Estimates of State and Local Government Revenue Losses from Pandemic Mitigation

While every revenue stream collected by state and local governments will probably be reduced by the current economic slowdown, the estimates here focus on the two largest sources: individual income taxes and sales taxes. Together, these taxes account for 60 percent of the revenue states collect. I have used the Current Employment Statistics (CES) and National Income and Product Accounts data to estimate the declines in the income and sales tax bases.

I calculated the declines in industry employment from February 2020 to April 2020 using the BLS Employment Situation Table B-1, which is based on the CES.¹ I matched these declines to industries in the Occupational Employment Statistics (OES).² I estimate the reduction in employment in each occupation and state by multiplying the industry employment declines by the number of employees in each occupation within the industry. I then multiplied the occupation declines by the occupation’s mean earnings and arrive at an estimated decline in the state’s income tax base. The implied declines in the income tax base varied from 11 percent to 15 percent among states and averaged 12 percent. The variation is driven by differences among states in industry concentrations and occupational earnings.

To estimate reduced sales tax revenue, I used the “Personal Consumption Expenditures by Type of Product” table from the National Income and Product Accounts.³ I selected the line items that are usually subject to sales taxes and observed a 4 percent decline in total expenditures on these line items from 2019:Q4 to 2020:Q1 (seasonally adjusted). I assume all of this decline is due to the shutdowns and it all occurred in the final two weeks of the quarter. This suggests taxable sales declined by 26 percent in these last two weeks. There is no geographic variation in the estimated decline of sales.

Data on state and local finances are collected every five years by the Census of Governments (COG).⁴ I inflation-adjusted the most recent income and sales tax revenues for each state and local government (Census of Governments 2017) and applied the income and sales tax declines. The COG revenue figures include revenues flowing into all funds, not just the government’s general fund. While most discussion of state and local budgets focuses on general funds, using the broad COG definition reflects that revenue losses in other funds might also create urgent demands for resources. Almost all states end their fiscal years on June 30, and this means that they had accrued or collected 73 percent of their FY20 revenue before shutdowns began in mid-March 2020.⁵ They will be collecting taxes from their reduced tax bases during the last quarter of FY20. The estimation calculations assume earnings and sales are suppressed throughout the quarter, but states are beginning to allow some businesses to reopen. To the extent that earnings and sales rebound during this quarter, the realized revenue losses will likely be less than is estimated here.

In table 1, I present the income and sales tax revenues that are likely to be lost in the remainder of FY20. These total $42 billion. The losses range from 0.3 percent (Alaska) to 5.5 percent (Texas) of annual own revenue. Because most states operate under balanced budget requirements, they will be forced to reduce spending by an amount equal to the revenue decline during the single remaining quarter of FY20. For example, a state that loses 4 percent of its annual revenue during the fourth quarter must cut 16 percent of the spending it planned to do during that quarter to finish the year in balance.

State governments maintain rainy day funds (RDF) and other unallocated assets that can be used to smooth through declines in revenue. The National Association of State Budget Officers publishes these fund balances annually.⁶ Because FY21 is very likely to be a financially difficult year for states, I have assumed that they will use half of their RDFs in FY20 and the other half in FY21.⁷ The last column of table 1 presents the revenue losses that would not be covered by the RDFs. This substantially reduces revenue shortfalls to $9 billion.

The lost revenue for local governments is presented in table 2. These estimates are calculated the same way as the state estimates except that I used OES data for the local governments’ metro or rural areas instead of the state-level data. The total estimated forgone revenue for local governments in FY20 is $12 billion. Local governments also maintain RDFs, so the need will be lower than this total implies. However, no good measure of these funds is available, so I am unable to adjust the figures.

Table 3 presents estimates of the FY21 lost revenue under three scenarios. The most optimistic scenario assumes that businesses will begin reopening in May 2020, that most businesses have survived the shutdowns, and that furloughed employees will return to their former employers. In this scenario, the income and sales tax bases reverse half of the shutdown decline by July 2020, and the recovery is complete by October 2020. For the second scenario, I assume the income and sales tax bases take four quarters to recover. This is modeled on the experience of the Great Recession. Personal income reached its recession low in 2009:Q1, and it took four quarters to return to its previous high. Consumer expenditures hit their trough in 2009:Q2 and took three quarters to recover. In the last scenario, I assume half of the declines are reversed by July 2020, but a resurgence of the virus forces the shutdowns to be reimposed in October 2020. The slow recovery described in the second scenario then begins in 2021.

Under the most optimistic scenario, states and local governments will lose $25 billion in revenue in FY21. They are estimated to lose $73 billion if we experience a slow recovery and $137 billion if there is a resurgence of COVID-19. Again, a portion of this can be offset by RDFs, but a majority will have to be matched with spending cuts unless state and local governments receive grants or raise taxes.