, state and local government spending cuts were a drag on the economy for four years, and it took until August 2019 to recover all the jobs lost, according to government data.

Congressional Republicans, who voted unanimously against the relief bill, said the aid was overly generous and would reward some states for fiscal mismanagement. Bolstering their arguments: State revenues haven’t declined as much as initially feared.

More broadly, critics said the $1.9 trillion pandemic-relief plan was too large, given that the economy is forecast to bounce back this year, and that it would feed record budget deficits. Larry Summers, a former economic adviser to President Obama, has said the stimulus risks stoking inflation, with possible consequences for financial stability.

State and local governments spent or invested $3.1 trillion in 2020, equivalent to 14.7% of gross domestic product, according to Commerce Department data. They employ roughly 13% of U.S. workers, whose spending fuels economic growth and who help deliver essential services.

The pandemic triggered widespread business closures and millions of layoffs, which have weighed on state and local tax revenue, while spending on jobless benefits, healthcare and other social services has risen. State and local governments shed more than 1.6 million jobs last year, mostly in local education, and have only added back about 200,000 of those jobs.

Still, the latest round of aid comes to four times the amount state and local governments might need to fill remaining budget shortfalls through the middle of 2022, according to an estimate from Moody’s Analytics.

“But if the goal of the bill is to stimulate economic activity, what Congress is really doing is they’re making a calculated bet that state and local governments will be able to do a better job of stimulating that growth than some federal programs,” said Moody’s Analytics analyst Dan White.

Under the law, $195 billion will go to states, and $130 billion will be divided roughly evenly between county and municipal governments. Tribal governments will get $20 billion.

The states and the District of Columbia are eligible for at least $500 million apiece, plus extra money based on the number of unemployed workers. Aid to cities is based on population and certain measures of poverty.

The bill gives large states such as California, Illinois and Texas a bigger share of the aid than previous relief measures, which were based on population alone. It also directs funding to states hit hard by the pandemic, including those reliant on the tourism, hospitality and energy sectors, such as Nevada, Hawaii and Alaska.

Unlike earlier relief packages, which were limited to covering costs related to Covid-19, the latest one permits recipients to use federal aid to offset revenue losses.

Republicans have opposed aid to states over concerns that it could be used to bail out underfunded pension funds. Democrats included a provision saying it cannot be used for that purpose. Still, analysts have said there is nothing stopping states from using the aid to plug another budget hole and then using money saved that way to backfill pensions.

Senate Democrats also attached a provision restricting states’ ability to cut taxes for as long as three years if they receive federal pandemic aid. Tax policy experts warn that could limit states’ ability to incorporate a new federal tax exemption for unemployment benefits into their state income-tax systems.

Republicans have said the provision would prevent financially strong states from providing tax relief to businesses and families. Idaho, New Hampshire and Utah are among states that had been contemplating tax cuts in the coming fiscal year.

Ohio Attorney General Dave Yost, a Republican, filed a lawsuit Wednesday seeking to block the restriction, which he called unconstitutional. That followed a letter from 21 state attorneys general on Tuesday asking Ms. Yellen to clarify that the measure would only preclude express use of the funds for tax cuts.

“This infringes on states’ authority to design their own fiscal policies and invites partisan politics into federal and state relations,” said Sen. Mike Crapo (R., Idaho), who introduced a bill this week to repeal the tax provision.

In a letter last week, Sen. Rick Scott (R., Fla.) urged governors and mayors to return any excess federal funds not tied to Covid-19-related expenses.

States and cities are just beginning to decide how to spend the money, which the Treasury must distribute within 60 days. In Dayton, Ohio, Mayor Nan Whaley said she notified police and firefighters’ unions last week that the city would resume its annual classes of new recruits, which were suspended last year.

She also plans to quickly fill some of the 100 vacancies created in 2020 when the city offered voluntary separations to avoid layoffs. Still, even as the pandemic recedes, fewer people are expected to return to work in Dayton’s office buildings, lowering income-tax revenue. The city of about 140,000 is set to receive $147 million under the latest bill, according to congressional estimates.

“A lot of this money will just help us have an exit ramp to the new normal after the pandemic,” said Ms. Whaley, a Democrat who is also the vice president of the U.S. Conference of Mayors and is considering a run for governor.

Write to Kate Davidson at [email protected]