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States and Cities Face the Prospect of Severe Budget Shortfalls

No one knows how deep or long the pandemic-triggered recession will be. But nearly every type of government revenue, including income, sales and gas taxes, will take a hit. Well-funded rainy-day funds should help.

Waiting for government services in St. Paul, Minn.
Waiting for government services in St. Paul, Minn.
David Kidd/Governing
Tulsa has already imposed a hiring freeze. Oklahoma’s second-largest city is an oil town. With crude oil prices dropping near 20-year lows, some of Tulsa’s biggest employers can’t make a profit.

Tulsa has other problems. The city owns its arena and convention center. Naturally, events at those venues are canceled through next month. As in other cities, Mayor G.T. Bynum has ordered gyms to close and restaurants to offer takeout service only. “We really don’t know what the impact will be,” says James Wagner, Tulsa’s finance director.

He knows it will be large. Tulsa relies on sales taxes for two-thirds of its general fund revenue. “Just in the last two months, we are $1.8 million behind budget, in terms of what we budgeted for our sales taxes,” Wagner says. “Those numbers came in low even before COVID-19 really hit.”

It’s bound to get worse, and not just for Tulsa. Last week, even before many businesses shut down, Seattle — a pandemic hot spot — was projecting a shortfall of $110 million in revenue, or 7 percent of its general fund. That would be a major hit, but now it seems like an optimistic figure.
In New York, the only state with a fiscal year beginning April 1, state Comptroller Thomas DiNapoli estimates the crisis could cost the state up to $7 billion in lost revenues for fiscal 2021.
Economists currently differ on the likely economic effects of the coronavirus crisis, but there’s consensus that the economy will contract, at least in the second quarter. The debate is only over how much. A Pew Research Center survey released on Wednesday found that 70 percent of Americans believe the coronavirus poses “a major threat” to the U.S. economy.

The anticipated downturn will have serious consequences for state and local budgets. Most revenue sources that governments rely on — personal income, corporate income, sales, capital gains and gas taxes — is bound to take a hit. “Almost every sector of the economy is being impacted,” said Lucy Dadayan, a senior research associate at the Urban-Brookings Tax Policy Center. “It’s not just one revenue that’s being impacted.”

The stock market has lost roughly a third of its value over the past month. The American Hotel and Lodging Association says the economic impact on the hotel business is already worse than the 2001 terrorist attacks and the 2008 financial crash — combined. The association is predicting 3.9 million jobs will be shed by the end of the year in its industry alone.

On Thursday, the U.S. Department of Labor will release weekly figures for initial jobless claims, an early indicator that historic lows in unemployment are rapidly becoming a thing of the past. Already, a number of individual states are reporting that unemployment applications have increased ten-fold, or more, from just a week ago. By Wednesday morning, Ohio had received nearly 78,000 unemployment claims, compared with 5,430 for all of last week — nearly a 1,500 percent increase.

In Pennsylvania, there were 14,000 claims last week. There were 50,000 on Monday alone — or nearly 2 percent of the state’s workforce. The number of claims also topped 50,000 on Tuesday. In several states, the number of unemployment applications crashed servers. 

As workers are furloughed or laid off, states are going to collect less money from withholding. Even a delay in payments past the traditional April 15 tax filing deadline might make it tough for states to avoid shortfalls in the current fiscal year, which ends for most states on June 30. States rely on April collections for as much as 15 percent of their annual personal income tax revenue.

“The traditional big recession effect is on income taxes,” said Ronald Fisher, an economist at Michigan State University. “I’m of the mind that this will be more substantial than the sales tax [loss].”

It’s not all bad news. The U.S. Senate passed a stimulus bill on Wednesday that includes $35 billion in extra federal funding for Medicaid and will enhance unemployment insurance. Upcoming packages are bound to include more money for states and localities.

State and local governments have greater ability to capture sales tax revenue from online sales than they did during the last recession. They also enter this downturn with healthier reserves than was the case heading into the 2007-2009 recession. “We do know there will be an adverse economic impact,” Arkansas Gov. Asa Hutchinson said at a Monday news conference. “That’s why we have a rainy-day fund.”

But rainy-day funds may not be enough. As is traditional during a recession, demand on government services — and thus their expenses — will go up at the same time that revenues are coming down. There’s no telling how deep or long-lasting the pain will be this time around.

“It’s definitely going to have a far-reaching impact on all areas of state government,” said Brian Sigritz, director of state fiscal studies for the National Association of State Budget Officers.

A Scenario Worse Than Planned

Sigritz notes that at the start of the year, many states were seeing revenues coming in higher than expected, following several earlier years of growth. “That will give states some wiggle room,” he said.

States ended fiscal 2019 with $72 billion in their rainy-day funds, or 7.6 percent of their general fund spending, according to NASBO. That compares with $33 billion in fiscal 2007, at the start of the Great Recession, which represented 4.7 percent of state budgets. “In terms of reserves, for sure most states are in better shape than they were before the Great Recession,” Dadayan said.

Still, it turned out they were preparing for another “normal” recession,” not an unpredictable drop in both supply and spending. As late as January, most were still forecasting growth for fiscal 2021. “This is completely different,” Dadayan said. “No state had projected that coronavirus was going to become pandemic and they really didn’t account for the impact on state budgets.”

While there’s been a nationwide run on grocery stores, most states either don’t tax food, or tax it at a lower rate than other goods. It’s possible that having more people stay at home will increase utility use, and therefore some tax collections, but that may be offset by businesses shutting down and not using much power and water. Maybe people will suddenly spend a lot on home repair, taking care of long-planned projects during isolation, but as unemployment grows, even people who still have jobs usually become tight-fisted.

It will take some time for the real effects on income tax collections to be known, but clearly states that are heavily reliant on top earners, such as California and New York, will feel some pain, especially if market losses persist.

With people commuting less and traveling hardly at all, gas tax revenues will surely go down. At the federal level – which hasn’t increased gas taxes since 1993 – the Highway Trust Fund already faces a $15 billion annual shortfall. That figure is bound to grow. 

A majority of states have raised gas taxes over the last few years, but you can’t tax what people don’t buy. And, unlike the feds, states that have to balance their budgets can’t print money to shift over to infrastructure. “If we see a decrease in gas tax revenues, it’s going to force states to make some hard choices about projects they were planning on moving forward,” said Jim Tymon, executive director of the American Association of State Highway and Transportation Officials.

Tymon emphasized that it’s too early to guess what the impacts will be. He noted that some members of Congress are talking about attaching reauthorization of the federal surface transportation law to an upcoming stimulus package as a way of getting money out to the states. “That’s going to be one of the top issues that Congress is going to have to grapple with, sooner rather than later,” he said. 

Spending More While Collecting Less

On Monday, California lawmakers passed a bill devoting $1.1 billion to the coronavirus response. On Tuesday, Washington state approved $200 million in emergency spending. That same day, Minnesota approved $200 million in emergency funding for health care providers. Georgia’s brand-new budget includes $100 million to fight the virus. More supplemental spending at the state level is all but certain. 

“As with all recessions, expenditure side effects can be substantial for states,” said Fisher, the Michigan State economist. “More unemployment affects not only unemployment insurance but also Medicaid, SNAP and other programs.”

As costs ramp up, some legislators around the country are proposing sales tax cuts for consumers and deferrals of sales tax payments for businesses, in hopes of helping the economy. Cities such as St. Louis, Philadelphia and Los Angeles have ended parking meter collections or will stop issuing tickets during street sweeping or for exceeding residential time limits. Counties including Los Angeles, King County, Wash., and Loudon County, Va., are considering delaying property tax payments. Those may all be wise and needed policies, but they won’t bring money into government treasuries.

All told, counties rely on property taxes for 72 percent of their revenue. Property taxes are unloved by the public, but they are the most stable source of government revenue. “Property taxes may be shielded a bit more from impacts,” said Teryn Zmuda, an economist with the National Association of Counties. “That could be good news for counties going forward.”

About half the nation’s counties have rainy day funds they can draw on. But Zmuda noted that it took counties years to recover in terms of sales tax collections following the last recession. 

Economic forecasts vary widely in terms of the fallout from the virus. There’s agreement that the economy will shrink in the second quarter (April through June), but a wide divergence in terms of the expected size of the downturn.

Most forecasters are predicting a quick recovery. State and local officials better hope they’re right. 

“No one can say at this stage how prepared states are,” Dadayan said. “We don’t know how long it’s going to last."

Alan Greenblatt is a senior staff writer for Governing. He can be found on Twitter at @AlanGreenblatt.
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