State Revenues Pour In, Raising Pressure on Biden to Divert Federal Aid

WASHINGTON — From California to Virginia, many states that faced devastating shortfalls in the depths of the pandemic recession now find themselves flush with tax revenues because of a rebounding economy and a soaring stock market. Lawmakers who worried about budget cuts are now proposing lucrative increases in school spending, tax cuts and direct payments to their residents.

That turnaround is partly the product of strong income tax receipts, particularly in states that heavily tax high earners and the wealthy, whose finances have fared well in the crisis. The unexpectedly rosy picture is raising pressure on President Biden to repurpose hundreds of billions of dollars of federal aid approved this year, in order to help fund a potential bipartisan infrastructure deal.

Last week, Senator Mitt Romney, Republican of Utah, suggested that Mr. Biden and Republican negotiators look to “some of the funding that’s been sent to states already under the last few bills” to help pay for that agreement. “They don’t know how to use it,” Mr. Romney said. “They could use that money to finance part of the infrastructure relating to roads and bridges and transit.”

Some economists and budget experts support that push, arguing that the money could be better spent elsewhere and that states’ spending plans could add to a risk of rapid inflation breaking out across the country. Other researchers and local budget officials say that the federal aid is rescuing harder-hit cities and states, like New York City and Hawaii, from a cascade of layoffs and spending cuts.

Biden administration officials say they continue to support distributing the full $350 billion in state, local and tribal aid that was contained in the $1.9 trillion economic assistance package that Mr. Biden signed in March. They say the aid will help ensure that the economic rebound does not repeat the years of state and local budget cutting that followed the 2008 financial crisis, which slowed the recovery from recession and contributed to millions of Americans waiting years to reap its benefits.

“We still feel strongly that the state and local plan is critical to ensuring we have a strong insurance policy for the type of strong growth we want, the type of equitable recovery the country deserves,” Gene Sperling, a senior adviser to Mr. Biden who oversees fulfillment of the March assistance package, said in an interview, “and to coming back from the 1.3 million jobs lost at the state and local level.”

Even if the administration wanted to recoup or divert the funds, it is unlikely that it could repurpose the money or make significant changes to how it is used without congressional action.

The debate over the state and local funding comes as Mr. Biden navigates a critical week of negotiations with Republicans over infrastructure in search of a deal, and as he prepares to travel to Cleveland on Thursday to speak about the economy. How to pay for any new spending is a primary hurdle in the talks, with Mr. Biden pushing to raise taxes on corporations and Republicans preferring increased user fees like the gas tax.

Repurposing unspent funds could help advance an agreement, particularly given Republican opposition to bankrolling state aid in previous rescue packages. Democrats pushed hard to include lucrative financial assistance for states, cities and tribes in Mr. Biden’s rescue bill. Republicans fought those efforts, warning they would serve as a “bailout” to high-tax, high-spend liberal states. They also cited a series of projections from Wall Street firms and other analysts suggesting that many states’ revenues were faring better than officials had feared in the early months of the pandemic.

It increasingly looks like many liberal states are not being “bailed out” — but also that some of them do not need more federal money. That is particularly true in states that do not rely primarily on the tourism or hospitality industries for tax revenues. Those with progressive tax systems that have caught surging revenues from investment income enjoyed by wealthy residents — like Silicon Valley moguls — are also faring well.

California officials expect a $15 billion surplus this fiscal year, after fearing a $54 billion shortfall. Virginia has seen nearly $2 billion in unanticipated revenues. As has Oregon, where economists recently upgraded the state’s revenue forecasts — moving it from projected deficits to surplus — in a report that surprised and delighted many lawmakers.

“It’s extremely surprising,” said Mark McMullen, the Oregon state economist.

“Obviously, when the shutdowns first set in and we saw these catastrophic employment losses, we treated them as a normal recession in our forecasts,” he said.

But surging income tax revenues and several rounds of federal assistance have now put the state “above our prepandemic forecasts,” Mr. McMullen added.

The strong revenue figures come as more federal relief money is just beginning to roll out the door. The Treasury Department began sending funds to states this month and has so far distributed more than $100 billion — about half of what is available to be disbursed immediately. Local governments are expected to receive the rest next year, although states still experiencing a sharp rise in unemployment will get a lump sum right away.

The Committee for a Responsible Federal Budget estimates that state and local governments have received a total of nearly $1 trillion in relief money in the past year. State and local revenues were running about 7 percent above their prepandemic levels in the last quarter — excluding the federal aid they have received.

Marc Goldwein, the senior policy director for the committee, said that states like Hawaii and Nevada that rely heavily on tourism clearly needed the assistance, but that for many others, the money was unnecessary.

The reasons vary, but Mr. Goldwein noted that home values have been surging around the country, providing a boost to property taxes; that states that were struggling from sagging oil prices have seen those prices pick up; and that consumers have been spending at a healthy clip thanks to stimulus checks and expanded jobless benefits.

“State and local governments, by and large, are frankly swimming in revenue,” Mr. Goldwein said. “It’s pretty clear to me that we spent a lot of money on states that we didn’t need to.”

Some economists, like Harvard’s Lawrence H. Summers, a former Treasury secretary under President Bill Clinton, have pushed Mr. Biden to repurpose the state and local aid for longer-term infrastructure projects, in hopes of easing what Mr. Summers warns is a dangerous buildup of inflationary pressure. Administration officials view high inflation as a much lower risk than Mr. Summers does.

Other analysts warn that state budget situations could sour if the stock market dips sharply or economic growth fizzles. Many cities, like New York, have struggled with sluggish tax revenues and still are reliant on federal to help avoid further layoffs.

New York expects to receive more than $22 billion in Covid-19 federal aid, according to the nonpartisan Citizens Budget Commission. Despite the funds, the city is still anticipating budget gaps in the coming years, the result of declining revenues like property taxes.

In retrospect, said Lucy Dadayan, a senior research associate at the Tax Policy Center, the March law should have included “more targeted funding” for the states and cities that need it most.

“I would still be all for helping state and local governments — more local governments than state governments, given what we know,” Ms. Dadayan said.

Treasury Department officials say the Biden administration wants states to have sufficient resources to cover immediate costs related to emerging from the pandemic and to be able to pay for more expansive services to help people who were hardest hit.

But many states and cities are eyeing windfall spending plans that go well beyond repairing their safety nets. Gov. Gavin Newsom of California, a Democrat facing a recall vote, has proposed a series of spending increases, including $1,100 stimulus checks to individuals and tax credits for filmmakers.

In Florida, the revenue forecast for 2021 has been revised upward twice in the past year. The state is now expected to get $8.8 billion from the federal government. Ben Watkins, the director of the Florida Division of Bond Finance, said the state was using the relief money to invest in infrastructure and water quality projects and directing some of its surplus funds to hurricane preparedness.

He described the windfall as staggering.

“It’s a good problem to have,” Mr. Watkins said, “but that doesn’t mean that it’s not excessive.”

States have substantial leeway in how they use the money, though they are prohibited from using the funds to subsidize tax cuts. Several Republican-led states have sued the Treasury Department, arguing that the restriction infringes on state sovereignty.

The lawsuits do not appear to be slowing the delivery of the funds. Ohio failed to win an injunction blocking the restrictions from being enforced this month, and Missouri had its case thrown out of court after a federal judge said the state did not demonstrate that the law caused it harm.

The Treasury Department plans to closely monitor how the money is spent and whether states are using budget gimmicks to actually fund tax cuts. The agency maintains that the federal government has a right to place conditions on how federal funds are used and that states are allowed to decline the money. A Treasury Department official said that no state had indicated yet that it would reject the funds.

In the meantime, states that are flush with revenues are pressing ahead with their plans. Nebraska approved a $26 million corporate tax cut last week, and lawmakers have told The Omaha World-Herald that they believe that by keeping the federal funds in a separate account from the state’s general fund, they will be in compliance with the law.

Nicholas Fandos and Dana Goldstein contributed reporting.