Skip to content

What States May Face During the Pandemic-Driven Recession

A look at California, one of the country’s largest states, and the tough budget decisions they had to make.

"What’s out there is darkness, uncertainty, decline and recession. So good luck, baby. — Gov. Jerry Brown as he unveiled his final budget, January 2018

Darkness was a regular theme for the four-term governor in the final years of his administration. In the midst of the longest economic recovery on record, he preached frugality and saving for the future. While it is unlikely that even Brown could imagine just how dark things could get, the recession he warned about has arrived.

California, the largest state,1 passed a budget for the 2020-21 fiscal year at the end of June. It is a budget that reflects the uncertainty that pervades just about every aspect of life at the moment. What policymakers produced was a document of guesses, difficult choices, and a bit of hope. Despite its scale, the California budget experience is similar to what is happening across the country, as state and local governments try to make ends meet during the pandemic-driven recession. It is a story of no good choices, only bad and worse ones, and perhaps most important, it may represent only the first milestone in what could be a long and difficult road.

Boom. Recession.

The year began full of promise. The state was maintaining its reputation for innovation, and Gov. Newsom proposed his second budget.

California Gov. Gavin Newsom visits the California Department of Forestry and Fire Protection's McClellan Reload Base in Sacramento, Calif., July 9. (Hector Amezcua, Pool/Associated Press)

From an economic perspective, things were very good in California in January of 2020. Unemployment for the state stood at 3.9 percent — its lowest level in over 50 years. The state’s economy had been growing steadily for a decade, and Newsom’s budget reflected this optimism. The Department of Finance projected that revenues would increase by more than $5 billion (3.5 percent) over the previous year. Spending was also going to increase, with K-12 and higher education slated to see proportionate growth. The governor even proposed new investments in early childhood education and support for housing. This budget continued to promote expanding access to state-supplied health care for undocumented residents; specifically, Newsom was planning on expanding coverage to seniors, regardless of their immigration status.

And then, everything changed. The virus hit the California economy quickly. The first case of COVID-19 was identified in California on Jan. 26, 2020. By the end of the month, there was a handful of COVID-positive residents who had been on cruises or traveling overseas. The CDC confirmed the first instance of community spread in California on Feb. 26. 2 The counties in the Bay Area issued their shelter in place order on March 16, and Newsom announced a statewide measure three days after that. With the state shut down, California’s enormous economic engine began to grind more and more slowly.

Employment figures offered the most immediate indication of the impact. By the last week in February, 42,000 Californians filed unemployment claims. In March, new unemployment claims in the state topped the 1 million mark, representing more than 15 percent of the country’s record-breaking figure of 6.9 million. Not surprisingly, the unemployment rate spiked, jumping to 16.4 percent in April (see Figure). To put these numbers in perspective, the peak unemployment figure for California during the Great Recession was 13.2 percent (in March 2010).

Less employment and economic activity translates into less revenue coming into the state treasury. As the money coming in fell, the money going out the door was going to have to increase in response to the health crisis. This was the world in which policymakers looked to fashion a budget.

Balancing Act.

The revenue forecast was bleak. For the current (2019-20) fiscal year, they projected that baseline revenues would fall almost $10 billion below what had been expected five months earlier (down 6.6 percent). For the upcoming year, the baseline numbers were worse, with estimated revenues down more than $32 billion, a massive 22 percent below expectations.

Compared to where Newsom had planned to be in January, without changes a $54 billion gap would emerge. The first shift was to simply shelve most of the new initiatives that had been proposed. Then, the state was able to draw upon its reserves — the rainy day fund — to offset the drop in revenue. California enters this recession in a fiscal position that is impressive both historically and relative to other states. The January budget calculated that total reserves for the state would be $20.5 billion, a record-breaking level representing about 13 percent of general fund spending. Compared to other states, the Pew Research Center estimated that California had saved enough to pay for state expenditures for almost 53 days, ranking it seventh by this measure among the 50 states for 2019. The governor also proposed a modest increase in taxes, suspending the use of net operating losses for medium and large businesses and temporarily limiting the amount of business incentive credits a taxpayer could use in any given tax year to $5 million.

The big spending hits are in the form of trigger cuts and deferrals. If the federal government does not provide an additional $14 billion in assistance by Oct. 15, the cuts would take effect. According to the Department of Finance summary, if the Congress doesn’t act by this fall, the current spending plan will shrink by the following amounts:

  • $6.6 billion in cuts to schools and community colleges;
  • $970 million in reductions to the UC and CSU systems;
  • Salary reductions and unpaid days off that will net $2.8 billion in savings from state employees; and
  • State courts and child support administrative services stand to lose $150 million.

Federal aid also would trigger an additional bump to counties, providing $150 million in assistance to the 58 jurisdictions that currently isn’t part of the budget.

With or without federal action, the state will be deferring payments to local school districts representing $11 billion. As part of this year’s budget agreement, the state promises to repay this amount in the 2021-22 fiscal year — over and above the money the state would otherwise provide. It is the districts’ responsibility to figure out how to manage their cash flow until the promised funds are backfilled.

The bottom line is that California government will be smaller this year than it was the year before. How much smaller? If all proceeds as planned — revenues come in as expected and the federal government provides at least $14 billion in aid — general fund spending will drop 9 percent relative to the previous year. Should Congress be unable to act and the trigger cuts kick in, the total drop in expenditures would be more than 16 percent. Budget cuts of that magnitude will be noticed. During the past recession, school classrooms got larger, colleges and universities turned away more qualified students, and maintenance of roads and public facilities was deferred. That is expected to happen again. Notably, the budget was a clear statement that the state’s most vulnerable — the very poor, elderly, and homeless — were largely shielded from cuts. That was an explicit goal and was largely achieved.

Uncertain future.

California’s budget makers likely felt a sense of relief when they passed this year’s deal. But, rather than marking the end of an ordeal, it is likely to represent just the beginning. Later this month, a more specific picture should emerge regarding the tax receipt picture and whether Congress will provide more aid. Beyond that, the path ahead remains murky. This recession is going to hit all states hard, and its impact on revenues and services is likely to last beyond one year. The COVID virus already has demonstrated its ability to deal a tremendous blow to the economy. And, the virus has also demonstrated its persistence. That persistence will translate into many more difficult choices ahead for those tasked with the job of balancing state budgets.

  1. 1

    Californians are fond of noting that if the state were a country, it would boast the 5th, or 6th largest economy in the world depending upon the source and timing.

    ↩︎
  2. 2

    At the time, that was assumed to be the start of the virus in the state. Weeks later, a Santa Clara medical examiner would report that a woman died of COVID on Feb. 6. The woman had not been traveling and most likely was exposed by community spread.

    ↩︎