How the Debate over State Aid Is Playing Out in Mitch McConnell's Backyard

By Daniel C. Vock • Issue #12 

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Can Kentucky Stay in the Black Without Federal Help?

National organizations that represent state and local officials roundly criticized the coronavirus rescue proposal that Senate Republicans finally released this week, because it had no direct aid for states or local governments.

The leaders of the “Big Seven” state and local organizations wrote in a joint letter that the federal response toward lower levels of government so far has been “distressingly inadequate.”

“Without significant relief from the federal government, state and local governments will have to take drastic action to balance their budgets, such as slashing education and health care and letting our infrastructure fall into disrepair. That would take money out of the economy at exactly the wrong time, making the recession deeper, delaying the recovery and hurting millions of families,” they argued.

The GOP majority’s opening gambit in the ongoing negotiations is not, of course, the final word on what will ultimately be included in the next round of federal pandemic relief. House Democrats, after all, included more than $1 trillion in aid to states and local governments in the relief package they passed in May.

But on the ground in Kentucky, the home state to Senate Majority Leader Mitch McConnell, reactions among state officials to the Senate’s plan has been mixed.

“Honestly, what I’m planning on from the feds is nothing,” said state Sen. Chris McDaniel, a Republican who chairs the chamber’s appropriations and revenue committee. “Then, if something does happen, that’s great.”

Despite the pandemic-triggered recession that walloped state revenues this spring, Kentucky finished the fiscal year that just ended in June in the black. Lower revenue estimates forced the governor to make $450 million in cuts in the last few months of last year’s budget. Lawmakers also adopted the state’s first-ever single-year budget for the current year, rather than a two-year budget, because revenue projections were so uncertain due to the pandemic.

McDaniel said the best use of federal relief money would not be to make direct payments to state or local governments. He prefers spending on infrastructure, because it would help people get jobs in the short term but provide benefits to the economy (and, therefore, revenues to governments) in the long term. Extending unemployment benefits would also help the state of Kentucky, McDaniel said, by injecting money into the economy.

That stance puts McDaniel at odds with the administration of Democratic Gov. Andy Beshear, which says it needs federal help to help deliver services and avoid program cuts during the national health crisis.

Beshear’s budget director, John Hicks, said the state’s financial picture is likely to be worse this year than it was last year. The biggest reason for that is that the pandemic only affected the final quarter of last fiscal year.

“Revenues in the fourth quarter were down by 4.5 percent, but Kentucky, like many states had above-budget revenues for the first nine months of the fiscal year,” said Hicks, a former executive director of the National Association of State Budget Officers.

Some of the revenue uncertainty from last year had to do with the fact that Kentucky extended the deadline for individual and corporate income tax payments from April to July. Those revenues ended up being nearly $105 million more than Kentucky lawmakers had budgeted for. But the payments covered income earned in 2019, before the pandemic hit.

Once the coronavirus shut down much of the economy, though, Kentucky’s revenues took a big hit. Sales taxes dropped 5 percent in the final quarter of the fiscal year. Corporate income taxes declined by 38 percent. Motor fuel taxes took a 19 percent hit. Hicks anticipates that the individual income taxes people will have to pay next April will be “much less” than last year’s, too.

“Kentucky, like other states, is in need of federal fiscal relief,” Hicks said.

Congress provided states with extra federal funds in the last two recessions, he noted, both with straight aid and a higher federal match for Medicaid spending. (In March, Congress did increase the federal matching rate for Medicaid, but not as much as it did in the last two recessions. The extra money could expire as soon as September.) Hicks said the increase in the federal Medicaid matching rate would be the “preferred method” for getting aid to states.

“Ten years ago that assistance prevented Kentucky from making drastic cuts to education, health care and public safety. Even with the fiscal relief, budget cuts were made. Without that type of assistance, Kentucky is facing even bigger budget cuts to critical state services and programs,” Hicks said.

Kentucky's revenues (orange) vs the national average (blue) after the Great Recession. Source: The Pew Charitable Trusts

The Great Recession’s long shadow

Although the Great Recession officially ended in 2009, it took most states much longer to see their revenues return to pre-recession levels. Kentucky’s revenues did not reach that point until the middle of 2015. Meanwhile, increases in the costs of Medicaid and increasingly higher payments to shore up Kentucky’s woefully underfunded pension system have squeezed state spending on most programs, even after the state recovered from the last recession.

“We had about 20 rounds of budget cuts since 2008,” said Jason Bailey, the executive director of the Kentucky Center for Economic Policy, a left-leaning think tank. “Pretty much every part of the government has been cut back. There have been no raises for state employees in eight of last 10 years. That has hampered our ability to respond [to the coronavirus].”

For example, he blames many of the troubles the state has had in processing unemployment claims on staff cuts and antiquated equipment at Kentucky’s workforce agency.

At the same time, though, demand for state-provided services has skyrocketed. The most obvious example is Medicaid. Nearly 200,000 more people have signed up for the government health insurance program since the beginning of the year. That means that a third of all Kentucky residents are now on the program.

Part of the surge in sign-ups has been intentional. Beshear has encouraged people to sign up by temporarily using a policy of “presumptive eligibility,” which means people can register by filling out a one-page application. They can get medical care for two months before they have to go through the normal eligibility screening process.

Beshear’s father, former Gov. Steve Beshear, pushed aggressively to expand Medicaid eligibility in Kentucky under the Affordable Care Act championed by President Barack Obama.

But for the younger Beshear, easier access to Medicaid has also been part of an effort to mitigate health disparities that have left Black residents more vulnerable to covid-19. While Black people make up 8 percent of Kentucky’s population, they have accounted for 14 percent of the state’s covid-19 deaths so far.

The governor has promised to find “100 percent” health coverage for Black people in Kentucky, as part of a larger set of reforms he said he would advocate for, in the aftermath of protests over the police killing of Breonna Taylor in Louisville this March.

Kentucky officials do not yet know the impact that the growth in Medicaid enrollment will have on the state budget. Much of it depends on the income levels of the new enrollees. The federal government reimburses 70 percent of the costs for lower-income patients that Medicaid traditionally covered. But it pays for 90 percent of the costs for people who earn slightly more and qualified under the Medicaid expansion authorized by the ACA.

How prepared should states have been?

McConnell has long been wary of sending relief money to states. This spring, the senator angered governors of both parties when he suggested that states should be able to declare bankruptcy (which they can’t do, for a lot of reasons) rather than get federal money.

“There’s not going to be any desire on the Republican side to bail out state pensions by borrowing money from future generations,” McConnell said in a radio interview in late April. “My guess is their first choice would be for the federal government to borrow money from future generations to send it down to them now so they don’t have to do that… That’s not something I’m going to be in favor of.”

McConnell’s comment came after the president of the Illinois Senate sent a letter to the state’s congressional delegation asking for $10 billion to help the state cover its pension payments during the crisis.

But McConnell’s comment could have applied just as well to Kentucky, too. The state has some of the worst-funded pension systems in the country. Earlier this year, the system had a funded ratio of just 33 percent.

McDaniel, the Republican state senator, said shoring up the state pension system has been his top priority since coming to Frankfort. As lawmakers have socked away more money for the retirement system, though, they had little leftover money for filling up the state’s rainy day fund.

Still, he said officials at all level of government need to prepare better for fiscal crises.

“While this is worse than most problems we’ve seen, problems are always to come at some point,” he said. “In the end, appropriate financial discipline will help you bridge most problems. The reason that a lot of these things are exacerbated right now is during the good times, everybody wants to spend every penny rather than putting money away like they should.”

Bailey, from the budget think tank, though, said it’s not realistic to expect states to be able to handle such a big downturn on their own. Every state, he pointed out, faces the same daunting financial situation.

“The reality is that, no matter how well-managed the state has been, they cannot have prepared for this,” he said. “In our federalist system, the federal government is really the only entity that can deficit spend and provide that counter-cyclical investment in a bad time.”

“One of the best ways they can do that is just prevent the states from pulling in the other direction by cutting their budgets and laying people off,” Bailey said.