The most vulnerable states for seeing their federal aid cut are those that already carried some of the lowest credit ratings.

Senate Majority Leader Mitch McConnell and New York Gov. Andrew Cuomo couldn’t be farther apart in their views of how Congress should help states recover from the recession. But their states are among those with the most to lose if the situation gets much worse. 

While every state is feeling the pressure, the most vulnerable ones are those that already carried some of the lowest credit ratings even when the economy was at its best — including Illinois, New Jersey, Connecticut and Kentucky. Even New York, which had good credit, has seen its outlook downgraded and will suffer without more federal help.

That’s left some local officials bitter that the federal government has been willing to cut blank checks to businesses regardless of how they are run but views helping state governments as unacceptable “blue state bailouts.” Now, with Congress debating another economic relief package that is unlikely to contain the $500 billion in aid that state officials were hoping for, they’re warning of a looming fiscal disaster, not only for themselves but for the country. 

“If Congress underestimates the economic tidal wave that is coming, even by the smallest of margins, we are all going to be swept away,” said Illinois State Treasurer Michael Frerichs. 

Already, the U.S. Labor Department has reported that some 1.5 million state and local government jobs were lost from February to June, adding to the tens of millions of private sector jobs that have been shed nationwide.

Nowhere is the politics of state aid more complicated than in McConnell’s Kentucky, which Donald Trump won by 30 points in the 2016 presidential election. Next fiscal year, its shortfall could be as high as $1 billion, according to the state’s budget director. 

McConnell has largely stayed out of the debate since setting off a political firestorm — and drawing a blistering rebuke from Cuomo — in April with the suggestion that states might use bankruptcy as a way to emerge from a fiscal crisis – a step that they’re not even allowed to take under federal law.

He walked that back a week later, saying there “probably will be” more funding from Congress.

Kentucky Gov. Andy Beshear — a Democrat — averted deeper cuts or layoffs this budget cycle by instituting hiring freezes and asking for a 1 percent reduction in agency budgets government-wide after coronavirus shutdowns suggested a potentially massive shortfall. But he warned this month that without additional federal support, cuts in the next cycle will need to go deeper than even during the Great Recession. Beshear has urged Congress and the Kentucky delegation, including McConnell, to approve more state funding.

Cuomo said the characterization that only Democratic states needed budget help was “the epitome of hypocrisy.” 

“You now have Republican states that are suffering worse than Democratic states,” he said earlier in July of the new surge of coronavirus outbreaks. “If they want to get this economy back running, you have to fund state and local governments.” 

Kentucky and New York have already begun either reductions in services or payment slowdowns, as have New Jersey and Illinois. 

While Connecticut planned to fill an operating deficit estimated to exceed $1 billion using reserve funds, the state ultimately balanced its budget through a combination of higher-than-expected revenue, tax increases and spending reductions, including by postponing service increases. Still, that the rainy-day fund is expected to quickly dry up in the future with deficits projected to increase.

The finances of those and other state governments have been upside down since the wave of economic shutdowns squeezed tax revenue. A federal delay in the tax filing deadline led many states to follow suit, which also slowed money coming in. At the same time, a historic plunge in crude oil prices further decimated oil-rich states like Alaska and North Dakota that rely heavily on royalties.

While the federal government has been able to print money to blunt the crisis’s economic blow to businesses, workers and the unemployed, states don’t have that option. Already, credit downgrades for some like New Jersey and Illinois mean future borrowing could be more costly, disrupting recovery plans. 

Still, state officials were hoping Congress would provide enough in direct grants to fill budget holes after lawmakers agreed to dole out hundreds of billions in forgivable loans to small businesses in the March stimulus bill. Then in May, House lawmakers agreed on legislation that included $250 billion to backfill state budgets.

Legislation proposed by McConnell’s Republicans on July 27 didn’t offer much room for optimism, however. The legislation calls for $105 billion to go to states for schools — but two-thirds of that is dependent on maintaining certain levels of in-person instruction.

The National Governors Association slammed the lack of additional state aid in the GOP package as “disappointing” in a statement Wednesday from Republican Gov. Larry Hogan of Maryland, the group’s chair, and Cuomo, the vice chair. 

Sen. Pat Toomey (R-Pa.) said in an interview on CNBC Tuesday that it was unlikely Congress would spend much more on local budget issues: “There’s a lot that’s already been done,” he said.

Toomey said money appropriated to states has not even been fully spent and that the Federal Reserve has set up a short-term government credit facility “that has not been drawn significantly but that is available.”

A recent report from the Treasury Inspector General backs up Toomey’s argument. The report found that as of June 30, states nationwide had only used an average of about a quarter of the funds from the CARES Act, the $2 trillion economic relief package Congress approved in March. But the National Governors association countered that states have already allocated approximately 74 percent of those funds, on average.

The next agreement will probably fall short because unemployment benefits, stimulus checks and additional small business loans — not state budget deficits — have dominated the debate. 

One ray of hope for the states: Legislation proposed by Sen. John Kennedy (R-La.) in May would give them more discretion to use a $150 billion coronavirus relief fund to cover operating expenses. Congress explicitly prohibited the use of the fund for that purpose when the money was appropriated in March.Language similar to Kennedy’s bill was included in the Finance Committee portion of the Republican Senate package.

But Sen. Rick Scott (R-Fla.), a former governor of Florida, criticized the increased spending flexibility in the Republican plan. “What I don’t want to do is bail out the states,” he said to POLITICO.

“We’re not crying wolf out here in the states about some of the drastic measures that would be necessary, and we’ve got proof in past recessions that we will cut,” said John Hicks, Kentucky’s budget director. “Federal fiscal relief is just critical for us to be able to maintain education, health and public safety.”

For its part, New York’s fate is tied financially to New Jersey and Connecticut — both states in worse economic shape — putting the financial health of its massive public transportation network at risk.

The Metropolitan Transportation Authority, which also provides rail service to Connecticut, is burning through $200 million a week.

New York officials said the state has already reduced spending by $4 billion since April through a combination of hiring freezes, new contracts and pay raises, as well as holding back 20 percent of funds to some of the state’s larger cities.

“This means lower spending for police, schools, health care, roads, courts, and support for our most vulnerable neighbors,” Freeman Klopott, a spokesperson for the New York State Division of the Budget, told POLITICO. “The Federal government must act to provide states with the resources we need or the negative impacts of its failure to do so thus far will only deepen.”

New Jersey has cut $1.2 billion in spending and delayed some major payments to schools and pensions. On top of that, Democratic Gov. Phil Murphy pared operating costs and grants and has ordered 15 percent reductions across departments. The governor is trying to get clearance to borrow up to $9.9 billion, but Republicans are challenging him in court.

“I would hope this is the moment right now for Congress,” Murphy said at a daily coronavirus press briefing in Trenton. “The next three weeks is do-or-die.” 

“I can’t tell you exactly what happens to our services or programs without that federal cash, but it’s ugly,” he said. 

Financial analysts sense big trouble in Illinois, which has the worst credit rating in the nation. Even before the crisis, the state had to slow down payments because expenditures exceeded revenue, and the coronavirus has stalled them even more, according to the comptroller. The state was hit with a series of negative financial assessments in April, further imperiling future borrowing.

Democratic Gov. J.B. Pritzker signed a budget with a $6 billion deficit in June and has warned that layoffs could come without significant extra federal funding.

In a sign of how bad things have gotten, the state is among the few to have accessed short-term credit from a Federal Reserve emergency facility set up in March. Advocates for more state aid have criticized the Fed’s lending option as too expensive, but the terms were actually more favorable for Illinois than the open market because of its poor credit. 

With all the election year pressure, governors fear Congress will opt for the approach taken in the Great Recession: Let states cut their budgets and gripe about a dragged-out economic recovery later. But this time around, it’s clear that governors are laying the groundwork to blame Congress. 

“It doesn’t matter what the political party of the state’s legislature or governor is,” Hicks of Kentucky said. “We’re all in the same boat together.”

This blog originally appeared at Politico on August 3, 2020. Reprinted with permission.

About the Author: Katherine Landergan covers the state budget, tax policy and labor issues for POLITICO New Jersey.

About the Author: Kellie Mejdrich is a reporter for POLITICO Pro Financial Services.