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Economy & Taxes — What to Watch in 2022

Inflation is back and wages are up, while consumer spending remains strong. Economists expect these elements to drive the economy in 2022. Meanwhile, tax collections look hale and hearty. Tax relief could be coming in some states.

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(David Kidd/Governing)
Editor’s note: Each January, Governing produces its annual Issues to Watch, a detailed look at the legislative activities that will keep states busy for the next 12 months. We have decided to break down the report into a series of articles that tie together related issues. You can find our “Biggest Issues to Watch in 2022,” in its entirety here.

Economy


In 2021, inflation surged to its highest levels in a generation, led largely by prices for fuel, cars and major appliances while snarled supply chains bred chaos in ports, rail hubs and grocery stores. Housing prices remained elevated too, with median home sales prices spiking in many locales. Buoyed by generous federal income supports, and a boom in consumer spending as vaccination spread and social distancing eased, American economic growth shot to levels almost double pre-pandemic figures. Unemployment dropped much faster than was predicted, recovering at an impressive clip in comparison to the sluggish recovery from the Great Recession.

Economists expect many of these features to remain a persistent part of the economic landscape in 2022, although in a more muted fashion than last year. Policymaking in D.C. is likely to be more conservative, with as many as four interest rate hikes possible this year and far less fiscal spending forecasted. Even if some version of President Joe Biden’s Build Back Better bill does pass it is not likely to inject much money into the economy in the short term, unlike 2021’s American Rescue Plan Act.

“You likely will continue to see inflation above the Fed’s two percent target for a lot of 2022, but not the kind seen in the second half of 2021,” says Alex Williams, research analyst with Employ America. “That is going to play a major role in fiscal spending decisions at the federal level and maybe at the state level.”

The politics of inflation are believed to have weighed on the Democrats in the 2021 elections, where Republicans won one of two governor’s races. Concerns over price rises are one of the reasons that U.S. Sen. Joe Manchin gave for setting back the president’s major social spending and climate change bill, evidence that a more conservative fiscal attitude may be winning out. Inflation is likely to be a persistent line of attack for Republicans in the 2022 midterms.

Supporters of Biden’s spending plans say that many of his priorities could ease inflation in the medium-to-long term, enhancing productivity through investments in child care, sick pay and clean energy. We may never find out if they are right, but the president made a similar argument about his infrastructure bill and local leaders are already planning projects with those funds to ease supply chain issues. But the fruits of such spending are unlikely to be seen in 2022.

The National Association of Counties points to investments by entities like Miami-Dade County, which is expanding cargo facilities at its airport. With federal aid and local funds, Chambers County, Texas, is purchasing two purpose-built barges to facilitate the movement of tens of thousands of additional containers around the region. These are just a few examples of the local investments in physical infrastructure, even before the funds from the bipartisan law are distributed.

During the pandemic, cities quickly adjusted their zoning and street codes to accommodate restaurants and other outdoor services for safer dining. This saved many eateries, coffee shops and bars and made life much more pleasant, especially in big cities where outdoor space is at a premium. But as 2021 wore on, some cities and counties rolled back these regulatory easements. In 2022, as the pandemic rolls onward, restaurant industry and outdoor groups may go back on the offensive.

Meanwhile, wages for lower income workers surged ahead of inflation as employers had to lure people out of their homes and compete with pay raises and mass hiring by major corporations like Amazon and Walmart. Labor strikes, union drives and other worker actions saw a notable uptick, although they remained low by mid-20th-century standards. Higher income workers did not see the same wage increases, although their amassed savings from 2020 provided plenty of cushion.

Economists believe consumer spending will remain elevated in 2022 even without further federal fiscal support, as a result of the strong job market, historically low unemployment and rising wages.

“Consumer spending is likely to be buoyed by strong labor markets and gross labor income growth in 2022,” said Williams of Employ America. “This is in contrast to the years leading up to the pandemic, which saw tightening labor markets without the kind of wage growth that we’re seeing right now.”

In 2022, local and state policymakers will continue to compete for scarce workers with the private sector. They have a deep deficit to build back from, and it will be worth watching to see if the public-sector employment levels can return to pre-pandemic levels.

Many public-sector jobs grew increasingly stressful in the last two years, especially in health care, law enforcement and sanitation. Additionally, in 2020, many local and state governments did not replace workers who retired or quit, fearing a coming budget crunch. In some cases, layoffs were enacted.

But today, even with revenues surprisingly robust, state and local employment is still far below its early 2020 levels.

“It's just gotten much more expensive to hire people,” says Tracy Gordon, director of the Urban-Brookings Tax Policy Center. “The great resignation affects the state and local sector as well. To the extent that governments want to hire people, or bring them back, they have to pay much higher salaries. And I do wonder about the sustainability of that.”

The National Conference of State Legislatures reports that the principal concerns over inflation next year for legislative fiscal officers are that everyone will be trying to recruit teachers, police and health-care workers. In addition to competing with the private sector for workers, states and localities will also be crafting bills to entice people into the workforce and prepare them for available jobs.

Along with the usual job training programs, some states are considering higher pay and benefits like child care to help parents ease back into the labor market. Minimum-wage increases to keep pace with inflation could be a possibility in a few states, and even fewer cities. Living-wage increases for government workers are expected in 2022, in an effort to help the public sector compete for employees.

“Every legislator I've been talking to is hearing about workforce problems, both for state employees and private-sector workers,” says Tim Storey, executive director of the National Conference of State Legislatures. “I think many states are going to be paying a lot of attention to workforce issues in the next few months.”

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(Shutterstock)

Taxes


After a year of grim uncertainty, state budgets looked surprisingly hale and hearty in 2021. Tax collections came in above projections almost everywhere, with states like Idaho posting revenues 24 percent higher than the previous year and California’s up by 20 percent. Revenues were boosted for sales, corporate, income and oil taxes.

The gains have been attributed to higher income workers who did not suffer as many layoffs, and continued paying income and payroll taxes, while lower wage workers continued to pay sales taxes as their spending was bolstered by unparalleled levels of federal support. Meanwhile, stock markets surged and profits remained robust, again largely due to massive intervention by the Federal Reserve and Congress.

States and cities also made cuts during the pandemic so had not budgeted as much money this year, anticipating something like the more anemic federal response during the Great Recession. With spending down and an unexpected surge in revenues, states look like they are in a much stronger place. That doesn’t even include the almost $200 billion for states in the American Rescue Plan Act assistance and the funds from the infrastructure law, which will largely be routed through states.

“State budgets are as healthy as they have been in decades,” says Tim Storey, executive director of the National Conference of State Legislatures. “This year [almost] every state budget is in really strong fiscal conditions starting these [2022] sessions.”

This unexpected bounty led many GOP lawmakers to cut taxes in 2021, with many of these efforts expected to come to fruition this year. In Idaho, $220 million in income tax rebates and $163 million in tax cuts for individuals and businesses were put into effect. In December, Arkansas lawmakers moved forward a $500 million income tax cut, the largest such effort in state history. Florida Gov. Ron DeSantis also pitched a $1 billion gas tax cut for 2022, exempting residents from such payments as gas prices remain elevated.

“There’s going to be a tremendous discussion in legislatures about tax relief in many states,” says Storey, “[they will be talking about] targeted reductions in taxes, one time or short term…because they’ve got to think about [not] necessarily [being able to] promise to maintain these efforts.”

Even if states appear flush, many localities would have been in deep trouble without the aid provided by the Biden administration. The biggest city in the country, New York, is still facing a projected budget deficit of $3.6 billion in 2023 when the federal funds ease off. Cities like Philadelphia and Cleveland are reliant on taxes from suburban commuters, revenue sources that are imperiled by the remote work trend.

In some areas tax increases may be under discussion, especially in cities that are suffering from a lack of tourism, office work and the consumer spending that spins off of it. Wealth taxes or other politically appealing targets, at least for progressive politicians, could be a possibility in more Democratically controlled jurisdictions.

But given the uncertain economy, tax increases may be a difficult sell. If the past is precedent, a 2012 Center on Budget and Policy Priorities study found that state budget gaps were largely filled by cuts to services (45 percent) while tax and fee increases accounted for only 15 percent of the responsibility for closing such gaps.

There is scope within the American Rescue Plan Act for tax cuts in cities and counties, but so far there’s been little discussion. However, municipal and county politicians will no doubt be under some pressure from constituents to provide relief, especially as federal household supports vanished at the end of 2021. In a couple states, including Nebraska, there has been talk of allowing local governments to cut property taxes with the understanding that revenue-rich state governments would backfill the revenue losses that result.

There are observers of state and local government who argue that tax cuts are not the best use of this potentially brief period of strong budgets. Given that funding at these levels of government did not recover from Great Recession-induced cuts until just before the pandemic, it might make more sense to reinvest in an atrophied public sector.

“They do have cash, they are running giant surpluses, but all in a context of historic underfunding,” says Amanda Page-Hoongrajok, assistant professor of economics at Saint Peters University. “They should focus on giving resources to all the sectors that faced austerity. Instead of giving tax cuts, they should give resources back from where they were taken from.”

— Jake Blumgart
Jake Blumgart is a senior writer for Governing and covers transportation and infrastructure. He lives in Philadelphia. Follow him on Twitter at @jblumgart.
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