State Revenues Decline for First Time Since the Great Recession, With the Worst Still to Come

By Shelby Kerns posted 09-08-2020 07:29 PM

  

State Revenues Decline for First Time Since the Great Recession, With the Worst Still to Come


The majority of states have closed out fiscal 2020 and, as expected, most states experienced a decline in general fund revenues, both compared to prior-year (fiscal 2019) collections and to pre-COVID revenue projections. This large swing in tax collections led to a roughly 6 percent shortfall for states for fiscal 2020 in just a few months’ time.  This initial decline is only the beginning of what is projected to be a multi-year revenue challenge facing states with the potential to dampen the economic recovery. As states continue to experience high unemployment rates and lower consumption levels, the trends seen in the fourth quarter of fiscal 2020 are expected to further depress state revenues in fiscal 2021 and beyond.

  • Despite three quarters of strong growth through March 2020, fiscal 2020 revenue collections could not overcome the impact of the COVID-19 pandemic in the fourth quarter (April-June), as the vast majority of states operate on a July 1 to June 30 fiscal year. States saw general fund revenues decline 3.0 percent compared to fiscal year 2019 collections, whereas prior to the COVID-19 crisis, collections were expected to grow 3.0 percent based on states’ latest pre-COVID revenue estimates reported to NASBO in the spring, creating a roughly 6 percent shortfall. States, required by law to balance their budgets, have responded to these revenue shortfalls with spending cuts, in addition to using reserves and other one-time measures. New York, which operates on an April 1 fiscal year start, experienced a 10 percent decline in General Fund revenues in the April-June 2020 quarter compared to the prior year, after adjusting for the tax filing extension and liquidity financing to offset the delay.

  • Facing more severe revenue losses ahead, many governors and their administrations have directed agencies to develop budget reduction plans of as much as 15 percent or 20 percent for fiscal 2021 and/or fiscal 2022. Declines in state tax collections (and state spending) tend to lag the economic cycle, and can take a long time to recover. After steep declines during the Great Recession, state general fund revenues took a decade to return to fiscal 2008 levels, after adjusting for inflation. Additionally, state general fund spending did not return to the inflation-adjusted pre-recession fiscal 2008 level until fiscal 2019, only to be hit with the current fiscal crisis the following year. Rising public health costs, as well as increased caseloads from citizens needing assistance during the economic crisis further increase state budget gaps.

  • These declines do not include those to non-general fund revenues such as gas taxes and program fees that have also been hit hard by this fiscal crisis.

 

Update on Fiscal 2020 Revenue Collections Compared to FY 2019

Based on a survey of states and territories, general fund revenues are showing year-over-year declines for fiscal 2020 compared to fiscal 2019, as shown in the chart below.

Yea-Over-Year Change in State General Fund Revenues FY20

Note: Some states reported estimates for fiscal 2020, as preliminary actual data were not yet available.

* The figures reported above only include states that operate on a July to June fiscal year, as these states all experienced a similar period of COVID-19 impact on their fiscal 2020 revenues. The states that do not operate on this cycle include New York (fiscal year starts on April 1), Texas (September 1), Alabama and Michigan (October 1), and New Jersey (only for fiscal 2021, October 1).

  • Sales tax collections, which states had estimated to increase 5.0 percent, instead declined by 0.5 percent, representing a roughly 5.5 percent revenue loss compared to pre-COVID projections. This decline comes despite the strong start to the fiscal year and the impact of temporary federal stimulus measures on spending levels. Figures from the Federal Tax Administrators (FTA) show a median drop in sales tax collections of 10 percent in the fourth quarter, an ominous predictor of what is in store for states dependent on sales tax as economic activity remains constrained by the pandemic and recession. Enhanced Unemployment Insurance and direct payments to individuals kept personal consumption levels from falling further than they would have otherwise. Most states have also been able to collect taxes on online sales activity, which helped soften the blow to collections.

  • Personal income tax collections, which states had expected to increase 2.7 percent, declined by 3.7 percent compared to fiscal 2019, resulting in a 6.4 percent revenue loss compared to projections. This category of revenue is expected to show a much steeper decline in fiscal 2021, since personal income tax returns collected in fiscal 2020 for most states reflected 2019 economic activity and income levels. In states that withhold taxes from unemployment benefits, withholding collections were buoyed by temporary stimulus provided by the federal government, namely the Enhanced Unemployment Insurance benefits. Additionally, the Paycheck Protection Program loans kept individuals employed and paying income taxes.

  • Corporate income tax collections, which states had predicted to see a modest annual increase of 1 percent, took a large hit, declining by 9.5 percent compared to fiscal 2019 – a 10.5 percent revenue loss from projections. This drop reflects a decline in corporate profits, even as stimulus measures such as the Paycheck Protection Program sought to keep companies operating.

  • Gaming/lottery revenues declined 17.5 percent from fiscal 2019, due to the closure of casinos and other gaming establishments during the pandemic, and continued negative impacts on this revenue source can be expected as consumers change their behavior. The scale of this reduction speaks to the magnitude of the pandemic’s impact on this revenue source, given that this represents a sharp year-over-year decline while casinos and other gaming were only shuttered for a few months of fiscal 2020. Before COVID-19, gaming/lottery revenues were projected to decline 3.6 percent (due primarily to one state’s elimination of this revenue stream as a general fund source), so the net revenue loss compared to projections is 13.9 percent.

  • All other general fund revenue declines include large hits to severance taxes in oil producing states. Collapsing oil prices and a sharp decline in demand will continue to depress this source of revenue. All other general fund revenue, which may also include fund transfers for some states, declined by 1.6 percent compared to fiscal 2019 overall. This broad category of revenues was expected to grow 0.7 percent, so this decline represents a 2.3 percent revenue loss compared to projections.

Impact of Delayed Tax Filing Deadline

An unusual circumstance impacting fiscal 2020 was the delay of the federal tax filing deadline. Most states extended their tax filing deadlines to conform with the federal government, which resulted in 19 states counting revenue in fiscal 2021 rather than fiscal 2020. Among those 19 states, 17 states were able to report preliminary or estimated amounts for those deferrals. If we account for those filings in fiscal 2020, the revenue comparisons improve slightly but continue to show the same troubling trends, especially when one remembers that the COVID-19 crisis only affected revenues for the last few months of the fiscal year. After adjusting fiscal 2020 revenues to include these deferred amounts, total general fund revenues declined 1.6 percent compared to fiscal 2019, with personal income taxes declining 1.1 percent and corporate income taxes declining 6.8 percent.

Fiscal 2020 Revenue Collections Compared to Pre-COVID Projections

As reported in NASBO’s Spring 2020 Fiscal Survey of States, before the COVID-19 crisis, states were estimating general fund revenue growth of 3.0 percent. Instead, this preliminary data shows revenue declines for fiscal 2020 of 3.0 percent, resulting in a roughly 6 percent general fund revenue gap for states, on average. States budgeted based upon forecasted tax collections, so these revenue losses left a sizeable budget gap for states to close, requiring them to take actions including spending cuts to core services such as education. Even some states that ended fiscal 2020 with general fund revenues up slightly year-over-year had to make budget cuts or turn to reserves, since they still fell short of projected tax collections. Deeper cuts will be necessary in fiscal 2021 and 2022 as budget gaps grow wider due to an expected continued decline in revenues and rising expenditure pressures from the public health crisis, economic downturn, inflation and population growth.


State Revenue Outlook Expected to Worsen

States are expected to see the impact of COVID-19 on their revenues for years to come. While most states saw revenue decreases in fiscal 2020, state revenues are expected to see more severe declines in fiscal 2021 than they experienced in fiscal 2020 for several reasons:

  • For the vast majority of states, only the last quarter of fiscal 2020 revenue collections were impacted by the economic fallout of COVID-19. Coming into this crisis, most states were seeing revenues coming in at or ahead of projections. This provided some immediate cushion for states to soften the blow of the precipitous declines experienced in the fourth quarter. As economic activity remains significantly depressed and unemployment remains high, this crisis will affect the full fiscal year of state revenue collections for fiscal 2021.

  • Federal stimulus measures, including checks to individuals, enhanced unemployment compensation, the Paycheck Protection Program, and other measures, have been propping up the economy, and therefore state tax revenues, but those have largely ended.

  • State tax returns for fiscal 2020 reflected the strong economic activity of 2019, while returns for fiscal 2021 will reflect the much weaker economy in 2020.

  • The decline in state tax collections typically lags the start of national economic downturns. For example, state revenues grew 4.2 percent in fiscal 2008 even though the Great Recession began in December 2007 (the middle of fiscal 2008 for most states), while tax collections declined 10.0 percent in fiscal 2009.

Forecasted Revenue Declines and Budget Impacts for Fiscal 2021 and Fiscal 2022

For the reasons outlined above, state revenue forecasts for fiscal 2021 (and fiscal 2022 for those states that have released estimates) are projecting more significant losses, especially without additional federal aid. Overall, state revenue losses resulting from the COVID-19 recession are expected to exceed the 11.6 percent drop states experienced over two years during and following the Great Recession, with some states anticipating revenue declines of 20 percent or more. Moody’s Analytics released an analysis on stress testing state budgets based on its latest economic forecasts, which estimates budget shortfalls through fiscal 2022. According to that analysis, state budgets could experience a fiscal shock (revenue declines plus increased Medicaid expenditures) of $498 billion due to a prolonged economic recovery and continuation of COVID-19 cases in the fall. This analysis assumes flat spending by states with no increases to combat the epidemic or address other needs.

States have already begun making budget cuts in response to these forecasted revenue declines, and more adjustments are expected. Numerous states that enacted budgets for fiscal 2021 based on pre-COVID revenue forecasts have called special sessions to revise those budgets, eliminating pay increases and making cuts to baseline spending and personnel. Meanwhile, states that passed budgets after the onset of the COVID-19 crisis similarly cancelled planned investments, implemented furloughs and other actions, and cut base spending. Many governors and their administrations have directed agencies to develop contingency plans to reduce their budgets, for fiscal year 2021 and/or fiscal year 2022, by as much as 15 or 20 percent.

Looking Beyond General Fund Revenue Impacts

This analysis is limited to general fund revenue impacts only, and therefore does not show the full magnitude of revenue loss facing states. States are also seeing significant losses and ripple effects in other critical revenue streams, such as gas taxes and various program user fees, due to the public health crisis. These revenue sources are typically less vulnerable to the economic cycle, but the COVID-19 pandemic is not a typical recession.

Strained State Budgets and the National Economy

State and local governments are major economic drivers. Their spending totaled $3.1 trillion in 2019, representing 14.7% of gross domestic product. As states continue to experience high unemployment rates, the trends seen in the fourth quarter of fiscal 2020 are expected to further depress state revenues in fiscal 2021 and beyond. Without additional federal aid to mitigate these revenue losses, states will be forced to make deeper cuts to services and spending, as well as turn to tax increases, creating a drag on economic growth at a time when the nation’s economy is attempting to recover.