Under the American Rescue Plan Act (ARPA) enacted in March 2021, state, local and tribal governments received $350 billion as part of the Coronavirus State and Local Fiscal Recovery Fund (SLFRF) program. According to the law, SLFRF recipients are permitted to use the funds to respond to the public health and negative economic impacts of the pandemic; provide premium pay for essential workers; invest in water, sewer, and broadband infrastructure; and replace public sector revenue lost due to the pandemic.
This last use – revenue replacement for the provision of government services – has so far narrowly claimed the largest share of states’ SLFRF allocations (when counting all allocations being reported to the U.S. Treasury Department under this category). However, it is also the least understood of the eligible spending categories. NASBO’s analysis shows that these funds are being used to support strategic investments in transportation and other infrastructure, education and workforce training, economic development, public health, and other key program areas. This blog aims to shed more light on how states are using revenue replacement funds and why it is unlikely to lead to a “fiscal cliff” for states when the funds run out.
Revenue Replacement: The Largest Share of SLFRF Allocations
NASBO recently conducted an analysis of 2022 Recovery Plan Performance Reports for states, territories and the District of Columbia (hereafter referred to collectively as “states”) examining the share of SLFRF payments allocated so far to specific uses by states and then breaking down those allocations by the expenditure categories established in U.S. Treasury guidance. Based on that analysis, NASBO identified roughly 81 percent of SLFRF funds sent to states have been allocated to specific uses so far. NASBO was able to link $148 billion – representing the vast majority of these fund allocations – to specific expenditure category areas defined by Treasury, with revenue replacement narrowly claiming the largest share of allocations in the aggregate at roughly 35 percent.
At first blush, this may be construed to mean that states are using these one-time federal funds to backfill existing programs and setting themselves up for a “fiscal cliff” scenario whereby they will face difficulties funding these ongoing expenditures once the SLFRF funds are depleted. However, closer inspection of Treasury’s reporting guidelines and how states are using these funds reveals a different story altogether. In fact, by and large, just as they are using SLFRF reported under the other expenditure categories, states are employing their revenue replacement funds for strategic investments thoughtfully crafted to assist those most impacted by the pandemic, support a robust long-term recovery, and build resiliency for future challenges.
Treasury Guidance on Revenue Replacement
Under the guidance developed and issued by the U.S. Treasury, states can report obligations and expenditures of SLFRF under seven expenditure categories (ECs):
- Public Health
- Negative Economic Impacts
- Public Health-Negative Economic Impact: Public Sector Capacity
- Premium Pay
- Water, Sewer and Broadband Infrastructure
- Revenue Replacement
- Administrative Costs
Calculating Revenue Loss
For revenue replacement (EC6), Treasury developed a formula for state and local governments to calculate general revenue lost due to the COVID-19 public health emergency. Treasury defined general revenue as revenue collected by a recipient and generated from its underlying economy, largely in line with the U.S. Census Bureau’s definition of “General Revenue from Own Sources.” Under Treasury’s SLFRF final rule, recipients measure revenue loss using a four-step process outlined by Treasury. First, they calculate their base year revenue (fiscal year 2019 – the last full fiscal year before the public health emergency began). Second, they estimate counterfactual revenue for each of four fiscal years or calendar years after that, using a growth adjustment factor of 5.2 percent (or the recipient’s annual revenue growth in the last full three fiscal years before the public health emergency, if greater). Third, they identify actual revenue collected, adjusted for any effects of tax cuts or tax increases adopted after January 6, 2022. Fourth, they calculate revenue loss as the amount by which counterfactual revenue exceeds actual revenue. As an alternative and for administrative convenience, the final rule also permitted government recipients to claim a standard allowance for up to $10 million. While this standard allowance has mainly been used by local government recipients, a few state governments have claimed the standard allowance as well.
More Flexibility and Less Reporting
Not only are states permitted to use SLFRF for revenue replacement; the U.S. Treasury has expressly encouraged SLFRF recipients to take full advantage of this eligible use and the flexibilities and reduced reporting burden that this category offers. This is true even for projects that might be otherwise eligible under one of the other categories, as stated in official U.S. Treasury guidance issued for the program. According to the Frequently Asked Questions (FAQs) for Treasury’s Final Rule: “Recipients may also use revenue loss funds to carry out investments that would be eligible under other eligible use categories, because those eligible uses are also services provided by recipient governments. Treasury encourages the use of government services funds on uses enumerated in these categories, including but not limited to affordable housing, childcare investments, supporting public sector workers, job training and workforce development, and investments in public health.” In accordance with this guidance, a number of the projects identified in the next section of the blog in areas such as health & human services, economic development & support, water & sewer projects, and premium pay would have otherwise been eligible under Expenditure Categories (EC) 1 through 5, but were instead reported under revenue replacement to streamline states’ reporting requirements, minimize administrative costs and maximize the amount of resources available to support service delivery.
States have taken a variety of approaches towards use of the revenue replacement category. Some are maximizing flexibility of SLFRF and claiming their full eligible revenue loss (up to their total payment), others are using little to no SLFRF in the revenue replacement category, and many are choosing a path somewhere in between – claiming a portion but not their full eligible loss.
Common Uses of Revenue Replacement Funds
In their 2022 recovery plans, at least 44 states and territories identified allocating some of their SLFRF payments for revenue replacement. States reported funds used or allocated for revenue replacement that made up as little as 1 percent or as much as 100 percent of their total funds allocated so far. Among the funds allocated by states, NASBO examined all projects identified in recovery plans and reported under the revenue replacement category with at least a $10 million budget. Through this analysis, a number of trends, themes, and common areas of investment emerged.
Provision of Government Services – General
As would be expected and in line with Treasury guidance, one of the most commonly identified uses of revenue replacement funds is for the general provision of government services. Some states did not break down how the revenue replacement funds would be used on a project basis but identified in the narrative of their reports that these funds would provide temporary enhanced support to core government services that faced increased costs related to the COVID-19 public health emergency, such as corrections and public safety, education, public health, and human services. States not reporting revenue replacement fund uses on a project-specific basis also said in their plans that the funds would be used to make one-time, targeted investments in facilities, technology, equipment, and economic development, among other purposes.
Transportation
At least 14 states are directing some of their revenue replacement funds towards transportation. This includes deposits to state highway trust funds for construction projects, as well as funds for rail infrastructure, transit operations, aviation projects, and as a state match for federal infrastructure projects. This influx of funds serves as a supplement to the investments under the federal Infrastructure Investment and Jobs Act (IIJA), helps states offset lost transportation revenues during the pandemic, reduces deferred maintenance backlogs, and supports economic development efforts.
Health & Human Services
At least 18 states reported revenue replacement funds used for a variety of health and human service projects. In health care, funded projects include covering additional COVID-19 direct response costs, providing operating subsidies to health care providers disproportionately impacted by the pandemic such as nursing homes, and funds to help address temporary healthcare workforce shortages. Some states are directing revenue replacement funds to behavioral health and substance abuse programs, while other projects aim to improve public health such as lead prevention and remediation programs and local health department funding for communicable diseases. For human services, states are directing revenue replacement dollars to provide temporary assistance to child care providers, food banks, homeless shelters, and other service providers that faced increased demands and costs due to the pandemic. Some projects identified in this program area include capital construction of healthcare facilities as well.
Economic Development & Support
At least 16 states identified projects using revenue replacement funds that are geared towards economic development as well as economic support to impacted industries. To foster economic growth, states have invested SLFRF revenue replacement funds into community development initiatives, small business assistance, and infrastructure projects to attract jobs. In light of the pandemic’s significant impacts on the tourism sector, a number of states are using these funds to support tourism and national marketing efforts, as well as grants to travel and hospitality businesses,. Other industries that were disproportionately affected by increased costs due to COVID-19, such as meat producers, received assistance from revenue replacement funds, while funds in this category were also sent to organizations and businesses that lost revenue such as large venues, zoos, and movie theaters.
State Buildings & Technology Infrastructure
At least 14 states reported using revenue replacement funds to invest in state building infrastructure, technology upgrades and related projects. For state facilities, projects included renovations and deferred maintenance, HVAC upgrades, and building construction. For technology, states reported projects involving overhauling or creating new case management systems, transforming digital government services, rural broadband expansion, and cybersecurity, among others.
Public Safety & Corrections
At least 12 states reported on projects under the revenue replacement category that serve a public safety purpose or support state corrections. Addressing court case backlogs, providing additional funds to meet increased costs of responding to COVID-19 in corrections facilities, enhancing prisons and jails to improve the health of inmates and staff, and reducing community violence are among the revenue replacement projects funded in this area.
Higher Education & Workforce Training
At least 11 states reported sending some revenue replacement funds to higher education institutions. This included providing funds for various higher education capital projects as well as temporarily enhanced operating support to colleges and universities, which faced revenue losses as a direct result of the pandemic. States also sent funds aimed at improving affordability, including for need-based scholarship programs and a tuition freeze.
In addition, at least eight states reported allocating funds for workforce training efforts aimed at skills-based education and work-based training programs.
Early Childhood and K-12 Education
At least 10 states reported using revenue replacement funds for educational purposes in the early childhood and K-12 sectors. This includes capital support for K-12 facilities, startup grants for preschools and child care centers, programs to address learning loss and support student mental health, digital literacy programs, and temporary funding to districts that experienced enrollment declines due to the pandemic.
Emergency Preparedness
At least 10 states identified projects using revenue replacement funds to increase emergency preparedness and response capacity. With the additional strain that the COVID-19 public health emergency put on emergency response providers, states have used funds to support volunteer fire departments and other first responders, emergency communication improvements, and other equipment upgrades, for example.
Conservation & Outdoor Recreation
At least eight states are directing revenue replacement funds towards environmental conservation and/or outdoor recreation projects. These investments are in part a response to the heightened demand that state parks and other outdoor recreation areas experienced during the pandemic. Among these projects are state park renovations, land acquisition, trail construction, and wildlife education.
Water & Sewer Projects
At least five states chose to report some water and sewer projects under the revenue replacement category, even though these would likely have been eligible under the Water, Sewer and Broadband expenditure category (EC5).
Premium Pay
Similarly, at least five states reported projects involving premium pay bonuses to address pandemic-related workforce shortages under the revenue replacement category. Examples include bonus payments to pandemic first responders, nursing staff, direct care workers, and teachers.
Other
A variety of other projects were reported by states using revenue replacement funds, including funding related to ARPA administration costs, grants to arts and cultural institutions, affordable housing, and additional aid to local governments.
Revenue Replacement Investments: Key Takeaways
As the nation’s laboratories of democracy, state governments are approaching the use of SLFRF for revenue replacement in a variety of ways. However, several common themes are evident, including:
- States are using these funds in large part to support strategic, one-time investments. These investments are thoughtfully crafted to foster the state’s long-term recovery from the pandemic, ensure this recovery is robust and equitable by supporting its most impacted communities, businesses and individuals, and prepare for future crises. Rather than backfilling existing programs, states are primarily using these funds to pay for targeted investments, many of which might not have been made absent the SLFRF program.
- States are using the revenue replacement category to reduce their reporting burden. Many of the spending items states are claiming under the revenue replacement category would be allowable under another Treasury expenditure category. However, they are claiming them under their calculated revenue loss to maximize flexibility and reduce reporting requirements, in accordance with federal law and guidance and as they have been encouraged to do by U.S. Treasury officials and in official Treasury guidance. Ultimately, this reduces the administrative burden for states carrying out the program and maximizes the amount of funding available to directly support government services.
- States are using revenue replacement funds to provide government services as intended under the law. To the extent that states are depositing these funds into their general funds and using them to support core services, this is exactly in line with federal guidance. Many areas of state government – including health and human services, education, transportation, and public safety – faced increased costs and/or reduced revenues due to the pandemic, and states are using their revenue replacement funds to help offset these budgetary impacts, as intended. At the same time, states are mindful that these funds are one-time in nature, and are planning for their wind-down accordingly. In cases where SLFRF is being used to support recurring spending, some states are using their own general funds for one-time targeted investments and/or identifying future revenue sources to support those recurring costs once SLFRF is fully expended.
For all of these reasons – along with their strong overall fiscal position and highest-on-record reserve levels currently – state governments’ use of SLFRF for revenue replacement is unlikely to result in a fiscal cliff scenario whereby states commit to more spending than they can support once these one-time federal funds run out.