Tax Policy – Breaking Down State and Local Aid under the SMART Act
The State Municipal Assistance for Response and Transition (SMART) Act, sponsored by Senators Bob Menendez (D-NJ) and Bill Cassidy (R-LA) in the Senate and by Rep. Mikie Sherrill (D-NJ) in the House, would provide $500 billion in flexible funding to state, local, and tribal governments to backfill lost revenues and otherwise provide fiscal relief during the COVID-19 crisis. Unlike the HEROES Act, which provides almost $1.1 trillion for state and local fiscal relief within a $3 trillion package, the SMART Act is focused exclusively on aid to subnational governments.
The SMART Act provides $16 billion to tribal governments, with the remaining $484 billion distributed to states, the District of Columbia, and Puerto Rico according to three equally weighted allocators, worth $161.3 billion each: (1) state population; (2) COVID-19 cases as of June 1, 2020; and (3) relative revenue loss, defined as the amount by which calendar year 2019 revenues exceed those for calendar year 2020. States are guaranteed a combined minimum of $2 billion.
To avoid a scenario where states could cut taxes or reduce fees and increase their revenue share under the third allocator (revenue losses), money forgone through such reductions are added back to calendar year 2020 revenues. Simultaneously, state spending on the non-federal share for public assistance under the Stafford Act (for disaster relief) is subtracted from 2020 revenues, increasing a state’s share under that measure.
States typically budget—and report revenues—on a July to June fiscal year, but will have to align revenue reporting with calendar years for purposes of the SMART Act to allow this portion of the federal aid to be calculated and remitted in early 2021 (the latter half of fiscal year 2021). Using comparisons of actual revenues, rather than contrasting actual current revenue with initial projections, reduces gamesmanship and arbitrariness, though the federal government may still be reliant on state assertions about the cost of tax changes.
Under the SMART Act, all federal funds except those for tribal governments would be disbursed to the states, but states are then obligated to further distribute one-third of the funding they receive to local governments by a formula established in the bill. Half of this local share is allocated to counties and the other half to municipalities, in both cases in proportion to their share of population and revenue losses compared to all similar jurisdictions (either counties or municipalities, as the case may be) statewide.
Whether by accident or design, this favors some jurisdictions more than others, leading to unequal distributions. The quirks of local government across the country also raise difficult questions. Here are a few ways this approach could prove challenging.
- Not everyone lives within a municipality. Over a third of a county’s population lives in unincorporated areas which are under a county government but are not part of any city, town, borough, or other form of municipal government. Those in a borough would benefit from receiving funding from both the county and municipal pools, but those in an unincorporated area a mile away would not have the benefit of any dollars from the municipal share, just the county one.
- County funding may prove disproportionate where the county seat is a major city, since the county may provide relatively few services to city residents yet still receive an allocation based on their population, whereas counties centered on smaller municipalities or unincorporated areas have greater obligations.
- Some places, like Philadelphia, Indianapolis, and Nashville, have consolidated city-county governments, while others, like San Francisco and Denver, are officially both cities and counties. It is likely, but not certain, that these jurisdictions would draw from both the county and municipal funding pools. Similarly, a few U.S. cities are independent cities which are outside of any county. This includes all 38 cities in Virginia, as well as the cities of Baltimore, St. Louis, and Carson City, Nevada. The Census Bureau regards these as county equivalents and they would likely share the same fate as consolidated city-counties.
- Some counties have no governing bodies. Two New England states, Connecticut and Rhode Island, have counties but treat them exclusively as administrative boundaries for courts and law enforcement, while local governance is provided exclusively at the municipal level. Because there are separate pools for municipal and county funding, these states could not simply pour all the combined funding into the municipal pool. Perhaps they would receive dispensation to allocate the county funding to municipalities based on their share of the county in question, but this is far from clear and no express authority to do so exists in the bill.
- Some states have populations outside of counties and Louisiana’s parishes and Alaska’s incorporated boroughs are considered county equivalents and pose no significant challenge here, but Alaska also has a sprawling Unorganized Borough encompassing half the state’s land area and comprising 13 percent of the state’s population. Part of the population is in municipalities or under tribal government, but not all. Populations outside those organized areas would presumably not receive any local funding, and those within municipalities would not get the benefit of county-level funding.
States may also face significant administrative difficulties in allocating the share of local funds distributed by revenue loss. Population data is easily come by, but revenue loss requires certification of calendar year 2019 and 2020 revenues for each jurisdiction (even though revenues are usually tracked on a fiscal year cycle), some of which are quite small and do not regularly report data to state governments. At last count, there are 19,495 municipal governments across the 50 states, and 1,150 of them have populations of fewer than 100 people, with 9,191 having fewer than 1,000 residents.
Finally, the SMART Act stipulates that the new funds cannot be deposited into a state pension fund. Although, as they free up other revenues, this prohibition may not be very significant. And it requires that states agree, as a condition of funding, that any cuts to state aid to local governments be based on an emergency need; be balanced and fair; and be justified on the basis of economic conditions in those localities, not in comparison to 2019 funding levels. While presumably designed to ensure that states do not cut their own aid to localities in a way that offsets the local aid they distribute under the SMART Act, this also represents a significant entanglement of state and federal finances under rather vague terms.
The $500 billion proposed under the SMART Act would be in addition to the $535 billion already appropriated to states and localities under already-adopted relief packages, though only a portion of that amount is flexible and can be used to backfill revenue losses. Notably, it does not provide flexibility for the expenditure of remaining dollars within states’ shares of the Coronavirus Relief Fund, which could be one reasonable way to provide states with additional aid using existing appropriations. Another proposal, introduced by Sen. John Kennedy (R-LA), focuses on this source of assistance.
The $500 billion figure also aligns very closely with total projected state and local revenue losses for fiscal years 2020 and 2021, meaning that if those projections pan out, the proposal would allow states to maintain something close to current spending levels, without adjustments. This would be markedly different than during previous economic contractions, including the Great Recession, when states received federal relief but were expected to make their own adjustments as well.
Source: Tax Policy – Breaking Down State and Local Aid under the SMART Act
Upstate Tax Professionals