The Viruscession: State Tax Implications From the Great Recession

An extended economic downturn is expected to be the result of the COVID-19 pandemic and the shelter-in-place response affecting over 90 percent of the U.S. population. Indeed, recent numbers on unemployment claims and a decline in consumer spending have led some forecasters to expect a recession worse than the Great Recession of late 2007 to mid-2009.¹

This downturn in economic activity is by no means a typical recession, a result of underlying economic factors, but is instead a result of the policy response to mitigate the pandemic and the expected effects on human health.² Not a typical recession, but a Viruscession.

Although substantial focus, appropriately, has been on workers (and families) who have lost jobs and income and on businesses small and large that have seen demand disappear, state and local governments will face substantial and truly unexpected budget challenges from the Viruscession as well. Subnational governments already have seen additional service and expenditure requirements to respond to the health crisis, which eventually will expand to Medicaid, educational and other technology, pension fund stability, quite possibly unemployment insurance, and more. Revenue, and especially taxes, will not only fall below forecasts, but will fall absolutely. State governments have just begun seeing those tax revenue decreases.

So how large are the potential revenue and tax implications for states and localities? Of course, no one knows for sure, as this is an unusual circumstance. As Tracy Gordon of the Urban-Brookings Tax Policy Center put it on Twitter, “Everyone struggling to put numbers to state revenue loss. Best guess is ‘grim.’”

The fiscal condition of the state and local government sector is crucial for the overall health of the U.S. economy. State and local governments employ almost 20 million people, about 13 percent of total employment, or nearly 1 in 7 of all workers. The overall economic impact is even greater, as state-local government spending accounts for about 19 percent of GDP. State-local governments are substantial buyers of private goods as well as providers of essential public services.

The forces behind expected substantial tax revenue decreases seem clear.³ A decline in sales tax revenue will result from closed stores, restaurants, entertainment opportunities, and diminished travel (both air and car). Not even the run on toilet paper will be enough to offset the tax effect of sales declines elsewhere.

Both short- and long-run forces will affect income tax revenue. The change in tax return filing deadlines will move past-year tax liability across fiscal years in many cases. As the Federation of Tax Administrators notes, “Fiscal years end between March and June 30, so the shift from April 15 to July 15 is pushing revenues from the current fiscal year, where they have already been budgeted, into the next fiscal year.”⁴ Governments will begin receiving lower withholding payments for the current year, as workers get laid off. In the long run, income tax liability will decrease from much higher unemployment as well as declines in dividends and capital gains.

The depth and length of these effects on state tax revenue is the unknown in large measure. With no recent similar experience to guide projections, perhaps the knowledge from the Great Recession 12 years ago might be instructive. The Great Recession began formally in December 2007 (fiscal 2008 for states) and ended in June 2009 (end of fiscal 2009), although the fiscal effects persisted beyond that. State government tax collections from the state individual income tax (IIT) and sales tax by quarter for years 2008 and 2009 (and part of 2019 for comparison) are shown in Figures 1 and 2. Calendar- and fiscal-year data are in Table 1.

State Income and Sales Tax Collections, Great Recession (billions of dollars)

Period
		Individual Income Tax	Individual Income Tax	General Sales Tax	General Sales Tax
FY 2007 (through June 2007)		$265.9		$238.6
	CY 2007		$272.1		$240.5
FY 2008 (through June 2008)		$282.4		$241.5
	CY 2008		$282.2		$241.0
FY 2009 (through June 2009)		$244.2		$230.1
	CY 2009		$234.4		$221.0
FY 2010 (through June 2010)		$236.1		$224.4
	CY 2010		$244.2		$229.8
FY 2010 - FY 2008		-$46.3		-$17.1
CY 2010 - CY 2008			-$38.0		-$11.2

Income tax collections obviously are highest in the second quarter every year (tax settlement). Those state IIT payments declined by about $27 billion (27 percent) comparing the second quarter of 2008 and the second quarter of 2009. Indeed, income tax payments were less for every quarter of 2009 compared with 2008. If the decline from the second quarter of 2019 to the second quarter of 2020 were similar, IIT revenue would fall by $35 billion to $40 billion. On the one hand, this may be an overestimate, as the Great Recession was well over a year in progress by the second quarter of 2009. On the other hand, although unemployment increased from about 5 percent to 9 percent from the second quarter of 2008 to the second quarter of 2009, many forecasts suggest more substantial growth of unemployment over a shorter period in the current environment.⁵

From a longer perspective, state IITs fell by $46 billion (16 percent) comparing fiscal 2008 with fiscal 2010, as shown in Table 1. Most current forecasts of the pandemic do not envision the economic disruption persisting for two calendar years. Still, it seems clear that the economic and fiscal repercussions will continue into the fall of 2020 at least (affecting two fiscal years). Based on IIT revenue for fiscal 2019, such a decrease would be in the magnitude of $65 billion.

The effect on sales tax collections is even more difficult to interpret from the experience during the Great Recession, when consumer spending was reduced because income and wealth declined. Although such reduced spending is also occurring in the Viruscession, even people who remain on payrolls are spending less because of mandated social distancing and the closing of businesses. Therefore, the decrease in consumer spending and the resulting decrease in sales tax revenue in the Viruscession may be greater than in a typical recession, at least for some period. 

During the Great Recession, sales tax revenue declined but not nearly as steeply as did income tax revenue, as shown in Figure 2. Between the second quarter of 2008 and the second quarter of 2009, sales tax collections decreased by only about $6 billion (roughly 10 percent). Over a longer period, sales tax revenue was about $17 billion less in fiscal 2010 than in fiscal 2008, which is only about a 7 percent reduction. State general sales tax collections were about $94 billion in the second quarter of 2019 and $344 billion in fiscal 2019. Therefore, sales tax revenue reductions similar to those experienced during the Great Recession would be in the area of $7 billion in the short run and $25 billion to $35 billion longer term. However, as noted, the sales tax effect will very likely be more substantial during the Viruscession, at least initially.

Revenue from other state taxes — corporate income, motor fuels, and oil and gas severance especially — is also expected to fall. Revenue from state alcoholic beverage and public utility taxes is less clear, as personal purchases of alcoholic beverages have increased but sales at bars and restaurants are down, obviously. Similarly, residential utility spending is likely to increase with “stay at home” behavior, but with utility expenditures falling from closed businesses. Again going back to the Great Recession, total state government tax revenue from all sources declined by $66 billion from fiscal 2008 to fiscal 2009 and by $74 billion comparing fiscal 2008 with fiscal 2010, a reduction of about 9.5 percent.

What is the bottom line? If the Viruscession affects state taxes similarly to the Great Recession, state governments might experience income and sales tax reductions of roughly $40 billion to $45 billion in the short run (the remainder of fiscal 2020), possibly rising to as much as $100 billion over a year (perhaps fiscal 2021). Total state government taxes could decline by 8 to 10 percent, or as much as $110 billion. We emphasize that this is not a prediction, but merely a relationship based on past, and very different, experience. However, in the absence of better data it may be instructive, or at least a place to start.

State governments, of course, have themselves begun developing estimates of potential tax and revenue decreases, which are outlined in a report from the Center on Budget and Policy Priorities.⁶ Estimates of general fund revenue declines for the current fiscal year vary from 3 to 14 percent (averaging about 7 percent). For fiscal 2021, those similar estimates fall in the very wide range from 1 percent (Kentucky) to 27 percent (New Mexico), with a rough average of about 10 percent. The National Conference of State Legislatures website of state-by-state budget updates shows six states have publicly revised their revenue projections, all falling.⁷ For instance, New York believes its tax revenues are down for the fiscal year that just ended March 31 from $4 billion to $7 billion (about 5 to 10 percent from that collected in the previous 2018-2019 fiscal year). Perhaps surprisingly, these preliminary state estimates are not out of line with the Great Recession experience, but the wide variance of the forecasts reflects the uncertainty.⁸

Of course, state governments will experience other revenue disruptions as well. State colleges and universities may see reductions in tuition payments, room and board fees, and entertainment sales. Public hospitals, although occupied with COVID-19 cases, may see revenue from other regular business decrease. Toll revenue for state highways and state park user charges will fall. The financial rate of return on pension funds and interest earnings will likely be affected.

When these revenue implications are combined with the increased expenditure demands, to deal both with providing immediate health services and with the subsequent public service needs, it seems clear that additional and substantial federal government support for states and localities will be warranted. In the aftermath of the Great Recession, the American Recovery and Reinvestment Act of 2009 provided about $280 billion to state and local governments by 2014 (with some additional amounts extending beyond then). It is hard to imagine a case for less federal support (beyond that already in the Coronavirus Aid, Relief, and Economic Security (CARES) Act) in the current circumstance of this health-generated economic and fiscal disruption.

Federal aid to state and local governments for the Viruscession likely should come quicker, be more concentrated, and perhaps be more targeted than for the Great Recession. The American Recovery and Reinvestment Act took substantial time to be approved, and support for states and localities was spread out over more than five years. The fiscal problems for subnational governments are affecting budgets now, coming as one fiscal year is ending and budgets are being adopted for the next. And those fiscal problems will seemingly be concentrated in those two years. Assistance is required now. Because the economic and fiscal disruption may not affect all states or regions equally, that assistance might be targeted to states most stressed by the necessary policy response to COVID-19.⁹