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Taxes in the Time of the Coronavirus

Posted on Mar. 23, 2020
Billy Hamilton
Billy Hamilton

Billy Hamilton is the executive vice chancellor and CFO of the Texas A&M University System. In 2015 Hamilton led Texas Republican Gov. Greg Abbott’s Strike Force on the Health and Human Services Commission to complete a management analysis of the agency. Before that, Hamilton was the deputy comptroller for the Texas Office of the Comptroller of Public Accounts from 1990 until he retired in 2006. He is also a private consultant, advising on numerous state tax matters.

In this installment of State Tax Merry-Go-Round, Hamilton takes an early look at how the fallout from the coronavirus may affect state economies.

A friend of mine, a former Texas Capitol reporter, said the other day: “It’s a bad sign when sports reporters are only talking about coronavirus. I can’t get away from it.” And that was before the NBA canceled the remainder of its season and the NCAA canceled March Madness.

My friend isn’t the only one feeling a little overwhelmed by the coronavirus at the moment, but if you thought you could open a tax magazine and avoid the mess that is the world in the time of the coronavirus, you’re sadly mistaken. The virus, now wreaking havoc across the globe, is the topic of seemingly every conversation. The virus is impossible to ignore, and at the moment the only things we know for certain are that it eventually will pass, but in the short run, it’s going to be trouble.

Beyond the health impact, there are broader implications that will be parsed for years to come. While we’re preoccupied simply with avoiding the virus, the longer-term economic implications are going to take on more significance as time passes. What happens when, as seemed to be the case in mid-March, a country simply slows to a crawl in the space of a week? The contagion, along with falling world oil prices, has jolted the world’s financial markets — not to mention national psyches — and very likely has brought an end to the longest national economic expansion of the modern era. It has frightened even the most resilient — or heedless — among us, including me. I’ve used more hand sanitizer in the last couple of weeks than in my entire life before now.

It’s still too early to make any real judgments about the pandemic’s eventual effect, but it’s already leeched into the culture — whoever put the words “social” and “distancing” together before now? But though it’s early, it’s still useful to begin thinking about the pandemic’s impact on the states, although about the only certain thing now is that the impact will be significant.

A recession, if it comes and depending on its length, could undo or erode many of the fiscal gains made by the states since the last recession. Dealing with the problem and its aftermath will preoccupy legislatures this year and next, crowding out other issues. That will include taxes — and especially tax cuts. Healthy state reserves will erode, and revenue forecasts made before the current crisis will begin to look hopelessly optimistic. The much-written-about “gig economy” is almost certainly in for a bumpy ride because, honestly, who’s going to ride-share in the next couple of months?

Keep Your Eye on the Barbershops

Not to toot my own horn where so serious a public health issue is concerned, but in October 2019, when Tax Notes asked its writers to predict the most important state tax story of 2020, my prediction was that the big issue would be “the impact of a recession on state and local finances, and whatever state and local governments do to their tax systems to deal with the problem.”

I had no special insight, and the tone of my column was joking. I hedged my bets, admitting that I had been predicting a recession annually for the last five years (true), and noting that recessions seldom begin in presidential election years. And yet, the current expansion — because it isn’t officially over — became the longest postwar expansion in July 2019, and the odds of it continuing long into the future seemed dubious. Since that prediction, the economy has wheezed a little, but until recently, it’s looked strong enough to sail on through this year to the first year of a new presidential term, when recessions are much more common — eight of the last 11 recessions have coincided with the first year of a presidential term.

While I was only looking for a novel twist for my column — taxation of digital products or marketplace sellers were more obvious choices but were a little blah — I’m not the only one who’s thought about a recession lately. Karen Dynan, a Harvard economist and former Treasury Department official, told Ben Casselman of The New York Times: “A lot of forecasters have been saying, ‘If we were to see a recession in the next year or two, it would be coming from some external shock,’ and indeed that’s just what we’re getting.”1

Similarly, a recent article in Foreign Policy quoted Richard Baldwin, a professor of international economics at the Graduate Institute of Geneva: “This virus is as economically contagious as it is medically contagious.”2 He said the pandemic amounts to a triple whammy for the manufacturing sector in most major economies: outright closures in many Asian plants, supply chain disruptions all over, topped off with a plunge in demand for cars, electronics, and many other manufactured goods as people wait out the crisis. He might also have mentioned falling world oil demand coupled with a global price war, which will hurt the energy-producing regions of the United States and other countries.

Regarding possible timing, Casselman quoted Tara Sinclair, an economist at George Washington University, who said the first real sign that a recession is coming will be when companies with no direct connection to the virus start reporting a slump in business. “The key is to watch big macro numbers rather than obsessively watching things tied to virus and supply chains,” she said. “If people aren’t getting haircuts anymore, that’s a bad sign.”

I’m not sure if this meets Sinclair’s definition, but The Washington Post reported March 11 that job losses already had begun in ports, bakeries, and travel agencies. “Economists worry more layoffs are coming as businesses see plummeting sales,” the article said.3

The Black Swan

On the surface, we appear to be living through a classic “black swan event.” The notion of black swan events was first described by Nassim Nicholas Taleb, a finance professor and former Wall Street trader. He wrote about the concept in his 2001 book, Fooled by Randomness, which concerned surprise financial events. In his later book The Black Swan, Taleb extended the metaphor to events outside the financial markets. In all cases, he wrote, a black swan event has three defining attributes: It’s outside the realm of normal expectations; it has a severe impact; and “in spite of its outlier status, human nature makes us concoct explanations for its occurrence after the fact, making it explainable and predictable.”4

Taleb’s last point has already happened before the fact. Health professionals have been warning for years that the United States needs to be better prepared for pandemics, which aren’t that frequent but aren’t uncommon. Apparently, we weren’t ready for this one, and now we can only wait to see how it goes while the medical and emergency response communities work to catch up.

Something that has been a surprise is how quickly this black swan moved from curiosity to global crisis. On December 31, 2019, an Associated Press report out of China was one of the first English-language news mentions of the virus. “Chinese experts are investigating an outbreak of respiratory illness in the central city of Wuhan that some have likened to the 2002-2003 SARS epidemic,” the story began.

The trouble started when a strain of the virus that previously hadn’t been seen in humans was detected in Wuhan, China. The novel coronavirus — referred to as SARS-CoV-2 — can cause mild, nonspecific symptoms, including fever, cough, shortness of breath, muscle pain, and tiredness. More serious cases produce far worse effects and can lead to death, particularly among “vulnerable populations,” in this case meaning older people. It’s hard to recall that on New Year’s Day, most of us had never heard of coronaviruses. We have had an education in them since then.

According to the experts, the virus is spread via respiratory droplets with an estimated incubation period of two to 14 days, although even that’s not certain. No vaccine exists to prevent the disease associated with the virus, COVID-19, and no cure has been found. We know more now than we did January 1, but most of what we know is, ironically, what we don’t know, even as the disease plays out globally before our eyes.

As a briefing paper prepared for the European Parliament in February notes: “The first and most crucial aspect of an epidemic or pandemic is, and will always remain, human suffering and the loss of lives. Nevertheless, the spread of a virus can also have important economic implications.” Regarding the economic effects, the paper focused on the healthcare and disease containment impacts, the impact on travel and tourism, and the effects on the agricultural and trade sectors. Those impacts are worth considering because they, in turn, can also affect the welfare of people and the decisions governments at all levels must make.

The economic impacts of pandemics can be significant. According to the briefing paper: “A recent article [from 2017] estimates that the total value of losses (including lost income — through reductions in the size of the labour force and productivity, increases in absenteeism and, importantly, as the result of individual and social measures that interrupt transmission, but disrupt economic activity — and the intrinsic cost of elevated mortality) incurred by a severe global influenza pandemic (such as the 1918 pandemic), could reach about US$500 billion per year, i.e. about 0.6% of global income.”5 A 2019 study by the Global Preparedness Monitoring Board, a joint project of the World Health Organization and the World Bank, pushed the predicted losses higher — to 2.2 percent to 4.8 percent of global GDP — about $3 trillion.6

Those were global estimates for a bad bout of the flu. The U.S. economic impact would be a subset of those losses, and that, too, is uncertain at this point, but past studies provide a way of gauging the potential impact. A study from the Society for Risk Analysis published in June 2016 estimated the potential GDP loss from a flu pandemic outbreak to be between $34.4 billion and $45.3 billion.7

Another point of reference is the H1N1 swine flu pandemic in 2009. In that case, the H1N1 virus spread quickly across the country. The Centers for Disease Control and Prevention estimated that between 43 million and 89 million people contracted H1N1 between April 2009 and April 2010. A 2013 study of the socioeconomic impact of the event found a cost of $1.09 billion — 0.14 percent of GDP. In today’s dollars, that would equal about $2.7 billion. That’s a large number, but nowhere near as large as a bad hurricane. But it’s important to bear in mind that H1N1 was significantly less severe than the pandemics of the 20th century. Although the pandemic turned out not to be severe, one study pointed out that public health officials discovered problems with their initial efforts to mitigate the disease and increase public support for those efforts, discoveries for which they apparently found no cure.8

There have been some early estimates of the impact of the current pandemic on the world economy based on the scope of the problem in China, where many international technology companies have factories or component providers, which has affected international supply chains. According to a March 13 study done by the ratings agency S&P Global: “Industries exposed to consumer discretionary spending (especially Chinese households) and dependent on Chinese supply chains and demand are more affected. The former sectors include retail, leisure, transport/travel and infrastructure and the latter, autos, technology, and commodities.” Also energy: China now accounts for about half of world oil demand, so when the country’s demand dropped by around 25 percent as a result of the quarantine measures, the impact on oil prices was significant.

The S&P study estimated that COVID-19 could trim 0.5 percent from global GDP growth this year, reducing China’s economic growth by 0.9 percent, the Eurozone’s by 0.5 percent, and U.S. GDP growth by 0.3 percent.9 Those estimates were an update of earlier predictions that were roughly 0.2 percent lower for all the areas estimated, so it doesn’t take a weatherman to tell which way the wind is blowing in terms of the final magnitude of the impacts.

Nobody Is Counting Right Now

It’s far too early to see the end of this pandemic or its full impact, so the best we can do is take sensible precautions, socially distance ourselves, and consider what comes next. With that in mind, I came up with six likely impacts of the pandemic on the states and their fiscal systems. Some are already happening; some can be expected.

First, the operations of state legislatures are going to be affected, which will slow down legislative work, including actual legislating and the interim work that lays the groundwork for next year’s sessions. AP reported March 12: “Mounting concerns about the coronavirus spread to state capitols across the country Thursday, as some lawmakers halted their sessions, shut out the public and scrambled to finish work on essential spending bills to keep government going.” One of those states is Missouri, which shut down its session until at least March 30: “We feel it may be in the best interest for us not to be in this petri dish that we all show up in every week,” Senate President Pro Tem Dave Schatz (R) said while announcing that the chamber was suspending its regular sessions.

Second, state revenue will be affected. As one source who follows state revenue and tax administration trends told me when I asked what the state revenue agencies were saying so far: “Nobody is counting right now. Their revenue estimates are already in, and sales tax dollars haven’t stopped coming through the door yet. So there’s nothing to go on. But everyone agrees we’re dealing with a recession, and hoping it won’t be a long one.”

The states, though, are beginning to think about the revenue effects even without data. “Forget the closure on Broadway,” New York Gov. Andrew Cuomo (D) said. “The loss of revenue to the state government right now is incalculable.”10

Assuming a recession does come, it will have a significant effect on state sales and income taxes. This will likely begin to show up in sales taxes remitted in the next three months as people are out less and spending less. On the other hand, the impact might be masked to some limited degree in the short run by hoarding behavior and price gouging, which will temporarily drive up sales of some items like toilet paper, hand sanitizer, and associated goods. Orders from online sources are likely to rise sharply as people avoid brick-and-mortar shopping, so Amazon wins again. Income tax effects will be slower in coming but will come if the current economic slump lengthens and companies begin to lay off workers. Corporate tax collections will also suffer.

A good rule for lawmakers who were contemplating cutting taxes this year or next using the surplus revenue they’ve accumulated from their strong economies is to exercise some social distancing from that idea until the scope of this crisis becomes clearer.

Third, state revenue operations will be affected. As in many industries, state revenue agencies — and other state and local agencies — are beginning to direct employees to work from home to the degree they are technologically able to do so. In Maryland, the state comptroller closed branch offices March 12 and is providing all taxpayer assistance by phone or email only. North Carolina state agencies also moved to remote work for employees who are able as of March 13. Here in Texas, the comptroller’s office implemented agencywide teleworking beginning March 16. There will be more, which will, like it or not, affect taxpayer interactions with the tax agency.

States are also likely to take actions to help taxpayers affected by the virus. In California, the Franchise Tax Board announced March 13 special tax relief for taxpayers affected by COVID-19. Affected taxpayers will be given an extension to file their 2019 tax returns and make some payments until June 15, 2020. The move was made in line with a March 12 executive order by Gov. Gavin Newsom (D), declaring a state of emergency that directed the Department of Tax and Fee Administration, the Board of Equalization, the Office of Tax Appeals, and the FTB to help taxpayers with extensions and other actions related to “filing, payments, audits, billings, notices, assessments, claims for refund and relief from subsequent penalties and interest.”

Fourth, most states at least have a cushion to draw on. In October 2019 Pew reported on the status of state rainy day funds, finding: “Overall rainy day fund balances have never been higher, according to data collected from the spring survey of state fiscal conditions by the National Association of State Budget Officers (NASBO). In fact, the current reality may be better than reported because some states budgeted additional deposits after the survey was finalized.”11

In December 2019 Moody’s Analytics reported that after a couple years of strong tax collections, states were “better prepared than ever” to weather a potential recession.12 The good news, though, was tempered by the fact that one-fifth of all states still had nowhere near enough money set aside to survive a recession without resorting to spending cuts or tax hikes. The study found that 10 states had a greater than 5 percentage point shortfall in the amount of reserves necessary to survive a moderate recession. Louisiana ranked the worst, followed by Illinois, Kentucky, Oklahoma, and New Jersey. Pennsylvania, Mississippi, Arkansas, New Hampshire, and Florida also made the bottom 10.

The key again will be the depth and length of the recession. The longer the recession, the more reserves will be depleted even in the strongest states, including the energy states like Wyoming, Alaska, North Dakota, and Texas, which rank near the top in terms of reserves but must deal with both the coronavirus and falling oil prices. In Alaska, Gov. Mike Dunleavy (R) announced a hiring freeze for state workers not essential to health or safety in the face of the pandemic and uncertain oil market. Meanwhile, state lawmakers were making plans to prepare for how they will handle their current session work if there were a confirmed case of the coronavirus in Juneau.

Fifth, state spending priorities will shift, at least to some degree. States will have to spend more on health and human services than they already are to mitigate the damage caused by the pandemic. In Washington, one of the badly hit states, lawmakers passed a spending package of $200 million to be used for combating the coronavirus before adjourning March 12. Funding will come from the state’s rainy day fund. A majority of the funding will be used for patient testing and to help slow the outbreak. Lawmakers set aside $25 million to assist with unemployment benefits for those who have been left or will be left without work. Concerns about the virus caused lawmakers to scale back funding in other areas of its supplemental bill, which made adjustment to the state’s two-year spending plan passed last year.

Sixth, the federal government can help. When President Trump declared a national emergency in response to the coronavirus outbreak March 13, the action freed up federal funding for the states to use in response to the crisis, enabling them to tap into $42.6 billion that could be applied to tests, medical facilities, and other supplies.

The emergency declaration falls under the Stafford Act, which governs the federal response to public health and natural disasters. It was previously used for a health disaster by President Clinton to address an outbreak of West Nile virus in New York and New Jersey in 2000.

The emergency declaration opens various methods for employers to provide tax-favored financial assistance for employees who are affected by the virus.

On March 18 Trump signed an economic stimulus package to address the coronavirus, providing paid sick leave for workers and directing billions of dollars to states for food programs and unemployment benefits. 

While they’re at it, Congress also should reinstate and fund P-SNAP, the Pandemic Supplemental Nutrition Assistance Program, and not kick 700,000 people off food stamps as the administration planned to do until a judge stopped it. A P-SNAP was authorized in 2009 for the H1N1 pandemic but not used, according to Politico. That program would give households with children eligible for free and reduced-price school lunches extra assistance with food while schools are closed. There is an equivalent to a P-SNAP activated during natural disasters, and it, literally, is a life saver. Keeping food stamp eligibility would help some gig workers without gigs get by for the next couple of months.

Life Is Very Unusual

In terms of health, conditions have been improving worldwide for decades, but the coronavirus pandemic demonstrates that our progress could be slowed if governments don’t act together. Like climate change or the financial crisis, pandemics don’t stop at borders. They are, by definition, global, and citizens should have confidence that their governments will act in their best interests, which also means acting in the best interests of everyone touched by the crisis.

That, after all, is one major reason we have government and pay taxes. We expect our governments to do the hard work that has to be done — and to do it for everyone. At this point, the federal response, frankly, has been behind the curve of the disease, but from what I’ve seen working with the Texas emergency management agency, state and local governments are mostly doing a good job of dealing with a situation that changes with dizzying speed. This effort is going to be expensive, but if we can avert needless death and suffering, it is money well spent. I believe most Americans feel the same way. This virus may have started at a seafood market in Wuhan, but it has become everyone’s problem and conquering it depends on everyone as well.

Eventually, the pandemic will pass, burned out or overcome by the work of researchers and medical professionals, but even when it’s gone, we need to keep acting together on what we learn from the event. States, in particular, need to improve their healthcare systems and ensure that their services are ready to weather the next pandemic, just as they prepare for the next hurricane or the next tornado.

They also need to use the occasion to better understand their own finances, which will face major stresses if the pandemic does trigger a recession. States should pour all the resources they can into fighting the pandemic, but they also need to make sure the tax and spending decisions made in all areas of the budget are consistent with a sustainable and resilient fiscal structure able to handle the unexpected in the future. There may never be another COVID-19, but something else big and unexpected will happen at some point. This is both a unique event and a lesson for how governments at all levels need to plan for the future.

In his New York Times article on black swan events, Taleb said we should plan for the future based not on what’s expected but what’s unexpected — “life is very unusual,” he wrote. “Can we understand health without considering wild diseases and epidemics? Indeed the normal is often irrelevant. Almost everything in social life is produced by rare but consequential shocks and jumps; all the while almost everything studied about social life focuses on the ‘normal,’ particularly with ‘bell curve’ methods of inference that tell you close to nothing. Why? Because the bell curve ignores large deviations, cannot handle them, yet makes us confident that we have tamed uncertainty.”

Who knows? At the rate the current situation is evolving, maybe by the time you read this, COVID-19 will be a memory without a recession in sight. That’s the way of hope. It’s not the way to bet. Life is very unusual.

FOOTNOTES

1 Casselman, “Will the Coronavirus Cause a Recession? Keep Your Eye on the Barbershops,” The New York Times, Mar. 3, 2020.

2 Keith Johnson, “An Economic Pandemic,” Foreign Policy, Mar. 9, 2020.

3 Abha Bhattarai, Heather Long, and Rachel Siegel, “The First U.S. Layoffs From the Coronavirus Are Here,” The Washington Post, Mar. 11, 2020.

4 Taleb, “The Black Swan: The Impact of the Highly Improbable,” The New York Times, Apr. 22, 2007.

5 Angelos Delivorias and Nicole Scholz, “Economic Impact of Epidemics and Pandemics,” European Parliamentary Research Service, PE 646.195 (Feb. 2020). The report cited is Victoria Fan, Dean Jamison, and Lawrence Summers, “Pandemic Risk: How Large Are the Expected Losses?Bulletin of the World Health Organization, Dec. 5, 2017.

6 Global Preparedness Monitoring Board, “A World at Risk: Annual Report on Global Preparedness for Health Emergencies” (Sept. 2019).

7 Fynnwin Prager, Dan Wei, and Adam Rose, “Total Economic Consequences of an Influenza Outbreak in the United States,” Risk Analysis, May 23, 2016.

8 Karen Hilyard et al., “The Vagaries of Public Support for Government Actions in Case of a Pandemic,” Health Affairs, Dec. 2010.

9 Terry E. Chan et al., “Coronavirus Impact: Key Takeaways From Our Articles,” S&P Global Ratings, Mar. 13, 2020.

10 David A. Lieb, “States Turn to Cash Reserves as Coronavirus Strains Budgets,” U.S. News and World Report, Mar. 15, 2020.

11 Mary Murphy, Steve Bailey, and Airlie Loiaconi, “Rainy Day Funds in 2019: Are States Ready for the Next Recession?” Pew Charitable Trusts, Oct. 1, 2019.

12 David Lieb, “Report: Many States in Good Shape to Weather a Recession,” Associated Press, Dec. 2, 2019.

END FOOTNOTES

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