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Opinion One economic prediction I’m glad to have been wrong about

A man walks into 5th Avenue Deli and Grill on June 4 in Mayfield Heights, Ohio. (Tony Dejak/AP)

In retrospect, there are a lot of things pundits and the general public got wrong last year. We didn’t need to wipe down our mail. Beach outings were safe. We should have moved mountains to resume in-person school as quickly as possible.

Some economic predictions, including some of my own, turned out to be much too pessimistic, as well. Among them: that the states were all about to go broke. Today, many states are flush with cash, with some even enjoying budget surpluses.

Here’s how I got this wrong, and why it matters.

Early in the pandemic — with entire industries shuttered and millions of workers laid off — state tax revenue plummeted. Demand for government-supplied assistance of various kinds spiked. Understandably, forecasts for state budgets looked ugly.

The implications for the economy were troubling, since state budget problems can drag on the private-sector recovery.

This is what happened during and after the Great Recession. That downturn left states and municipalities strapped for cash; state and local governments’ own-source revenues (those excluding federal grants) plunged by 8 percent and stayed below their prerecession level for years. Balanced-budget requirements and insufficient federal aid forced states to implement austerity measures, which then rippled throughout the rest of the economy.

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More than a year into the pandemic, though, things look quite different.

After an initial dip, tax revenue quickly rebounded. Nominal state and local tax receipts over the past four quarters were slightly higher than over the preceding year, according to the Bureau of Economic Analysis. Recent state tax revenue data from the Urban Institute shows strong growth so far in 2021, with states’ coffers likely to fatten further as the economy rebounds.

There are both good and bad reasons for states’ better-than-expected budgetary health.

First, the bad reason: Most of those sky-is-falling forecasts for tax revenue had assumed a much more equitable distribution of job losses than actually occurred. High-wage workers largely kept (or quickly regained) their jobs; low-wage workers did not. Poor people generally pay less in taxes than the rich even in good times, especially in states with progressive income tax systems. So with unemployment unusually concentrated among the most vulnerable, income tax revenue took a smaller hit than predicted.

There are other, less depressing reasons for why revenue remained intact, though.

The stock market did quite well, which boosted capital gains tax collections. California in particular enjoyed a one-time windfall from some big initial public offerings. Even more encouraging, federal fiscal support turned out to be much more generous than many of us had predicted — certainly more generous than had been the case in the Great Recession.

The unprecedented expansion of federal unemployment benefits was especially valuable in propping up incomes — and, more indirectly, revenue, since these benefits are taxable in many states. Jobless benefits and stimulus payments also kept consumer spending afloat, which helped states that rely on sales taxes.

There are some caveats to this happy story. The fiscal recovery has been uneven, and some states (such as tourism-dependent Nevada and Hawaii) did have big revenue declines. With the vaccine rollout and other public-health measures, states also may have had higher expenses this past year.

As of May, there were still more than 1 million fewer state and local government employees than there had been pre-pandemic, even though revenue held up pretty well. It’s possible that states were overly cautious in their budgeting, given their experience in the last downturn. Social-distancing measures and virtual schooling also likely contributed to many of the layoffs, as Brookings Institution fellow Louise Sheiner points out. Hopefully, when campuses reopen in the fall, bus drivers, cafeteria workers and others will be rehired.

One implication of all this is that (many) states did not need the tremendous cash infusion supplied by the covid relief bill this spring, which included $350 billion of direct aid through the Coronavirus State and Local Fiscal Recovery Funds. Not all of the money has been disbursed yet, and some Republicans have proposed clawing back unused funds. Such an action, though, might be unlawful and is likely trigger legal challenges, according to Georgetown University law professor David A. Super. It would almost certainly create political headaches, too.

That said, there might be ways to incentivize states to use excess covid relief funds for other priorities that Congress is now considering. For instance, the infrastructure package could be designed around matching grants that require states and localities to kick in more funding, as the Progressive Policy Institute’s Ben Ritz has suggested. (Some language in the framework of the bipartisan infrastructure deal suggests this might be on the table for broadband.)

In any event, more than a year into the pandemic, this is one prediction I’m delighted to have been wrong about — particularly to the extent it means the federal government did better than I’d feared it would. I hope to eat more similarly flavored crow in the future.

Read more:

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