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How Will State and Local Governments Budget for COVID-19?

Posted on May 18, 2020
Roxanne Bland
Roxanne Bland

Roxanne Bland is Tax Notes State’s contributing editor. Before joining Tax Analysts, Bland spent 17 years with the Multistate Tax Commission, where she worked with state revenue agency representatives to draft model legislation pertaining to sales and use taxation and corporate income, analyzed and reported on proposed federal legislative initiatives affecting state taxation, worked with legislative consultants and representatives from other state organizations on international issues affecting states, and assisted member state representatives in federal lobbying efforts. Before that, she was an attorney with the Federation of Tax Administrators for over seven years.

In this installment of The SALT Box, Bland considers the financial impact that COVID-19 will have on state and local government budgets as they brace to support unemployment and other services.

There are over 1 million reported coronavirus infections in the United States, and roughly 60,000 deaths from COVID-19.1 As states begin to reopen, and stay-at-home orders are lifted, residents will attempt to immediately return to their everyday routines prior to COVID-19. For states and localities, the fallout from the pandemic will last far longer.

States and Cities Will Be Devastated

States are spending millions of dollars on crisis-related goods, such as personal protection equipment for healthcare workers and life-sustaining machinery. Nationally, unemployment stands at 20.6 percent; around 30 million workers have filed claims in the past five weeks. When combined with the 7.1 million unemployed from before March 13, over 33 million Americans are jobless — the highest number since the Great Depression.2 The sheer number of Americans claiming benefits has been characterized by Dominic Wells, a political science professor at Clayton State University, as a “shock to the unemployment system,” with states simply not being “prepared for such a sudden spike in unemployment claims.”3 Lee Roberts, the former North Carolina budget director, agrees, stating that “no system is designed for this level of unemployment.”4

State unemployment payouts are fast depleting funds. Compounding the problem is that some states’ programs were underfunded. Payroll taxes collected by states are deposited into the Federal Unemployment Account, managed by the U.S. Department of Labor. The department deems a state solvent if it has enough money to pay claims over a year; the amount is derived from the average of the three years of greatest unemployment over the past 20 years. Some state systems, like California and New York, are woefully underfunded. California has enough funds to last just over two months, and New York’s fund will be depleted in a little over four.5 Yet fully funded or not, given that the numbers of the unemployed are so high and may rise higher still, all states could see their funds depleted in a matter of weeks. If a state’s funds run out, it can borrow money from the federal account, which it must pay back. The federal fund stands at $78.6 billion, but if enough states borrow funds to pay unemployment claims, the federal fund could also run out of money.6

Cities will not be spared, although the fiscal impacts are largely dependent on their tax structures and types of local industries. Calculations derived from data on local governments gathered from the 2017 U.S. Census of Governments show that most cities rely primarily on property taxes or fees and other miscellaneous revenue. A smaller number of cities rely on sales taxes and gross receipts, and a still smaller number rely on income taxes. Cities that rely on sales taxes and gross receipts have taken an immediate hit from the closure of retail and food establishments. Those that rely on income taxes will also experience a sharp decline in the coming months because of the significant job losses. Cities that raise the bulk of their revenue from property taxes will not see an immediate decline because values are determined either by the market — i.e., when the property changes hands — or by assessment. Thus, property tax bills reflect values of property anywhere between 18 months and a few years before collection. However, as rising unemployment curbs the demand for real estate, these cities will be affected, especially if the number of foreclosures increase due to unemployment. In addition, cities with a large percentage of workers in high-risk local industries, such as oil and gas, are particularly vulnerable because of job losses, especially if they rely mainly on income taxes to fund general revenues.7

State Budget Blues

It’s likely that the rapid changes in the states’ fiscal health over the past few months has kept forecasters busy recalculating revenue estimates for the present and future fiscal years from the figures that were presented in January. Although the difficulty of forecasting is compounded by this unpredictable pandemic, one thing is certain — the numbers will go down. Brian Sigritz, director of state fiscal studies at the National Association of State Budget Officers, says “every revenue sector will be affected, like the individual income tax, corporate income tax, sales taxes because people aren’t buying, and gas taxes because people aren’t driving.” He adds that the “hospitality sector will [also] be affected, especially in states like Florida and Hawaii that rely heavily on tourism.”

The impact of the revenue decline on budgets across the states will vary based on “how fast the economy recovers and where the largest percentage of a state’s budget comes from,” Sigritz says. “States that rely heavily on oil revenues will see large declines based on oil prices if the prices don’t go up.” The pandemic has sparked a price war between oil-producing countries, which thus far has cut the price of a barrel of oil in half. Oklahoma’s budget, for example, was based on a price of $55 per barrel. With oil selling for about half that, the state stands to take a $100 million revenue hit. Alaska, which gets its revenue almost entirely from oil production, is projected to lose $500 million.8 Revenues in New York and California are highly dependent on the financial markets. Much of their revenue is drawn from high-income earners, especially when those earnings come from capital gains. In California, the top 1 percent of earners pay almost half of the state’s total tax revenue. Moreover, about 25 percent of the income of residents earning $500,000 or more annually comes from capital gains. California’s revenue forecast was based on the Standard & Poor’s 500 stock index trading at approximately 3,120; the index stands at 2,304. If the markets don’t bounce back, residents that would have had large capital gains might instead have large capital losses, thus lowering their tax payments and reducing the state’s revenue.9 Regardless of which sector the decline originates in, the downturn will leave all states hard-pressed to maintain their pension funds, some of which have been underfunded for years.

Conclusion

The pandemic has steadily turned the lives of Americans upside down. The unemployment rate has skyrocketed, with record numbers of unemployment claims being filed in the states. Where will the money to pay these claims come from? The economic downturn from the pandemic will sharply reduce the sources that states and localities rely on to fund these services, regardless of which sectors their revenues come from. The plunge will undoubtedly play havoc with state and local budgets. To maintain the same level of services, states and localities will have to either raise taxes, reduce services, or both. Raising taxes may prove difficult because so many taxpayers are jobless and may be unable to pay. Moreover, the downturn will likely make it difficult for unemployed taxpayers to gain employment unless the economy rapidly improves. What will or will not happen is difficult to predict because there are so many unknown factors, such as how long the pandemic will continue. All we have is the present.

FOOTNOTES

1 Worldometer, Apr. 28, 2020.

4 Id.

5 Id.

6 Id.

7 Michael A. Pagano and Christina K. McFarland, “When Will Your City Feel the Impact of COVID-19?” Brookings Institution, Mar. 31, 2020.

8 Steven Malanga, “The Crisis’s Effect on Budgets,” City Journal, Spring 2020.

9 Id.

END FOOTNOTES

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