California's streets are empty, schools across the state have shuttered and businesses have closed their doors. The drastic measures being taken to contain the COVID-19 outbreak in California are creating a new dimension to the disaster: The pandemic — which has already claimed 68 lives and infected a confirmed 3,243 people in the state as of Thursday morning — will exact a heavy economic toll.
Anticipating a coming surgein cases of the fast-spreading virus, Gov. Gavin Newsom has quickly mobilized resources and expanded his order for roughly 40 million Californians to continue sheltering in place in the coming weeks. The sharp shift in economic output could hit California hardest among all states.
“This is really going to be a recession unlike anything we have ever seen before,” said Dr. Mark Duggan, a Stanford University economist and director at the Stanford Institute for Economic Policy Research. “Usually with recessions,” he explained, “it’s somewhat gradual. This will be just an instantaneous change in the economy.”
Already, nationwide unemployment claims have exploded past previous records. New data from the U.S. Labor Department shows a historic 3.28 million new initial applications filed last week — a twelvefold increase from the week before. The last record, set in 1982, was 695,000.
Some officials have raised concerns that unemployment could surpass the 2008 Great Recession — or worse, the Great Depression. U.S. Treasury Secretary Steve Mnuchin cautioned lawmakers last week that if drastic actions aren’t taken, the nation could see 20% unemployment.
But Newsom insists the nation's most populous state — with the fifth-largest economy in the world — is well-positioned to weather the storm. Armed with $21 billion in reserves and a strong safety net already in place, the governor remains confident that the state is ready for the recession.
The road to recovery, however, could be rocky.
California’s underfunded unemployment insurance program has been a problem for decades and only regained solvency in 2018.
The state's economic resilience also will come down to revenue.
California's budget relies on taxes from stock market investment wins more than most. While the market rallied on Thursday in anticipation of the historic stimulus bill that is expected to pass Congress, the coming recession could just as quickly send stocks spiraling again. Now that the markets are taking investors for a ride, a sizable chunk of California’s revenue is also on the rollercoaster.
Compared to other states, California may need more help from the federal government for both response to, and recovery from, the disaster and is already expected to be among the first to begin borrowing, especially to help cover unemployment benefits.
Newsom, who waived the one-week waiting period in place before the crisis, said this week that California's unemployment insurance claims have already passed the 1 million mark.The U.S. Labor Department report shows the state had the largest increases in initial claims with rates rising faster than the country at large, and the numbers are more than 13 times higher than they were two weeks ago.
Before the crisis, the state averaged 2,500 claims a week — but for the week ending March 21, more than 186,800 new claims were filed.
The UCLA Anderson Forecast, which revised its quarterly estimates for the first time in its 68-year history last week, projected that California's reliance on tourism would make it particularly vulnerable in the coming recession. Economists predict that more than 280,000 payroll jobs will be lost as a result, more than a third from the leisure, hospitality, transportation and warehousing sectors.
A new report from the Economic Policy Institute, a nonprofit, nonpartisan think tank, paints an even bleaker picture, projecting 604,741 jobs will be lost in California by this summer.
The state’s underfunded unemployment insurance system will not be able to sustain the need for long, at least not on its own.
“The unemployment insurance program in California is in the worst state of any, in respect to its reserves,” Duggan says. For decades, analysts have cautioned that California needs to shape up its beleagueredunemployment insurance fund. U.S. Labor Department reports from the past two years deemed California's fund was the least solvent state in the nation.
An EDD report issued October 2019 shows the fund ended a nine-year insolvency in 2018, with $2.3 billion left over at the end of the year, and was projected to end 2019 with $3 billion. That's a narrow margin for a fund that pays out roughly $5 billion in good years. The report states that, "the current financing system does not allow for sufficient fund reserves to be built up during better economic conditions."
California has long struggled with underfunding unemployment insurance
Last month, U.S. Department of Labor listed California as one of six states that would not be able to handle unemployment increases on its own. Duggan said California likely won’t make it to the end of this year on its own coffers.
“[California] made some questionable choices for how [they] finance unemployment insurance,” he said. “We will be the first state going to the federal government and asking for money for our unemployment insurance.”
The system is designed so that taxes collected from employers during a strong economy can sustain the surges in unemployment when things take a turn. But in the late '90s, California got stuck in a political standoff between businesses and labor unions and opted to increase its benefit rates without raising the taxes needed to pay for the increase. The state still levies unemployment taxes on only the first $7,000 of each employee’s annual wages — the minimum allowed by the federal government.
“It is extremely insufficient," economist Ken Jacobs, chair of UC Berkeley’s Labor Center, said. "That was clear after the Great Recession," he explained, adding that the state quickly went into the red and had to borrow from the federal government. "Changes weren’t made then. They need to be made now."
When the economy recovered, California continued paying interest on its $10 billion federal loan out of the general fund, but the principal was paid back by employers with higher taxes. That created an increasingly difficult environment to make long-term changes to the system.
“[Employers] have been willing to do the payback afterward, rather than being willing to raise the rates," Jacobs added.
The state Employment Development Department has conceded that it is ill-equipped to handle a recession. In the last report, issued at the end of 2019, the EDD wrote that it weathered nine years of insolvency until 2018.
In good times, the fund pays out roughly $5 billion a year. This year, it will need to pay significantly more. To put it into context, before the pandemic hit, the EDD projected roughly 836,000 applications in 2020. In just the first two and a half months of the year, Californians had already submitted more than 1 million claims.
It’s not just financing that is posing a problem. The rapid change caused by this crisis left little time for the EDD to bolster its staffing. Already, the agency is struggling to keep up and quickly process all the claims.
While the EDD is rushing to staff up, California Labor Secretary Julie Su has directed the department to streamline the process, and is bolstering the agency's workforce with staff from other departments and enlisting the help from recent retirees while the office continues to work around the clock.
In the short term, Californians can still expect to get their benefits and the state’s system will be shored up by the federal government. The Families First Coronavirus Response Act, signed into law on March 18, could funnel roughly $120 million to the state for unemployment insurance. It also adds an extra 13 weeks to federally funded benefits. A separate stimulus bill, which passed the U.S. Senate on Wednesday night, could also add $600 to state benefits for up to four months, which otherwise fall between $40 and $450 a week.
Even with the added help, California's program is likely to fall into the red.
“We will be borrowing from the federal government and the federal government will be borrowing a lot, too,” Duggan said. “The federal government doesn’t have to run a balanced budget like the states do so the federal government can throw more weaponry than California can. I think the two working together will be really important.”
California could lose revenue on capital gains
Even well-funded unemployment systems are not intended as a long-term solution, and typically provide only a fraction of pay a person would otherwise have gotten from their normal job.
The real resilience test will come down to revenue, and the state's ability to get the economy back on track.
In a report published last week by the nonpartisan California Legislative Analyst’s Office, analyst Gabriel Petek emphasized that it’s too early to know for sure how badly the budget will fare, but that the pandemic — and the economic uncertainty it causes — will “significantly affect California’s near-term fiscal outlook.”
One issue is the state’s close financial ties to the stock market.
California taxes capital gains, or the positive amounts investors earn, as regular income. That means when investors take a hit, so does state revenue.
In the governor’s $222.2 billion budget proposal, released in January, officials projected the price level for the S&P 500 stock index — which measures the market performance of 500 listed companies in the United States to gauge the overall health of the stock exchanges — would stay pretty flat. But after a slight upward swing late last year and into January, the markets plummeted this month.
Petek said, by the office’s preliminary analysis, that means several billion dollars less will flow into state coffers than what was initially projected in the Newsom's budget. That revenue crunch is further complicated by the “suddenness of the pullback in activity across wide swaths of the economy," Petek wrote.
The timing is tricky, as the emergency response falls just weeks ahead of the deadline for the governor’s May budget revise. Along with a two-month extension given to taxpayers who can now file through July 15, that “will further complicate the task of developing revised revenue estimates,” the government will have to significantly change legislative priorities, presenting new “logistical challenges” Petek wrote.
The constitutional deadline to pass the budget is June 15, and amid so much uncertainty, righting the ship won’t be easy — especially with an extended need for emergency spending.
It’s not all bad news out of the analyst's office, though.
Analysts have left room for the possibility of a “V-shaped recovery” where financial activity spikes back to normal levels just as rapidly as it sank, with the help of state and federal stimulus. California was, after all, on good footing going into the crisis. In recent years, the state prioritized paying down its debt and stashed surplus cash in its rainy day fund.
“We were in a good place in a number of areas,” said Jacobs. “There are resources to be able to respond and that’s central to being able to keep things going — being able to keep safety net programs going and respond to the emergencies,” he said. “That is very big.”
Newsom echoed this point during a March 15 news conference, assuring the public that he is confident in the state’s position despite the uncertainty that lies ahead.
“We’ve never been in a better position to weather a recession,” Newsom said, explaining that his team has projected a three-year $70billion reduction in revenue and a $40 billion reduction in the general fund.
“We are better position, I think, than the vast majority of states in the country,” he added, saying that he expects federal support and the state’s ability to quickly change spending priorities to play a big role.
California has had to maneuver around recessions in the past — and even rewrote its budget three times during the 2008 financial collapse. The ability to bounce back will likely hinge on just how long it takes to contain the virus. Economic systems can sustain short periods of shock, and as Christopher Thornberg, founder of Beacon Economics told Politico, regions tend to recover quickly from natural disasters.
“It’s spending delayed, not spending canceled,” Thornberg said, likening four weeks of coronavirus shut down to a hurricane. “But to be clear, if this goes 40 weeks, California is not in a good position,” he added. “Our revenue system in the state is so hypersensitive to shifts in capital gains that if the stock market really did stay down where it is right now, we’re going to take a massive hit.”
Emergency managers are finding, however, that this disaster poses new problems.
“We are in response mode right now and we are going to be in response mode for many months,” said Samantha Montano, an expert in emergency management whose debut book “Disasterology” is forthcoming. She noted that the coronavirus emergency is unusual compared to other disasters because it's not geographically isolated and that it is expected to stretch over a longer period of time.
“Usually you are looking at a response that lasts a couple of days — or a couple of weeks at most,” she adds. “To have this really long period of response, which looks a lot different than moving into a period of recovery, to be activated to that extent is really unprecedented.”
The feds will need to play a big role
As in most disasters, California will look to the federal government for help. Newsom has already requested $1 billion from Trump to help finance his response efforts.
The president has also made two declarations and both will provide much-needed resources for the state to take on this crisis. First, on March 13, he declared a national state of emergency. He also granted Newsom’s request to declare a major disaster for California on March 22. New York and Washington also have been granted declarations.
California and other states and territories that receive the declarations can bill some of their emergency expenses to the U.S. Federal Emergency Management Agency. Typically, the state is expected to cover 25% of the expenses with the remaining 75% covered by the federal government. FEMA staff are also deployed to disaster areas, and affected businesses can qualify for low-interest loans from the federal Small Business Administration.
But it is still unclear just how much money California will get.
In recent years, the federal government has sought to limit the burden it shoulders, especially facing increasingly expensive disasters. FEMA has floated a policy that would require states to have disaster deductibles to curb federal expenses.
Sometimes, though, FEMA reimburses states for more. The process is murky and complicated — and adds even more uncertainty to an already financially precarious situation. Jacobs said the extent that the federal government decides to support California will determine just how economically devastating this disaster will be.
“If the federal government doesn’t step in in a very big way right now — not just with general stimulus but with targeted support for workers and small businesses that are directly affected —we could see a very changed economy coming out on the other side,” he said, adding that he thinks the Newsom administration’s response has been impressive so far. “There are clearly things the state can and should be doing, but we really will need the federal government to step up in a big way.”
On Wednesday, the Senate passed a historic $2 trillion coronavirus stimulus bill, hoping to curb the expected economic contraction caused by the outbreak. Senate Majority Leader Mitch McConnell, R-Ky., likened the spending to "a wartime level of investment for our nation." The House is scheduled to vote on Friday, and is expected to quickly send it on to the president to sign.
If the bill passes, Americans could soon will be getting direct payments from the federal government. Most individuals making under $75,000 will receive $1,200, with an additional $500 per child. Married couples earning $150,000 or less would receive $2,400. Those in higher income brackets will receive less, with a hard-stop for anyone earning above $99,000 or married couples with combined salaries above $198,000.
The bill also provides about $350 billion in new aid to small businesses, $500 billion for corporations, $100 billion in direct assistance to hospitals, and roughly $150 billion for state stimulus.
On Wednesday, Newsom announced that California would receive $10 billion from Congress in state block grants. About $5.5 billion of that would go toward statewide efforts, with the remainder going directly to cities and counties.
“This bill will be very helpful and is very timely," Newsom said, as the state prepares to allocate billions to secure the safety of the people of California.
Trump has wavered on his approach to the crisis— vacillating between assuring the public that the outbreak will quickly be contained and cautioning Americans that the country may have to undergo long-term distancing to stop the spread.
This week, he called for the country to reopen by Easter — April 12 —oft repeating that he doesn't want the "cure" to be worse than the disease.
Public health officials warn that prematurely lifting social distancing orders could raisethe death toll considerably, and will do little to stave off recession as the economic effects will magnify if outbreak explodes.
Newsom has chosen a different path for the state of California, telling residents that the next 8-12 weeks will be crucial to containing the virus. His stringent orders to remain at home, he stressed, will limit the most devastating consequences that could come from this outbreak.
"This is a dynamic situation," he said during a livestreamed press conference, conceding that he and Trump "are moving in a different direction." But, he emphasized, that in conversations and with the "significant support and resources" promised by the president, suggest "an understanding of the unique situation the state is in."
Gabrielle Canon is a California Reporter for the USA Today Network. You can reach her at email@example.com or on Twitter @GabrielleCanon.