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Best Defense Against Virus Proves Crushing to States’ Finances

Jason Grotto, Shruti Date Singh and Noah Buhayar
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Best Defense Against Virus Proves Crushing to States’ Finances

(Bloomberg) --

It’s a bitter irony: As state and local governments struggle to blunt the new coronavirus outbreak, the most effective weapons hammer their fiscal health.

Social distancing has already begun to crater their revenue, even as emergency expenses, pension costs and other long-term liabilities are poised to surge. The market has priced in the impact of the slump, leading to the worst muni-bond rout since 1984 and prompting desperate calls for federal support.

The U.S. government has begun sending billions to states to offset the cost of combating the virus, but additional pressures are likely to build in coming weeks and months as revenue declines, unemployment spikes and business activity slows.

“It’s unprecedented, unlike anything else we’ve seen in our time,” said Lucy Dadayan, a senior research associate with the Urban Institute. “Every single state I’m talking to so far is working to revise revenue forecasts, and they will be revised substantially downward.”

Despite the longest running economic expansion in U.S. history, some states and cities were struggling even before the global pandemic.

Few states face a crisis as deep as Illinois, which has more than $7 billion in unpaid bills, about $137 billion in unfunded pension liabilities and only $1.2 million in reserves. Just over a week into the pandemic, initial jobless claims in Illinois jumped more than 10-fold compared with the same period last year.

Gaping Deficits

Chicago, Illinois’s biggest city and the nation’s third largest, is also in a tough spot. It already faced deficits and its pension contributions were to jump this year to $1.7 billion from $1.3 billion after decades of shorting the four retirement funds drove unfunded liabilities to about $30 billion.

“Illinois and Chicago were ill-positioned for a crisis before all this started,” said Laurence Msall, president of the Civic Federation, a Chicago-based independent, nonpartisan research organization. “The only way you can get out of this is a massive federal stimulus for state and local governments.”

Governor J.B. Pritzker said Thursday he has spoken with House Speaker Nancy Pelosi about legislation to provide help. “We are trying to mitigate that damage, just like we are trying to mitigate the virus itself,” Pritzker said during his daily news conference.

Illinois and Chicago aren’t the only ones at a precipice.

Transit agencies were among the first to seek federal lifelines. Steep ridership declines in New York led the nation’s largest transit system, the Metropolitan Transit Authority, to request $4 billion in aid Wednesday. On Thursday, New Jersey Transit requested $1.25 billion after ridership fell 88% since March 9. That evening, it reduced its service to weekend levels until further notice.

Bay Area Rapid Transit, in the San Francisco area, also saw ridership decline by 88% compared with the previous month. Its executives are lobbying local, state and federal officials for funding.

Analysts warn it could take months to gauge the virus’ impact on other revenue streams. They said sales-tax take could increase soon as people prepare to hunker down at home, but then lag as isolation stretches out.

Washington state, which has seen one of the worst U.S. outbreaks, already budgeted $200 million from its reserve to respond. That won’t be enough, said Andy Nicholas, a senior fellow at the Washington State Budget and Policy Center, a nonpartisan group. The reserve was about $1.7 billion at the end of June, and lawmakers likely must tap more of that rainy-day fund.

“It’s raining,” Nicholas said.

Seattle Mayor Jenny Durkan called on the federal government to backstop cities with $250 billion in flexible funding. “Most major cities across the country had already become the social safety net of America before this truly unprecedented crisis,” said Chelsea Kellogg, a spokeswoman for the mayor.

Stock-market turmoil, meanwhile, threatens states like California because of its reliance on taxing its wealthiest residents. Capital-gains levies account for about 10% of its revenue this year. The state will likely have to make up for several billion dollars given that officials in January had assumed the S&P 500 would hover around 3,120, said Gabriel Petek, the state’s nonpartisan legislative analyst. The index closed Thursday at 2,409, down 25% for the year.

Increased revenue before the outbreak has left some cities in a better position. Los Angeles’s reserve, for example, is twice what it was before the 2008 financial crisis. Already, $20 million has been tapped for the response.

New York Governor Andrew Cuomo and New York City Mayor Bill de Blasio have each asked for aid. State officials estimate New York could lose anywhere from $4 billion to $7 billion in tax revenue out of the $87.9 billion projected for next year’s budget. The city will lose $3.2 billion in revenue over the next six months, Comptroller Scott Stringer estimated.

During a Thursday morning briefing, Cuomo drove home the dire needs: “We have to run a government. We need the health-care system up and running. We need police. We need fire fighters. We need bus drivers. We need daycare workers. All these functions have to continue.”

Commodity-dependent states are especially vulnerable to the coronavirus’s impact on energy markets, Moody’s analyst Emily Raimes said. North Dakota, Oklahoma, Alaska and New Mexico are among states that “historically have had the most volatile revenues,” she said.

On Thursday, New Mexico’s Republican lawmakers sent a letter to Governor Michelle Lujan Grisham, a Democrat, requesting a special session of the Democrat-led legislature to address a potential budget crisis. Plummeting oil and gas revenue and the coronavirus response will have a “devastating impact,” the letter said.

Build America

During the 2008 financial crisis, the federal government stepped in with infrastructure funding through the Build America Bond program, as well as increases in the Medicaid matching rate, which injected billions of dollars into state coffers. Analysts predict similar measures this time.

Since early March, the federal government already has injected nearly $1 billion in direct public-health aid for state and local governments, provided $40 billion in disaster relief and provided billions more through an increase in the matching rate, according to Fitch Ratings.

But as the virus fight stretches out, pressures will mount along with the needs.

“A lot more is going to have to be done,” said Fitch analyst Eric Kim. “But how much more and when, that’s very much unsettled.”

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