A year ago, in the midst of the pandemic, all hands were wringing about shortages – shortages of food, everyday essentials, salaries, and government revenues. State budget experts were expecting revenue shortfalls of between 5% and 10%. Massive layoffs of state workers were possible, even possibly reaching into the ranks of university professors.
Now, a year later from those uncertain times, the exact opposite has occurred for state revenues. Revenues are up – way up! Compared to forecasts made earlier this year, revenues for the largest state spending category – the General Fund – are expected to be more than $6 billion higher this fiscal year and the next two fiscal years combined. The biggest issue now in state government is not how to cope with a budget shortfall, but instead how to use these unexpected billions of dollars.
How were the financial fortunes of the state turned around so quickly? In a phrase – federal government spending. From March 2020 to March 2021, the federal government passed several Covid-19 assistance bills totaling $6 trillion. This level of assistance is unprecedented. In my 43 years as a professional economist, I have never observed – nor have I read about – as massive of an effort like this one to help the economy through a troubling time. North Carolina’s share of the $6 trillion is $81 billion.
Of course, at the times most of these legislative bills were passed in Washington, decision-makers knew little about how long or deep the pandemic and pandemic-induced recession would last. Besides the death toll from Covid-19, we were worried about how much of the economy would be permanently lost, causing earnings by both businesses and households to plunge.
However, with the benefit of looking in the rear-view mirror, we can now see Washington over-compensated for the losses. Comparing the broadest measure of the aggregate economy – gross domestic product, or GDP – for 2020 to 2019, we now know the national economy lost $500 billion. Yet, the federal government pumped in $6 trillion to the economy, or $12 of stimulus for every $1 of loss. Consumers actually ended 2020 with more available income than before the pandemic. This over-the-top stimulus is a big reason why many economists are worried about higher inflation. As my first economics professor taught me a half-century ago, we’re in a situation of “too many dollars chasing too few goods and services.”
The situation is the same in North Carolina. The latest estimates indicate our state will receive $81 billion from the various federal programs designed to fight Covid-19 and its economic impacts. Yet comparing North Carolina’s GDP for 2020 to 2019 shows the state lost $5 billion of aggregate output. This is a 16 to 1 ratio of monetary help to monetary loss. I estimate the $81 billion of federal help is responsible for over half the $6 billion improvement in this year’s and the next two fiscal years’ of General Fund revenues.
This happy situation has, however, left challenges for managing our state’s budget. As I indicated, inflation may be on the way up. If faster inflation does occur, it will make future spending higher. Also, higher inflation rates typically cause interest rates to rise. Many economists thought interest rates were already set to jump due to the massive federal borrowing for the Covid-19 stimulus spending. Higher interest rates also increase costs, especially for borrowing.
These factors mean tough decisions for the state budget. How much of the state surplus should be spent, and – if spent – what’s the best type of spending – one-time or continuous? How much of the surplus should be returned to taxpayers, and – if returned – should it be done as a one-time return or continuous return in the form of permanent tax cuts?
Finally, for economic forecasters, if federal stimulus programs have now run their course, will the state economy and budget slip back somewhat in future years? If yes, it would argue for temporary measures.
These are all questions that make today’s good news more sobering.
Michael Walden is a William Neal Reynolds Distinguished Professor Emeritus at NC State University.