State and local government employment in the COVID-19 crisis

•State and local government employment fell sharply at the onset of the COVID-19 pandemic.•Employment declines are explained by fiscal pressures on state and local governments.•Federal aid prevented 401,000 state and local layoffs in April 2020.•Balanced budget requirements of state and local governments a source of fiscal fragility. Local governments are facing large losses in revenues and increased expenditures because of the COVID-19 crisis. We document a causal relationship between fiscal pressures induced by COVID-19 and the layoffs of state and local government workers. States that depend more on sales tax as a source of revenue laid off significantly more workers than other states. The CARES Act’s provision of $150 billion in aid to state and local governments reduced the fiscal pressures they faced. Exploiting a kink in the formula for allocation of funding across states, we estimate that without this funding state and local governments would have laid off an additional 401,000 workers in April 2020, 40 percent more than realized. State rainy day fund balances limit the sensitivity of employment to these revenue shocks, revealing that balanced budget requirements for state and local governments increase the procyclicality of public service provision.