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Balanced-budget requirements made state and local government employment highly sensitive to changes in state revenues during the early stages of the COVID-19 pandemic, find Daniel Green of Harvard Business School and Erik Loualiche of the University of Minnesota Carlson School of Management. Using variation in state reliance on sales taxes, which were particularly affected by the decline in consumption caused by COVID-19, the authors show that a 10 percentage point increase in the share of revenues from sales taxes led to a 2.6 percentage point increase in the unemployment rate amongst public-sector workers. Conversely, increased CARES Act funding as a share of revenues decreased layoffs. Without this federal aid, the authors say, 401,000 state and local employees would have been laid off in April 2020, 40% more than occurred. Finally, public employment in states with smaller rainy-day funds for emergency spending was more sensitive to both sales tax revenues and federal aid, further suggesting that layoffs stemmed from budget constraints. Although states prioritized retaining health care workers, increased federal aid did reduce public health care layoffs—a reminder, the authors argue, that the inability of states to borrow out of future tax revenues has consequences for their ability to provide needed public services in times of crisis.
Government borrowers can reduce the interest they pay by reducing the risk of their debt by providing more information via intermediaries like bond insurers, negotiated underwriting, or credit ratings. Using the variation in increased risk posed by the COVID-19 pandemic across municipal bond sectors, as well as variation in the pandemic’s severity and timing across municipalities, Lang Kate Yang of George Washington University and Ruth Winecoff of Indiana University study which of these methods are adopted by issuers when market risk increases, and which are most valued by investors. They find that as the pandemic worsened, issuers in high-risk sectors increased their usage of bond insurance and negotiated underwriting more than issuers in low-risk sectors, but did not increase their use of credit ratings. But they also find that this increased use of negotiating underwriting and bond insurance wasn’t associated with larger reductions in the offering yields in high-risk sectors than in low-risk sectors. In contrast, the difference in yields between rated and unrated bonds expanded more in the high-risk sectors, suggesting that investors value the information embodied in credit ratings in times of high uncertainty. Still, using data from California on both interest and offering costs, the authors find that bond insurance may save issuers more than credit ratings or underwriting at time of crisis.
Delegating resources and decision-making to local governments can allow them to tailor public services to local needs. Natural disasters, however, may be difficult to address this way. Benefits and costs of mitigation can spill across municipal borders, leading to inefficient investment across localities. Local officials have incentives to prioritize immediate local needs, such as economic development, over low-probability disasters. When disasters do occur, they often overwhelm the capacity of local leaders and services, and federal or state aid is more complicated to distribute when funneled through additional levels of government. Qing Miao of the Rochester Institute of Technology, Yu Shi of the University of North Texas, and Meri Davlasheridze of Texas A&M find that a 10% increase in the share of a state’s natural resource spending that is controlled by local governments—including flood control, drainage, and wetland management—is associated with an 8% increase in flood-related economic damages in the following year. This effect is driven almost entirely by states with a high risk of flooding. As climate change increases the risk and severity of flooding and storms in the coming years, the authors argue, state governments may be better suited to coordinate a response than local governments. (For more from the Journal of Public Budgeting & Finance, see here.)
How has the COVID-19 pandemic affected state tax revenues?
Indiana University Environmental Resilience Institute, Accelerate Indiana Municipalities, Association of Indiana Counties, Health by Design, and Indiana Public Health Association
“The announcements and planning-to-date of the coming Biden administration signal climate change as a top priority. State and local government will be a critical part of that agenda. Smart planning necessitates that the requirements of a changing climate be a part of any infrastructure plan—both national and local…In relation to federal infrastructure dollars, the point is clear: it makes little sense to improve a 30-year infrastructure asset without giving substantial thought to the challenge of climate change that may threaten or even make it irrelevant.
Climate change will require four sets of investments: 1) retooling infrastructure away from dependence on fossil fuels, 2) critical adaption projects, such as sea walls for threatened U.S. geographies, 3) an investment in dislocated workers currently part of the existing economy that will require a new livelihood given the phasing-out of their jobs as part of this essential transition, and 4) an acknowledgement that 'managed retreat' is likely in some geographies that includes an infrastructure stabilization strategy to mitigate the social discord and provide necessary services to those individuals who are part of a relocation plan.”
The Municipal Finance Conference brings together academics, practitioners, issuers, and regulators to discuss recent research on municipal capital markets and state and local fiscal issues. It is sponsored by the Hutchins Center at Brookings, the Rosenberg Institute of Global Finance at Brandeis International Business School, the Olin Business School at Washington University in St. Louis, and the Harris School of Public Policy at the University of Chicago.
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