State and Local Government Holdings of U.S. Treasury Securities
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When it comes to the high and rapidly rising Federal debt, which is now $36 trillion, a lot of attention is paid to the increasing debt service costs, how they are impinging on spending programs, and potential implications for interest rates. Foreign holdings of US treasuries, which amounts to $7.5 trillion, or 31% of total publicly-held government debt, receive a lot of attention. And there’s a large amount of research on the Fed, which through its massive asset purchases, is the largest holder of U.S. treasuries, with $4.4 trillion. This note does not address any of those issues. Rather it addresses the dramatic rise in US treasuries owned by U.S. state and local governments.
The U.S. Treasury estimates that state and local government holdings of treasury securities have soared from roughly $750 billion prior to the Covid pandemic to a whopping $1.7 trillion in 2024Q3. That means state and local governments rank as the second largest holder of US treasuries behind the Fed, well ahead of foreign holders Japan, China and OPEC nations. This observation reflects the evolution of the U.S.’s structure of fiscal federalism and has far-reaching implications for the different fiscal roles played by the different layers of government. It also a central issue in the current initiatives that aim to streamline the government and reduce deficits.
Some of the biggest components of Federal government spending is distributed directly to individuals: Social Security and other income support programs, medical care providers for Medicare and Medicaid, U.S. treasury creditors for debt services costs, and defense contractors. A big chunk of Federal spending that has been authorized by Congress is disbursed to state and local governments for a wide range of activities—education, transportation and infrastructure, commerce and judiciary, etc. State and local governments hold these disbursements along with other savings that result from a surplus of receipts over spending in US treasury securities. All states maintain “rainy day” funds and use them for a variety of purposes.
Prior to the pandemic, as shown in Chart 1, state and local government holdings of US treasuries hovered around $720 billion. Their dramatic rise during 2020-2021 reflected primarily the surge in Covid-related Federal government fiscal transfers to state and local governments that culminated with the $350 billion disbursement as part of President Biden’s $1.9 trillion American Rescue Plan of March 2021. According to the official U.S. Treasury Fact Sheet, “The Rescue Plan will provide needed relief to state, local, and Tribal governments to enable them to continue to support the public health response and lay the foundation for a strong and equitable economic recovery.” (March 18, 2021).
By then, the economic recovery had strengthened significantly and was generating rapid growth and recovery in state and local tax receipts. At the same time, the Federal government was distributing additional Covid-related health care subsidies to state and local governments. State and local government finances quickly repaired, as tax receipts accelerated and health-related spending demands subsided. Unlike Federal taxes, most state governments do not index their individual and corporate income taxes to inflation, so their elasticities of tax receipts with respect to state income is far higher than for the Federal government’s tax receipt elasticities. Thus, increases in real personal incomes and soaring inflation boosted nominal incomes and tax receipts. The quick rebounds in retail sales as the economy reopened generated a big boost to state sales taxes. The soaring home prices generated an acceleration in local government property tax receipts in some states like California, this occurred with a short lag; in other states it unfolded with a longer lag.
Chart 1. State and Local Govt Holdings of US Treasuries
Accordingly, state and local government surpluses mounted and their savings were held in US treasury securities, presumably in short-term duration “cash accounts”. By the second quarter 2021, state and local government holdings of US treasuries had soared above $1.3 trillion.
Since then, the state and local government holdings have risen to $1.7 trillion through 2024Q3. The continued rapid rise reflects a combination of factors. First, Federal government spending, particularly for infrastructure, has soared, and a lot of the funding is disbursed through state and local governments. Most prominently, the American Jobs and Infrastructure Act enacted in November 2021 authorized $1.1 trillion over a ten-year period. Second, sustained strong growth in the economy and profits along with the combination of rising home values and a rising stock market has generated big gains in individual and corporate income taxes, and sales taxes at the local level. Third, as the Fed began raising rates beginning in March 2022, rising yields on short-duration treasuries provided handsome income gains that compounded in state and local government accounts.
Just to put the magnitude of state and local holdings of US treasury securities into context, they now equal approximately one-half of the total $3.4 trillion of state and local debt outstanding and represent over 5% of nominal GDP.
This brings up a host of issues that require more research. What is the process of the Federal government disbursements to state and local government, and is there any consolidated financial statement that tracks these funds? If not, isn’t this a logical task for the Office of Management and Budget (OMB), an arm of the Executive Office the President charged with administering the budget and overseeing its efficiency, and also the responsibility of the General Accounting Office (GAO), Congress’s watchdog that is charged with investigating Federal spending and performance? Once fiscal legislation is passed by Congress and enacted into law, that shouldn’t be the end of the story. Implementation is critically important. Do state and local governments still hold unspent Federal funds that were disbursed during Covid that were specifically designated to be spent on Covid-related health care? Which Federal government agencies determine the allocations of funds to states? Are cost-benefit analyses used in determining these allocations?
The surge in magnitude of these state and local government holdings of US treasuries brings up many questions about fiscal federalism and the roles of the different layers of government that require further investigation.
Mickey D. Levy
AuthorMore in Author Profile »Mickey Levy is a macroeconomist who uniquely analyzes economic and financial market performance and how they are affected by monetary and fiscal policies. Dr. Levy started his career conducting research at the Congressional Budget Office and American Enterprise Institute, and for many years was Chief Economist at Bank of America, followed by Berenberg Capital Markets. He is a Visiting Fellow at the Hoover Institution at Stanford University and a long-standing member of the Shadow Open Market Committee.
Dr. Levy is a leading expert on the Federal Reserve’s monetary policy, with a deep understanding of fiscal policy and how they interact. He has researched and spoken extensively on financial market behavior, and has a strong track record in forecasting. Dr. Levy’s early research was on the Fed’s debt monetization and different aspects of the government’s public finances. He has written hundreds of articles and papers for leading economic journals on U.S. and global economic conditions. He has testified frequently before the U.S. Congress on monetary and fiscal policies, banking and credit conditions, regulations, and global trade, and is a frequent contributor to the Wall Street Journal.
He is a member of the Council on Foreign Relations and the Economic Club of New York, and previously served on the Panel of Economic Advisors to the Federal Reserve of New York, as well as the Advisory Panel of the Office of Financial Research.
Dr. Levy holds a Ph.D. in Economics from University of Maryland, a Master’s in Public Policy from U.C. Berkeley, and a B.A. in Economics from U.C. Santa Barbara.