As President Joe Biden and House Speaker Kevin McCarthy spar over the debt ceiling, the fate of state economies hang in the balance.
Earlier this month, Moody’s Analytics released an analysis of what a prolonged debt ceiling breach would do to state economies.
The biggest impacts Moody’s estimated were around jobs. With the federal government not making payments, large states could lose hundreds of thousands of jobs. If the federal government runs out of spending authority, it won’t be able to pay federal workers such as agency professionals, military, or staff at national laboratories.
Moody’s estimates these impacts could be large in big states. According to the firm, California would lose over 800,000 jobs, Texas over 500,000 jobs, Florida and New York about 400,000 jobs, and Ohio, Pennsylvania, and Georgia over 200,000 jobs.
These would lead to massive unemployment problems in states across the country. Moody’s projects Michigan’s unemployment rate would reach 10.8% under a sustained debt ceiling breach, up from 4.1% today. California’s unemployment rate would reach 8.7% and Ohio’s would approach double digits at 9.5%. All this would lead to a pronounced recession in most states.
What would this mean for state policy? One major impact would be that revenues would crash compared to expectations. States that rely on income taxes to fund state programs would have direct impacts on state revenues as massive job losses lead to much lower income tax collection rates than expected. States that rely more heavily on sales taxes would also have a significant reduction in revenue. This is because if people have less income to spend, they are less likely to make purchases that are subject to sales taxes.
This would lead to states needing to plug the gaps in their budgets with “rainy day” funds. These are funds put in place to help continue government operations in the case of a revenue shortfall. Among states, there are a range of different sizes of “rainy day” budget stabilization funds.
According to an analysis by Pew, Wyoming’s budget stabilization fund could fund the government for nearly an entire year without taking in any additional revenue. On the opposite end, New Jersey would be unable to finance state spending tomorrow if forced to rely on its budget stabilization fund. The average state could finance state spending for a little under a month and a half with their budget stabilization funds.
Another major impact to a debt ceiling breach on state government would be strain on the state social safety net. A massive spike in unemployment caused by a debt ceiling breach would put states with weak unemployment trust funds in a bind. As of January, California, Connecticut, Illinois, and New York had $0 balances in their unemployment trust funds. States like Michigan, Ohio, and especially Pennsylvania also had very low balances that put them at risk of insolvency.
These sorts of situations are even worse in the case of a recession triggered by debt ceiling breach because the federal government cannot step in to fill the gaps in state social safety nets. During the COVID recession of 2020, the federal government passed legislation that bailed a lot of state governments out of some tough fiscal situations to fund unemployment, school lunch, and SNAP and to stimulate the economy with cash payments to individuals. A federal government hitting its debt ceiling would not be able to do this.
The silver lining is that Moody’s report only gives a 10% chance of the debt ceiling actually being breached. But playing chicken with state economies has become commonplace in federal policymaking. Let’s hope policymakers come to an agreement that brings us further from what would be a disaster for the states.