State and Local Tax Revenues Better Than Expected

State and Local Tax Revenues Better Than Expected

Rickey Rogers

Many economists worried that local tax revenues would fall sharply in the wake of the coronavirus pandemic, creating a long-lasting drag on the economy as payrolls shrank and public investment declined, but state and local finances have held up surprisingly well, according to a report out this week.

“In the early stages of the pandemic we warned that a plunge in the tax receipts of state & local governments was likely to result in major budget shortfalls, which could total between $300bn and $400bn over the 2020 and 2021 fiscal years,” Andrew Hunter of Capital Economics said in a research note Monday. “With most governments legally required to run balanced budgets, that raised the risk of severe cuts to spending, which could weigh on the recovery for years to come.”

But that dramatic fall in revenue hasn’t played out. Tax receipts did fall sharply in the early days of the pandemic, but by less than economic models predicted, Hunter said. Income tax revenues were particularly resilient, reflecting the skewed nature of job losses, which were – and still are – concentrated among low-income workers, who pay less in taxes. Additionally, the massive fiscal stimulus passed in the spring provided replacement incomes for millions of workers, and the economic rebound in the third quarter helped drive state and local tax revenues significantly higher – higher, in fact, than they were a year ago.

“As a result, the revenues of state & local governments for FY2020 (ending on 30th June) were only about $30bn smaller than their pre-pandemic forecasts,” Hunter wrote, adding that shortfalls were expected to remain roughly at that level in the next fiscal year as well.

The politics of stimulus: With the shortfalls in tax revenue at the state and local levels coming in considerably smaller than predicted at the beginning of the pandemic, reducing the severity of the economic drag caused by cutbacks in public spending, some lawmakers are now supporting a smaller Covid-19 stimulus package, or one that provides little or no aid to state and local governments.

The bipartisan stimulus package unveiled Monday gives lawmakers the opportunity to provide $160 billion in state and local support, but combines that aid in a bill with controversial liability protections for businesses, packaging the two provisions together in such a way that both could be rejected if negotiators are unable to reach an agreement. Senate Majority Leader Mitch McConnell (R-KY) has previously spoken in favor of rejecting both items as a way to reach an agreement on a separate, broader package focused on aid to the unemployed and small businesses, and Democratic leaders in recent days appear to have backed away from the red line they have drawn on the issue.

Still, the drops in tax revenue are having a negative effect, Hunter said, noting that state and local employment is down by 1.3 million since February. “[F]urther fiscal support for state & local governments would still be worthwhile,” Hunter wrote, even if the scale of the problem has proven to be smaller than first feared.