State and local governments face daunting fiscal crisis, with serious economic consequences.

Moody’s Analytics delivered a stark message about state and local finances last week, one that links the fiscal health of the public sector to the recovery of the private economy. The key bullets:

◾  States and local governments will need approximately $500 billion in additional aid over the next two fiscal years to avoid major damage to the economy.

◾  Timing is of the essence, as state and local policymakers face several important budget deadlines in the weeks and months ahead.

◾  If action is not taken quickly enough, the spending cuts and tax increases that would need to be undertaken could cost several million additional jobs and further delay the recovery.

◾  The specter of a second wave of widespread infections is broadening the distribution of potential downside scenarios.

The data seem clear, if daunting.

Through the end of fiscal 2022 the fiscal shock to state budgets under baseline economic assumptions is projected to be $312 billion. This roughly matches what was our more severe scenario projection during the April stress-testing exercise. Both revenues and Medicaid spending are significantly impacted, with much of the stress concentrated in fiscal 2021, which begins this July for most states.

When potential shortfalls at the local government level are added, total fiscal drag on the economy over the next 21⁄2 years comes out to be almost $500 billion. Relying on economic multipliers from some of our previous research, we estimate that such a severe drag could shave as much as 3 full percentage points from real GDP and erase about 4 million jobs.

As we’ve seen, in developing a budget response to the pandemic lawmakers are challenged by the lack of certainty regarding a federal aid package. It’s true everywhere, Moody’s notes.

If the federal government fails to act quickly enough, state and local policymakers will have to go into impending budget negotiations with no knowledge of how much, if any, aid is headed their way. This will require them to be even more cautious than usual to the detriment of the economy. More than 1.5 million government workers have already been laid off since the pandemic began. Without quick action, millions more could be next.

The Associated Press has more on last week’s report.

Even with additional federal aid, states are still looking at significant spending cuts,” said Brian Sigritz, director of state fiscal studies for the National Association of State Budget Directors. “But if additional aid is provided that states are able to use to address revenue shortfalls, the cuts would be less severe.”

There’s still no clarity about how much will be provided, or when. Moody’s underscores the consequences for the recovery,

The magnitude of the fiscal shocks estimated in this exercise is more than even the most well-run state or local government can handle without having to make substantive spending cuts or tax increases. These fiscal actions will have economic consequences, amplifying the business cycle and damaging the recovery,” Moody’s said.

Yet,

“We may ultimately need large state bailouts, but it’s premature to commit hundreds of billions of dollars before we have exhausted all alternatives. There’s about 20 or 30 states that have the reserve funds to get through the next year,” said Brian Riedl, a budget and economic analyst at the conservative Manhattan Institute.

“If we really get hit with a second wave and the economy remains shut down, then, yes, we will need a few hundred billion dollars for states. But I think, right now, the combination of rainy-day funds and more flexibility with pandemic grants can cover most of the gaps.”

Tick tock.