Tax and budget policy expert Randy Bauer was Governor Tom Vilsack's budget director for six and a half years and has evaluated tax and revenue policies for many state and local governments.
In late September, Governor Kim Reynolds announced that the State of Iowa had a $1.24 billion surplus for fiscal year 2021, which ended on June 30. In a news release, she and the state's interim budget director credited their own fiscal management for the surplus. Top Iowa Republican lawmakers have echoed that message.
Was it really all that praiseworthy? I’d suggest not. Here's why this record surplus was not the big deal Reynolds and her minions made it out to be.
MANY STATES NOW REPORTING RECORD SURPLUSES
While a state budget surplus is welcome news, it is not surprising in the current environment. Nearly every state is reporting a strong surplus at the end of FY2021. In many cases it is far larger than that reported by the State of Iowa.
The definitive source for information about state budgets are the twice annual surveys conducted and published by the National Association of State Budget Officers (NASBO). This independent professional and education organization was founded in 1945 and conducts research, policy development, education, training, and technical assistance through publications, membership meetings, and training sessions. NASBO members are the heads of state finance departments, the states’ chief budget officers, and their deputies. All other state budget office staff are associate members.
The U.S. Census Bureau provides perhaps the second-best source of state government revenue expenditure performance in its Quarterly Summary of State and Local Government Tax Revenue.
Those sources show very favorable state revenue results across the country. The Census Bureau's summary through the second quarter of 2021 (published in September) noted that total state tax revenue increased 56.4 percent in the second quarter of 2021. Individual income tax was up 77.0 percent, in part due to timing of tax collections. General sales and gross receipts taxes, which wouldn’t have some of those timing issues, increased by 36.7 percent.
While not capturing data as recent as the U.S. Census Bureau survey, the NASBO Spring 2021 Fiscal Survey reports that states are doing well. It reported that general fund collections are coming in above original projections in 38 states, on target in four states, and below projections in eight states. That's important, because every state except for Vermont has a constitutional or statutory requirement to balance its budget on a yearly basis.
As a result, projected revenues are the ceiling for adopted budgets, and when revenues are running ahead of forecast, you would expect states to run a surplus. That is what's happening now.
Every year, NASBO brings state officials together at spring, summer, and fall meetings. The participating states typically provide a summary of the existing conditions in their state, including expected budget outcomes, projected revenue, and expenditures.
Last week, I attended the first NASBO meeting since 2019 that was conducted in person. That meeting in Washington, DC was well-attended, with 33 states participating. (Iowa was not in attendance, as they have skipped NASBO meetings for several years, but that unfortunate circumstance is a topic for another day.)
The prevailing judgement from every participating state was that 2021 was an outstanding (and often astounding) year for state budgets. Many—maybe even most—states are ending their year with record surpluses. It was often a weird discussion, with states suggesting they were not exactly sure how they would deal with their new-found financial largesse. Having attended NASBO meetings for more than 20 years, I can say this was a one-of-a-kind discussion.
MOST STATES UNDERESTIMATED REVENUES LAST YEAR
This wonderful financial position for most states is demonstrated by their reported reserves, which are unspent state funds. Unlike the federal government, states are expected to balance their budgets on a yearly basis. In most states, revenue comes from a combination (or single source) of personal income tax and sales and use tax. Both sources are subject to swings in collection based on economic activity. For that reason, states must maintain reserves in case revenue forecasts do not match actual performance.
It’s not surprising that states generally under-forecasted their revenue for the last fiscal year. The recession that commenced in February 2020 was based on an unprecedented U.S. economic hibernation triggered by the COVID-19 pandemic. Given the sharp drop in economic activity, state revenue estimators understandably reduced their expectations for the year. What really wasn’t understood was how short would be the duration of the recession and how it would impact the economy in general.
In fact, the 2020 recession commenced in February and ended in April – the shortest U.S. recession on record. That didn’t mean it didn’t have an impact – the decline in gross domestic product was far greater than in any other recession. What differed was how it impacted the U.S. economy: while service-related businesses (such as restaurants, hotels and retail stores) saw dramatic declines in economic activity, other parts of the economy, such as professional services, did not experience similar reductions. It was notable that lower paying service jobs bore the brunt of the dramatic job losses, while higher-paying jobs in other sectors largely remained intact.
Kierkegaard was right: life can only be understood backward but must be lived forward. State revenue forecasters did not know the 2020 recession would be super-deep but the shortest on record. They expected the downturn would last longer than it did. As a result, most state revenue forecasts built in a sharp decline in revenue that had a duration of at least a year or longer.
STATE TAX COLLECTIONS DIDN'T DROP AS MUCH AS FORECAST
In fact, this did not turn out to be the case. To be sure, some timing issues affected revenue collection. Most states followed the federal government’s lead and moved back their 2020 income tax filing dates from April 15 for tax year 2019 to a later date, which was generally July 15.
For most states, that moved the final pay of 2019 individual income tax from one fiscal to another, because 46 of the 50 states (including Iowa) have a fiscal year that runs from July 1 to June 30. Given that for most states, personal income tax collections are their largest or second largest source of revenue (sales and use tax being the other primary source), this had a big impact on their FY2020 bottom line.
Of course, moving the final due date for individual income tax did not alter the responsibility to pay the tax, it just moved back the final pay date. What states found, once those final pay returns were received and calculated, was that state individual income revenue was higher than they had forecast, often substantially higher.
As previously noted, this was largely because of the nature of the 2020 recession. Unlike most prior recessions, this one was concentrated on a few economic sectors (in this case service industries like bars and restaurants, hotels, and retail). While these are important sectors for employment, they are not high paying sectors. Given that other higher paying sectors continued to perform reasonably well, state tax collections didn’t go down as much as was forecast.
PANDEMIC RELIEF LOWERED STATE COSTS, BOOSTED REVENUES
The other factor that state revenue forecasters didn't take into account was the extent of federal support for the states, starting during the Trump Administration with the March 2020 Coronavirus Aid, Relief, and Economic Security (CARES) Act.
The CARES Act was a wide-ranging assistance program. For states, one of the important provisions was the increased federal match for the Medicaid program. Medicaid is the nation’s public health insurance program for people with low income and the principal source of long-term care coverage for Americans. It covers 1 in 5 Americans, including many with complex and costly needs for care.
State are required to match federal participation in Medicaid, based on a formula. Every state is guaranteed at least 50 percent federal match for Medicaid expenditures. The CARES Act increased the federal share of the program by 6.2 percent, which reduced the state required expenditures by that same amount.
As a result, Iowa’s federal match for the Medicaid program was increased by $690 million through the end of 2021, and the state responsibility reduced by the same amount. Needless to say, Iowa would not be experiencing its record surplus without that and other forms of federal help.
The CARES Act also provided substantial direct assistance to state and local governments. For states (beyond the Medicaid assistance already discussed), it provided per capita assistance at a minimum level of $1.25 billion, the amount Iowa received. As a point of reference, the State of Iowa’s entire general fund appropriated budget for FY2020 was $7.824 billion, meaning the CARES Act funding equaled about 16 percent of the entire state general fund budget.
For those following along at home, it is notable that the state’s surplus at the end of FY2021 was slightly less than this $1.25 billion.
The CARES Act assistance did come with restrictions; it was primarily meant to cover costs associated with the pandemic. What that means is open to interpretation. As a former state budget director, I will tell you that a lot of government activities can be rationalized as qualifying under the CARES Act language.
Iowa seemed to stretch the limits of that sort of rationalization – even beyond what was acceptable (which is another story for another day – so many stories with the Reynolds administration). Regardless of the restrictions, CARES Act funding was a great resource for the state. While the governor claims to have exercised fiscal responsibility, she and her staff had no role in creating that $1.25 billion windfall.
FEDERAL SUPPORT FOR STATES GREATER THAN DURING PAST RECESSIONS
The other major federal assistance program for states was the American Rescue Plan, passed in March 2021. Among its features, it provided significant funding to state and local governments. For the State of Iowa, that assistance totaled $1.481 billion, which came with far fewer restrictions than the CARES Act.
Notably, Reynolds has highlighted some uses of those funds (such as housing or broadband programs), even though she opposed passage of the law that made that money available. The governor often referred to the American Rescue Plan as a "blue state bailout."
It is not unusual for the federal government to assist state and local governments during an economic downturn. While states and local governments generally are required to maintain a balanced budget throughout their fiscal year, the federal government can run deficits. As a result, it has greater opportunity to help "prime the pump" for the national economy during recessions. State and local government comprise somewhere between 14 and 18 percent of national gross domestic product (which varies by year and the state of the economy), so government is a significant component of the economy, and significantly reduced spending on its part can lengthen and/or deepen a downturn.
During the current pandemic, federal support for all states, including Iowa, has been much larger than in past recessions. The largest prior level of federal support was during the "Great Recession," which lasted from December 2007 to June 2009. The federal government response through the American Recovery and Reinvestment Act carried a price tag of $840 billion; however, most of that was targeted to individuals or infrastructure-related programs. The only significant direct support to state governments included in the 2009 stimulus bill was an increase in the federal match for Medicaid, which translated into $105 billion for states.
OTHER PANDEMIC-RELATED POLICIES INCREASED STATE REVENUES
While the direct federal support to states has been extraordinary, the literally trillions of dollars that have been pumped into the economy in 2020 and 2021 have also bolstered state economies. Direct assistance to individuals and businesses, including the Paycheck Protection Program, enhanced and extended unemployment benefits, three rounds of economic impact (stimulus) payments to individuals, and advance child tax credit payments, helped the U.S. economy rebound from its induced hibernation related to the COVID-19 pandemic. Those funds helped keep people employed and active participants in the economy – which translates into taxable consumption and income.
Given that the vast majority of Iowa’s revenue comes from state sales and income taxes, that federal support was critical to its FY2021 surplus.
Iowa is hardly different from other states in its current experience. According to the NASBO spring 2021 survey, estimated total balances (states’ rainy day fund balances combined with general fund ending balances) for all 50 states reached $126.4 billion in FY2021, a new all-time high in nominal dollars, and 13.8 percent as a share of general fund spending.
Iowa’s surplus at 15.2 percent of the state's general fund spending is higher than the average, but it is far from being an outlier. Eleven states have a larger total balance as a percent of spending (Alaska, Colorado, Idaho, Montana, Nebraska, New Mexico, North Dakota, Oregon, South Carolina, West Virginia, and Wyoming). Another two have the same percentage (Arizona and California). In other words, even some "blue" states (California, New Mexico, and Oregon) are doing as well or better than Iowa in this respect.
CELEBRATED "FISCAL STEWARDSHIP" WAS MANDATED UNDER STATE LAW
The other fact that gets in the way of the Iowa Republican celebration of their fiscal stewardship is that they had no choice. Iowa’s budget law requires them to do much of what they did.
In 1992, the Democratic-controlled Iowa legislature passed a historic budget reform bill. (I was there and helped craft it – but that’s another story for another day.) A key part of that reform was a mechanism to fill its rainy day fund. The state had a rainy day fund on its books at that time, but it was empty. The budget reform law required the state to spend no more than 99 percent of its projected revenue, with the remainder going into its rainy day funds (Iowa has two of those).
It is true that the Republican-controlled legislature appropriated less than the law allowed during the 2020 session. However, even if they had spent up to the limit, they would have been required to maintain a reserve level that is above average for all states, because that is how Iowa’s budget reform law works. When revenues exceed expectations (as they did this year), the result is a greater ending balance. As mentioned above, Iowa is hardly alone in enjoying this sort of strong fiscal performance.
The good news keeps coming in other states as well. For example, Virginia (where there is a Democratic trifecta) reported a $2.6 billion surplus at the end of FY2021, the largest in its history. California (another state where Democrats hold the governor's office and control both legislative chambers) had a budget surplus of $38 billion, once again the largest in its history, and a phenomenal number, considering that Iowa’s entire general fund budget is around $8 billion.
REYNOLDS REJECTED FEDERAL FUNDS THAT COULD HAVE HELPED MORE
It’s also an open question as to whether the fiscal restraints practiced by Iowa’s Republican leaders really served the state well during the recession. You generally cannot determine whether fiscal stimulus was effective until after the end of an economic downturn. However, most of the analysis done related to the 2009 stimulus and the Great Recession, including studies by the Congressional Budget Office, economists Alan Blinder and Mark Zandi, and the Federal Reserve Bank of San Francisco, suggest that the federal stimulus was vitally important for economic recovery.
The Republicans now running Iowa didn’t exactly go out of their way to "prime the pump" during and after the 2021 recession.
For example, Reynolds eschewed federal money meant for Iowa’s unemployed and ended the enhanced benefit three months early. Her action literally took federal money out of the hands of jobless Iowans. Her premise – that these benefits were keeping people from working – hasn’t proven to be true. In fact, Iowa’s employment numbers after her benefit cut for unemployed workers were among the worst in the country. September's employment numbers revealed that Iowa was one of only three states to have an actual reduction in employment. By contrast, Iowa’s "purple" neighbor to the north, Minnesota, continues to outperform related to employment growth.
So, what is to be learned from this deep dive into budgets and outcomes? First, Iowa – like every state – is benefiting from historic federal assistance. The entirety of Iowa’s surplus could be matched and exceeded by the federal assistance the state has received in 2020 and 2021.
Second, Iowa’s current budget fortune is largely the result of following its own budget laws, which a Democratic-controlled legislature put in place long ago.
Finally, a strong argument can be made that some of the current surplus might have been better used to grow Iowa’s economy.
The Republican cheers about the strong budget results remind me of an old baseball analogy. It sounds like Kim Reynolds and her minions were born on third base and think they hit a triple.