Without claiming to own a crystal ball, my multi-decade experience in public finance and investment analysis gives me some insights that can hopefully help state and local government policymakers, budgeters, managers and union leaders as they plan ahead for the economy's transition from pandemic recession to an elongated economic and fiscal recovery.
It doesn't take a crystal ball to see that even if the economy grows by 6 percent in 2021 from this winter's bottom-out point, as the most optimistic Wall Street economists forecast, many states and localities will remain underwater, struggling or unable to maintain full-scale public services in the face of continuing revenue shortfalls.
Let's first clear the air about the stock market and its limited forecasting value for public budgeting. The major stock indexes are back up to pre-pandemic levels, but that is not a useful predictor for governmental tax revenues. The lost earnings of 2021 will have only a fractional impact on the long-run value of shares in big businesses; blue-chip investors are already looking out toward 2022 and beyond. Where the business-sector pain will continue to be felt most acutely is in the lower tier of smaller public companies and the even smaller privately owned businesses.
They are the ones with limited capital, and before this pandemic is over their debt burdens will force many of them into layoffs first and then bankruptcy, with an outsized impact on state and local revenue shortfalls next year. New startup businesses will rise from the ashes, but that process takes time. Consequently, income and sales taxes realistically cannot recover quickly to pre-COVID-19 levels early next year.
Most farmers will keep producing despite the pandemic (thankfully), so income- and sales-tax shortfalls will mostly beleaguer the predominantly urban-suburban states and, through them, political subdivisions that receive shared revenues. Income-tax-dependent cities will be hurt more than those that rely primarily on the property tax, as will local governments that collect sales-tax revenues directly or by piggybacking on their states' tax systems.
Income taxes are immediately impacted by unemployment and reduced business profitability. But unless you predict a horrific prolonged global spike in COVID-19 deaths, disregard some lobbyists' and partisans' dour and alarmist claims that these revenues will shrink by more than 20 percent from their pre-pandemic baseline for the entire year of 2021. Unemployment is now 10 percent, not 20 or 30. Nationally, GDP was down by almost 10 percent in the second calendar quarter of 2020, and another (but smaller) decline seems possible in Q3. But the media did us all a disservice by sensationally broadcasting the annualized rate of minus-32 percent, which would require the economy to keep shrinking by 9 percent in each of the next three consecutive quarters.
Such a free-fall is unlikely to happen. Barring a disastrous second COVID-19 wave, GDP could actually rebound a bit by late winter, with income and sales taxes following national income. Thanks to Zoom and our digital post-industrial economy, millions of formerly office-based workers have been able to keep producing from home at levels nobody imagined before March. With the stock market back up, capital-gains taxes will not evaporate as they did in 2008. We will likely see the worst in income-tax shortfalls in the months ahead, but uptrending calendar-year 2021 receipts will remain depressed from pre-pandemic levels, particularly in the first half.
Sales taxes are likely to remain below prior revenue peaks, but underperform less than income taxes. Internet sales taxes are becoming even more important, significantly offsetting the sales slump in physical stores. Local-source sales taxes from malls and regional brick-and-mortar stores will be hardest-hit, and local property-tax assessors can probably give budgeters some indications of what they hear from the storefront level. In the optimistic case, if coronavirus herd immunity is achieved by mid-2021, sales-tax receipts in the second half of that year could creep upward to near-normal levels. However, receding but lingering unemployment will continue to be the drag on income and sales taxes all year long, at least until the late-2021 holiday shopping season.
Property taxes will be the most stable of the major public-sector revenue sources. Residential property assessments are slow to adjust and should sidestep red ink. In some jurisdictions, assessments are not revalued annually, and those will benefit from pre-COVID increases catching up. In others, property-tax limitations such as California's Prop. 13 have capped prior-year increases at the consumer price index, thus leaving a reserve of untaxed appreciation in assessment values; they will simply grow at the rate of inflation in 2021. For jurisdictions that do re-assess annually at market value, the single-family residential property tax base is still growing nationally as lower mortgage rates and migration from urban multi-family units drive demand upward. Lower-income apartment valuations and taxes, however, could decline slightly for fiscal years beginning next July or later.
Where property tax revenues are at risk for next year is in the commercial sector, with brick-and-mortar retail, food service and entertainment businesses closing for good. Overall revisions probably won't exceed 5 percent in that one sector, but the direction is likely to be downward. Office buildings could face a similar impact, although several national experts expect those to become more visible in 2022, not right away. Nonresidential property assessments will likely remain suppressed in many localities for several years, not just 2021, until vacant leases re-fill.
What's the outlook for other revenue sources, such as those tied to transportation and tourism?
Mass-transit fares will continue to suffer. Work-from-home preferences and crowd avoidance will continue to impair ridership and farebox receipts, with the first half of 2021 likely to be worse than the following half. As with the airline fees and concession income that airport authorities rely on, it is hard to imagine a quick rebound to pre-pandemic revenue levels in 2021, but the worst will be over whenever the pandemic passes or Americans finally adjust culturally and apolitically to Asian-style mask-wearing.
Similarly, the hospitality taxes that tourist centers depend on could snap back in the second half of 2021, but only if immunity is established and consumer-traveler confidence is regained. So far, however, it looks like those jurisdictions will be on their own to weather their fiscal drought unless the composition of the Senate changes next year.
The main takeaway for public officials working on 2020-21 budget adjustments and layoffs is that one should not expect a V-shaped recovery to pre-COVID revenue levels until late 2021 at the very earliest. We can hope it will happen faster, but hope is not a strategy. In all probability, it will be up to the next Congress to decide how much ongoing pain the public sector must endure before economic recovery can put budgets sustainably into the black in 2022.