State and local governments find funds plentiful, but labor scarce

Summary

State and local (S&L) governments are in a much different place today compared to where they were in the years following the 2008-2009 financial crisis. On the fiscal front, aggregate state and local tax revenue grew 1.8% in 2020. Although this was the slowest pace of growth in more than a decade, it was still faster than the 0.9% growth seen in 2008 and the sizable 5.1% decline in tax receipts in 2009. As the economic recovery has gathered steam this year, S&L revenue growth has surged. Through the first nine months of 2021, S&L tax revenues are up 9.0% compared to the first nine months of 2020.

S&L governments' improved financial situations are not just a product of resilient tax collections. Federal government aid has poured into S&L coffers since the pandemic began. In total, S&L governments have received about $500 billion in grants from the federal government since the pandemic began, and we estimate there is at least another $100 billion still to be released. In addition, the recently enacted Infrastructure Investment & Jobs Act provides roughly $550 billion of new spending over the next decade for a variety of infrastructure areas, such as roads, bridges, public transit, water and broadband. Even S&L public pension funds have seen their fortunes improve amid robust asset price returns and increased contributions from governments and their employees. In the aggregate, S&L pension funding ratios are at the highest levels since the 2008-2009 financial crisis.

This relatively optimistic outlook does not mean that S&L governments are free of economic challenges. S&L government employment is still down nearly one million jobs compared to its pre-pandemic peak, and employment in this sector accounts for 22% of the shortfall in total nonfarm payrolls compared to pre-pandemic employment levels. Unlike the 2010s, the employment decline appears mostly attributable to labor scarcity and ongoing pandemic challenges rather than rigid austerity.

In addition, the aggregate state and local data mask divergences across different parts of the country. Our regional team has covered these various economic trends at length, but we will highlight just a few examples to illustrate the point. Public transit ridership remains well below pre-pandemic levels. Domestic tourism has largely rebounded, but international tourism and business travel are still depressed compared to 2019. We suspect it will be awhile before these sectors see pre-COVID levels of activity again. The "return to office" movement is ongoing, but progress has been gradual rather than sudden. This in turn has created challenges for office-centric regions, particularly the major gateway markets, such as San Francisco and New York City.

For now, robust federal aid, strong asset price returns and tax collections that have topped previous projections have combined to generate a rosy fiscal outlook for S&L governments nearly everywhere. As a result, we expect S&L government output and hiring over the next year or two to be much more resilient than it was in the few years following the 2008-2009 financial crisis. That said, regional disparities will likely persist, and the longer-run outlook remains clouded as the economy and society grapple with what "normal" will look like in a post-COVID world.

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