Much has been written on the expected impact of the corona virus on the economy as a whole, with leading forecasters expecting a drop in second quarter GDP ranging from 14% (JP Morgan) to 30% (Morgan Stanley). In short, it is certain that a severe recession and possibly a depression is heading our way, and indeed has likely already started.
But little guidance has been provided about the expected impact on local (i.e, municipal, county and township) government finances, and/or in comparison to state level budgets. Since virtually all of Power Almanac’s clients sell products and services to local governments, we thought it might be helpful to try to understand the likely impact of this pandemic on local vs. state government finances.
Our conclusion: local government budgets are certain to come under pressure, but much less so than state governments.
(And, incidentally, dramatically less so than commercial enterprises in a wide variety of industries, such as retail, restaurant, travel, entertainment and oil and gas.)
Revenue Impact: Local vs. State Government
As a starting point, let’s consider the sources of local government revenue. The Urban-Brookings Tax Policy Center provides a breakdown in the chart below, for FY 2016.
Compare the above to state government revenue sources in the chart below from the Tax Policy Center.
Local and state have similar reliance on intergovernmental transfers, which are likely to be relatively steady, especially in light of recently approved and likely future federal government stimulus programs. Charges and fees are trickier to predict given their diverse nature, but the proportion of revenue is similar for local and state governments.
Sales & Income Tax Losses to Hit States Hard
There are two areas in which their revenue sources differ dramatically. The first is sales tax. States are far more dependent than local governments (23% vs. 7%) on this source. Such revenue is certain to be severely depressed given the now nearly universal “stay at home” orders. The differences in dependence on corporate and individual income taxes revenue is also enormous: 20% at the state level vs. 2% locally. Given the expected drop in GDP, income tax revenue losses will be far greater at the state level.
Local Government Property Tax Revenue is More Stable
By contrast, property tax revenue, the second largest source of revenue for local government (at 29.8%), is likely to be far more reliable and stable. Two factors affect this revenue – the underlying property values and assessments based on those values.
A study by Zillow found that past pandemics have had a modest impact on housing prices, although transaction volumes dropped considerably. In most recessions, according to researcher ATTOM data solutions, housing prices have actually gone up.
As part of the recent stimulus package, the federal government has implemented a moratorium on foreclosures and directed mortgage servicers to offer forbearance and reduced payments on federally backed mortgages. Bond buying programs and interest rate cuts by the Federal Reserved have helped to lower mortgage interest rates, which could provide further support for home prices.
In additional, most states adjust their property assessments on an annual basis, suggesting that any major impact on property tax revenue is likely to be at least one fiscal year into the future, depending on how well the market holds up. Some local governments could even choose to raise rates to offset any declines in property values.
Expenditure Impact Comparison
To get a complete financial picture, we need to consider not just government revenue sources, but also expenditures. Consider the following spending comparison from the Urban Institute for 2017.
There are significant differences in expenditures on elementary vs. higher education, but such spending is unlikely to change much as a direct result of the crisis. Health and hospitals spending will likely grow, but the proportion of spending is similar at the state vs. local level.
State Public Welfare Spending Certain to Skyrocket
The primary area of meaningful difference is in spending on public welfare, which is dramatically higher at the state level (43% of expenditures) than for local governments (4%). Public welfare spending includes programs such as unemployment benefits, Medicaid services, services to low income beneficiaries, Temporary Assistance to Needy Families (TANF), etc.
Unemployment benefits, in particular, are expected to surge. The St. Louis Fed has projected crisis related job losses of up to 47 million. While federal government helps the states with unemployment benefits, the programs are primarily managed and funded at the state level. Losses in employment naturally lead to spikes in demand for virtually all other public welfare programs.
States are likely to have to significantly raise their spending on public welfare programs, just as losses in sales and income tax income are reducing their revenue sources. The impact on state budgets is likely to be severe, offset somewhat by the availability in some states of “rainy day” funds.
Pressure on local government budgets, by comparison, is likely to be much less severe, and result primarily from loss of sales tax revenue, increased spending on healthcare services and possibly loss of fees & charges.
PS, shortly after we published this post, a New York Times front page story came to a similar conclusion: The Virus is Vaporizing Tax Revenues, Putting States in a Bind.