COVID-19’s Implications for State and Local Governments’ Revenue Collections

April 6, 2020

By: Amanda Kass, Associate Director, Government Finance Research Center

The COVID-19 pandemic is an unprecedented, worldwide event that, as of this writing, is still unfolding. While the full impact may not be known for months or even years, the consequences on many aspects of daily life are advancing day by day.

Since my research focuses on public finance, I have been thinking about how the pandemic is likely to impact local and state revenues. The effects will vary from government-to-government, and depends, among other things, on how long the pandemic lasts. Other important factors to consider when thinking about how an individual government may be affected includes their revenue structure, economic base, whether they have a rainy day fund (and how large is it), and overall financial condition prior to the crisis.

As for revenues, in an effort to curb the spread of COVID-19, public officials have ordered businesses to close and people to shelter-in-place. This sudden and sharp decline in consumer spending means state and local governments’ excise and sales tax revenue will be impacted. The drop in, in-person spending, however, may be somewhat mitigated by online sales, and consumer spending could spike once restrictions are lifted.

There are 45 states in the United States that have a general excise or sales tax (referred to as “general sales tax” in the remainder of this blog). For those states, the portion of their revenue derived from general sales taxes ranges from a high of 31% (Nevada) to a low of 6% (Vermont). On average, general sales tax revenue accounted for 16% of states’ total revenue in 2017. The table below shows the 10 states with the largest share of total revenue from the general sales tax

The reliance on consumer activity for state revenue is even greater when taxes for items like alcohol, gaming, motor-fuel, and tobacco are included (referred to as “gross sales taxes” in the remainder of this blog”). All fifty states derive some revenue from gross sales taxes, ranging from a low of 3% (Alaska) to a high 46% (Nevada), and an average of 22%.

In addition to state sales taxes, local governments can have their own excise and sales taxes if their states allow them to do so. More than half of the 19,000 cities in the US have a local sales tax. Though municipal governments are less reliant on general sales tax revenue than states, in 2017, local excise and sales taxes accounted for some portion of municipalities’ revenue in all but one state. On average, gross sales tax revenue from local rates accounted for 14% of municipalities’ total revenue.

Beyond direct declines in municipal revenues as a result of a sales tax drought, they also can be fiscally hurt by a decline in intergovernmental revenue. State governments provide aid to local governments in a variety of ways, one of which is revenue sharing; state government distributes a portion of its tax collections to local governments. Of the 45 states with a general sales tax, thirteen share part of that revenue with municipalities. In addition to those thirteen, the state of Nevada has special statewide rates (the Basic City and County Relief; and, Supplemental City-County Relief Tax) in which the tax revenue is exclusively for local governments. Because of revenue sharing, declines in state revenue may also hurt local governments’ finances.

Municipalities’ reliance on intergovernmental revenue varies widely from state-to-state. In 2017, unrestricted state aid accounted for 27% of municipalities’ total revenue in Nevada, while it accounted for less than 1% of municipalities’ total revenue in twelve states. On average, unrestricted aid accounted for 5% of municipalities’ total revenue in 2017. The table below shows the top ten states for unrestricted state aid as a percentage of municipalities’ total revenue.

In addition to municipalities seeing less intergovernmental revenue due to declined state tax collections, state leaders may cut aid to local governments as a means of shoring up their own finances, as happened in the wake of the Great Recession.

While we remain surrounded by the huge uncertainties concerning the pandemic, the immediate imperative is actually dealing with the health care crisis. But the same necessary actions that have hope of blunting the blow of this deadly virus, like sheltering-in-place, will unfortunately, impact state and local governments’ finances, so we should be aware of the fiscal challenges that await once the immediate public health crisis subsides.