Will recovery funds really allow state and local governments to build back better?
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This is a Guest Article for Notes on the Crises
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Amanda Kass is the Associate Director of the Government Finance Research Center.
Philip Rocco is an assistant professor of political science at Marquette University and co-author of Obamacare Wars: Federalism, State Politics, and the Affordable Care Act.
The phrase “Build Back Better” was at the heart of Joe Biden’s 2020 presidential campaign. Yet during his first months in office, the President’s rhetoric and policy proposals have been dominated by a central tension. Should the administration’s emphasis be on building back, simply restoring the American political economy to its pre-pandemic status quo? Or on building something better: policies designed to address long standing inequalities, and insulate households and communities from future COVID-like shocks?
The tension between “building back” and “building better” is nowhere more visible than in the debate over the American Rescue Plan Act’s (ARPA). ARPA amounts to $350 billion in multipurpose aid allocated to states, Tribal governments, U.S. territories, and local governments. For fiscal hawks — who believe that “building back” should end when the crises lift —ARPA’s State and Local Fiscal Recovery Funds are the height of federal profligacy. (Didn’t state and local revenues already bounce back from their nadir in the second quarter of 2020? What else needs to be “built back”?)
Yet COVID-19 has also demonstrated that––far from an exogenous shock––crises are fundamentally shaped by pre-existing policy infrastructures. What did the Coronavirus crisis result in over the short term? Chronically underfunded city health departments and social service agencies struggled to deal with the earliest phases of the pandemic, as they waited for federal aid to arrive. Overcrowded school buildings with HVAC systems that hadn’t been updated in years made it unsurprisingly difficult to adapt to pandemic conditions. These stark realities require something beyond a reversion to the status quo — the ‘better’ in Biden’s slogan.
More than this, the onset of the COVID-19 pandemic coincided with a series of police killings of Black Americans that were captured on video and seen by the general public, including George Floyd and Breonna Taylor. This violence sparked a renewed call for racial justice in the United States, and it should force us to carefully examine who the American Rescue Plan will rescue. State and local recipients of ARPA aid continue to operate in the shadow of the 2008 financial crisis, which deepened racial and economic inequality in the United States. Defining “building back better” thus raises crucial questions about how to use fiscal aid to redress these inequalities.
Is $350 Billion in State and Local Aid Necessary?
The passage of ARPA is nothing short of a milestone in the history of American fiscal federalism. Not since the creation in 1972 of General Revenue Sharing (GRS)––a fiscal program that delivered roughly $388 billion (current dollars) over 15 years in unrestricted federal aid to state and local governments––has Congress made such a significant commitment of multipurpose transfers for the work that states, cities, and counties do.
The timing of ARPA’s passage, as the US vaccine rollout hit its stride and as state and local revenue performed better than initially feared, led some commentators to criticize the aid as wasteful and unnecessary. In a New York Times article, for example, the senior policy director for the Committee for a Responsible Federal Budget declared that states were “swimming in revenue” and, “It’s pretty clear to [him] that we spent a lot of money on states that we didn’t need to.” Whether fiscal aid was needed was hotly contested in the run-up to ARPA’s passage, and was almost cut from the bill.
However, as we have argued elsewhere, the notion that state and local governments no longer ‘need’ federal emergency aid relies on a myopic understanding of need and is based on evaluating just the revenue side of the ledger. First, simply because aggregate state and local revenues have rebounded relative to the dismal position they were in during the second quarter of 2020 isn’t altogether reassuring. This does not mean that they are on track with where they would have been in the absence of the pandemic. Aggregate figures, however, mask wide state and local variation. To what degree revenue has rebounded also depends on what’s being examined, and commentaries and news on COVID’s revenue impact have used a variety of approaches, like comparing actual 2020 vs. actual 2019 revenue and comparing actual 2020 revenue vs. estimates of 2020 revenue done at the start of the crisis. But the best approach is an event study, which compares actual revenue with an estimate of what revenue would have been but for the event (in this case, COVID). Using this approach, Professor Kenneth Kriz has estimated that COVID resulted in a nearly $1.5 billion revenue loss for the State of Illinois.
Second, COVID’s fiscal impact is not captured by revenue performance alone. While budget deficits tell us the gap between spending and revenue, this too provides an incomplete picture. State and local governments are often bound by balanced budget constraints, and their budgets also only capture planned spending — that is the spending levels that revenue can support. As such, budgets are not meant to capture spending needs. The uneven impact of COVID and the K-shaped economic recovery reflects pre-COVID societal inequalities. But still more worryingly, it suggests a deepening of them. As such, spending needs go beyond what’s recorded in a budget, to mitigating the direct and immediate health and economic consequences of COVID. It must also extend to factors that led the impact to be so uneven and dire, in the first place. And especially to provide relief for low-income, Black and Brown communities.
While COVID’s revenue impact is hotly tracked (albeit in different ways), less effort has been spent quantifying what it would cost to pay for all the direct and indirect spending needs. Take for example how the issue of unpaid sick leave has led to hesitancy among some workers to get the vaccine. Workers have been reluctant due to worry that the possible side effects will lead to missed work days. The public sector could guarantee paid vaccine sick leave, but the theoretical cost of doing so (and the societal cost of slowed vaccinations) are not captured in any budget or fiscal report. Such a cost would only be recorded if the money was actually spent.
How Significant is ARPA for State and Local Governments?
It’s easier to understand the importance of ARPA’s Fiscal Recovery Funds by comparing them to the Coronavirus Relief Fund (CRF), the core multipurpose component of the 2020 CARES Act’s aid to state and local governments. As the table below shows, ARPA not only provides more than double the amount of aid offered by CARES, it entitles a far larger number of local governments (more than 30,000) to be prime recipients of the aid. This means they are guaranteed federal aid, and do not have to wait at the mercy of state governments for a discretionary “pass through.” The CARES Act allocated CRF funds based on population — while ARPA’s fiscal aid is allocated using several different formulae.
Yet perhaps the most distinguishing feature of ARPA is how state and local governments can use recovery funds. Under the CARES Act, multipurpose aid to state and local governments proved cumbersome to use.Especially limited, officials had to show that funds were used for necessary expenses tied directly to COVID-19’s health and economic impacts. In practice, this resulted in confusion and delay. Researchers at the National Academy of Public Administration found that the CARES Act’s restrictions on aid led to administrative burdens that delayed the effective use of these dollars. They called for greater flexibility. All in all, the design of ARPA appears to reflect some amount of policy learning as state and local governments have greater spending discretion. We compare key aspects of each multipurpose aid program in the table below:
Comparing Multipurpose State and Local Aid in CARES Act and ARPA
While ARPA affords more flexibility than the CRF, state and local governments’ spending nevertheless must align with the parameters outlined in the act itself. They’re also restricted by the Treasury’s subsequent rules. If spending is found to be ineligible, governments would have to pay back the funds to the federal government. State and local governments can spend ARPA funds in three broad policy categories[1]:
- Addressing the direct health and economic impacts of COVID. Examples of eligible spending includes payroll for public health workers, economic impact payments to households, and replenishing state unemployment trust funds. State and local governments must be able to directly connect spending that falls into this category to the “disease itself or the harmful consequences of the economic disruptions resulting from or exacerbated by the COVID-19 public health emergency” (p. 10).
- Maintaining government services that would otherwise be jeopardized because of COVID related revenue shortfalls. Spending in this category can be for general government services, meaning the spending does not need to tie directly to COVID. However, because this category is intended to address revenue shortfalls, state and local governments have to provide the Treasury Department with a calculation of COVID’s impact on their revenue to justify spending in this category,. Furthermore, the use of Fiscal Recovery Funds for this category cannot exceed the revenue loss. (The Interim Final Rule specifies how governments are to calculate the revenue impact).
- Infrastructure projects to address needs that existed pre-COVID and exacerbated the crisis's impact. More specifically, the money can only be spent on water, sewer, and/or broadband projects. For this category, governments will have to provide the Treasury with information on “workforce plans and practices” — although the additional reporting requirements have yet to be determined.
Across all three of these categories, the Treasury Department has encouraged state and local governments to deploy funds in targeted ways that would benefit communities most affected by the COVID-19 pandemic. COVID’s health and economic effects, as we know, disproportionately fell on Black and Brown communities. And given that the pandemic exacerbated pre-existing disparities in these communities, Treasury has suggested that recipients may use funds to redress those disparities, too. Among other things, that includes: “Remediation of lead paint or other lead hazards to reduce risk of elevated blood lead levels among children” and, “Evidence-based community violence intervention programs to prevent violence and mitigate the increase in violence during the pandemic” (p. 23).
Given the magnitude of the pandemic, as well as the scale of state and local government needs that preceded it, the above categories of eligible uses is necessarily broad. It constitutes the largest one-time transfer of multipurpose intergovernmental aid in decades.
Yet, importantly, multipurpose aid is not the same thing as unrestricted aid. Since the beginning of the pandemic, proposals for state and local relief funds have assumed that these dollars could be used flexibly. However they are still primarily allocated for the purpose of responding to the pandemic, covering costs, or replacing foregone revenues.
Even when compared to earlier proposals, such as the House-passed HEROES Act, ARPA includes a number of additional restrictions on how state and local officials can use federal dollars. It specifies that ARPA funds cannot be used to pay for state/local tax cuts, to pay down unfunded pension liabilities or outstanding debt, and/or replenish rainy day funds[2].
Restrictions on the Fiscal Recovery Funds reflect the tense political environment in which ARPA was passed. Republicans repeatedly placed Democrats on the defensive over so-called “blue state bailouts” and preemptive charges that additional aid was “not necessary” filtered in. For their part, Democrats clearly did not want to give Republicans at the subnational level the ability to claim credit for a tax cut, in the midst of a pandemic year.
In addition to partisan friction, ARPA’s legislative guardrails––as well as Treasury’s interpretation of them––reflects a conceptual tension in the visions for recovery aid. On the one hand, the legislation’s stated rationale of COVID relief suggests a need to ensure that allocated funds are used in ways specific to the pandemic and go to support the local communities most impacted. Yet, if the Biden administration’s policy goal is to build back stronger state and local governments than existed before the crisis, there’s some cause for concern. We should recognize that governments’ inability to meet unfunded pension liabilities and other, outstanding debt burdens has contributed to the whittling away of core social and health services. This clearly became even more crucial during the pandemic.
Moreover, federal restrictions on aid and other reporting requirements add up to significant administrative burdens for state and local officials. In its own Interim Final Rule, the Department of Treasury estimates that reporting and auditing requirements may result in an annual 1.5 million hours of paperwork for all state and local governments, using the recovery funds. For comparison, consider that General Revenue Sharing (1972–1986)––as a no-strings-attached program––included only minimal reporting requirements in the form of a one page report on planned (and actual) use. Audits were only intended to reveal fraud or illegal activity[3]. Thus while the Treasury Department has a clear responsibility for overseeing the proper use of ARPA funds, it will also be necessary to ensure that audit culture does not become the enemy of effective policy implementation.
Actual Use Report Form for General Revenue Sharing Program
Will state and local governments be able to use ARPA dollars in transformative ways?
As budget season heats up, ARPA dollars are recasting state and local fiscal policy debates around the country. This comes in the context of calls for racial justice, and last year’s nationwide protests that were sparked by police killings captured on video. Yet ARPA’s scale and flexibility do not guarantee transformative policy. Rather, what matters are the decisions that state and local officials make now. These choices will be influenced not only by pre-existing community needs and the macro-policy context, but also the role played by technical experts. As ever, experts are informed by the usual public finance norms, and mobilized publics, that always appear in fiscal politics.
The history of General Revenue Sharing provides an instructive lesson about how potentially transformational reforms can––once implemented––revert to a logic of incrementalism. As one prominent study of the program concluded, despite high-flown rhetoric about the program’s potential to catalyze change in local governments, “city executives neither expected nor reported actually using much of the new revenue to initiate new programs or expand existing services.” Instead, GRS funds were far more frequently used to maintain existing services, rather than to address needs not currently incorporated into city services. Local officials’ caution makes sense, especially given that GRS transfers were not designed to increase with inflation or federal income tax collections. Moreover, by 1978 the program was enmeshed in a context of local tax revolts, including significant cutbacks on intergovernmental aid to cities, and threats to retrench revenue sharing funds themselves.
Prior experiences with intergovernmental aid––as we have noted in a report published by the Government Finance Research Center––suggest that we need a dedicated, automatic intergovernmental aid program. One that expands during recessionary periods, and contracts as normal economic conditions resume. A one-time program, created months into an economic and public health crisis, is simply not enough.
Still, even in the absence of a permanent program with an automatic trigger, there are ways to ensure that ARPA will fulfill its potential. One major challenge that officials at all levels of government currently face is developing the institutional architecture for planning ARPA spending. As one of us has written about earlier in the pandemic in Notes on the Crises, the decay of formal institutions for intergovernmental relations has resulted in a more fragmented and chaotic policymaking context. The Treasury Department has only recently set up an office to oversee the administration of recovery funds.
Local governments are, to varying degrees, still establishing explicit processes and institutions to guide ARPA spending. Indeed, with limited planning capacity, local officials may choose “shovel ready” projects, which are easy and quick to implement, rather than strategic investments (an issue seen with CARES Act spending). Using ARPA funds for the payroll of existing employees, for example, is administratively less burdensome than creating a brand new program.
In addition to creating dedicated institutional capacity for ARPA planning, local officials must ensure the representation of community members whose voices are traditionally marginalized in the fiscal policy process. Because ARPA is a one-time infusion of federal dollars, local officials may face pressure to support one-time capital improvement projects––including those already in the works. There’s reason to worry that this could contribute to uneven development and gentrification. City officials may also be under pressure to devote one-time ARPA funds to purposes that have a better chance of enhancing bond ratings, than they do addressing outstanding needs. At the same time, the ability to use ARPA funds to ensure communities have clean drinking water (as notoriously did not exist for Flint, Michigan) reflects how the act was informed by pre-pandemic issues. This speaks to the Biden administration’s vision that building back better entails tackling longstanding societal inequities.
To be sure, local officials in some cities appear to be striving for a more participatory model of decision-making where ARPA funds are concerned, with, for example, Detroit holding 25 community meetings to solicit residents’ input. In Milwaukee, a proposal is currently on the table to divide an equivalent percentage of ARPA funds among aldermanic districts “based on the principles of participatory budgeting.” But consultation and participation will likely not be sufficient to ensure that ARPA funds are equitably spent. Rather, sustained mobilization by community organizations to expand the scope of conflict may help to develop policy alternatives that reflect the most urgent needs. They could also generate greater attention to the typically obscure details of local fiscal policy.
In short, ARPA’s legacy and its capacity to close racial and economic disparities is contingent on two things. First, on local capacity and how fiscal policy experts deploy principles of public finance. Second, on whether those with the power to make decisions about how to spend the Fiscal Recovery Funds see these issues as at the core of what it means to “build back better.”
[1] In addition to the three categories, Fiscal Recovery Funds can also be used for premium pay for essential work, and can be used for retrospective premium pay. Premium pay is defined as up to $13 per hour, with a cap on how much an individual worker can receive.
[2] Fiscal Recovery Funds can, however, be used for the pension “payroll contribution” that is part of an employee’s overall compensation and benefits package. Treasury specifically differentiates “payroll contributions” with a pension fund “deposit”, with the latter referring to an extraordinary payment into a pension fund for the purpose of reducing an accrued, unfunded liability”).
[3] This explains both the program’s popularity among state and local officials as well as its poor reputation with conservatives.
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