Robert Inman is a professor at the University of Pennsylvania’s Wharton School. David Skeel is a professor at the University of Pennsylvania Carey Law School.

How does Congress address the states’ economic crisis caused by the pandemic? In their war of words with Senate Majority Leader Mitch McConnell (R-Ky.), Democrats such as New York Gov. Andrew Cuomo (D) have rightly pointed out that the states were not responsible for the economic shutdown from covid-19 and that they have suffered massive losses as a result. But McConnell is right that emergency aid from Congress should not be a bailout for state deficits that have nothing to do with the pandemic.

It is possible to achieve both sides’ objectives. Congress should act as the insurer of last resort, covering the extraordinary costs of the covid-19 disaster. But it should not bail out past excesses; nor should it replace revenue loss that would have been caused by an ordinary recession, since fiscally responsible state and local governments should have rainy-day funds for that.

To calculate the extraordinary costs related to the pandemic, it is necessary first to identify the revenue state and local governments are losing. This consists of lost income and sales taxes, as well as fees and other revenue that have dried up with the absence of economic activity. Add that to the cost of surging unemployment claims — which have already increased six-fold from 2019 levels — and the unusually high health-care expenditures.

By our calculations, the cost of this covid-19-caused “hole” in state and local budgets would be $500 billion over the next fiscal year (to June 30, 2021), plus roughly $65 billion in added health-care costs.

Here’s how we got that figure: We project a 20 percent decline in income, sales and fee revenues over the next year. This translates to $275 billion in lost revenue from sales and income taxes and an additional $95 billion in lost fees (such as university tuition) and miscellaneous revenue (e.g., lotteries). If state unemployment insurance costs rise six-fold, the added covid-19-related benefit payments would cost $130 billion. Exact increases in health-care expenditures related to covid-19 are highly uncertain, but such costs would certainly include a significant increase in Medicaid expenditures. To date, Congress has appropriated $65 billion for expenditures related to covid-19 through the Cares Act; we expect at least an additional $65 billion in costs over the next year.

Determining how to distribute these funds is nearly as important as calculating the amount. Congress needs to protect the national economy against the risk of a deep, pandemic-caused recession. The country’s experience with the Obama-era stimulus package makes clear that direct revenue sharing with no strings attached is the best way to replace lost state and local revenues. Infrastructure spending is essential, but such outlays tend not to get money to people, and thus circulating in the economy, fast enough. Congress should make a direct grant of $358 billion — consisting of the $370 billion of lost revenues, less a $12 billion “deductible” reflecting the cost of an ordinary recession, for which state and local governments should have prepared.

Because some states will be hit harder than others, Congress should allocate the $358 billion based on each state’s rate of covid-19 cases and related unemployment claims. Under this approach, New Jersey would receive proportionately more than Wyoming.

To help with soaring unemployment claims, Congress should pay $130 billion directly into the unemployment insurance trust fund available to the states, once again allocated based on each state’s increase in claims related to covid-19. For health care, Congress could simply increase the federal matching rate for Medicaid costs by 10 percent. This strategy was highly effective in stimulating the economy during the 2008 recession and ensured that the most vulnerable individuals benefited from the federal money.

Our approach would compensate state and local governments for the extraordinary costs of the crisis while also encouraging them to do their part by setting aside funds for an ordinary crisis (as some states, such as California and Alaska, did — though others did not). This is how ordinary insurance works: coverage for direct losses, a deductible to encourage caretaking and a co-pay to encourage efficient spending.

To be clear, we are not suggesting that this approach would solve the long-term problems of states that faced severe fiscal problems before the novel coronavirus threat. One of us thinks that Congress should enact state bankruptcy legislation for these problems; the other is not so sure.

Our proposal focuses on the short-term objective of covering the extraordinary costs the economic shutdown has imposed on state and local governments without bailing them out. To help the states and to avert a massive recession, Congress needs to urgently pass a rescue package reflecting these principles.

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