Connecting state and local government leaders
COMMENTARY | States are facing significant shortfalls in tax revenue. Leaders will need to think carefully how to execute tax policy in an uncertain economic climate.
There have been numerous recessions throughout history. Some widespread and others more regional. Yet, none of those recessions are quite like what state governments are anticipating in the age of Covid-19.
Typically, this time of year is when states bring in a lot of revenue. In the last two years alone, states have recorded anywhere from $36 billion to $50 billion in quarterly and final tax revenues in April. That will not be the case this year. While the true financial impact on state governments has yet to take full effect, it’s clear that amid widespread stay-at-home orders and supply chain disruptions that no government entity will escape a budget crisis in the wake of this pandemic.
Depending on the duration of the pandemic and the amount of financial aid Congress will provide, the options that governments have available to offset budget shortfalls vary widely. And, while each state will differ in their approach throughout the response to the crisis, it’s undeniable that government leaders across the nation will have to move quickly and efficiently.
While the debate on additional federal relief for states and localities continues, the onus remains on each state to identify the best ways to save money and lessen the blow of Covid-19 on fiscal budgets. As a result, budget officials will likely turn to a number of tried-and-true processes to mitigate the impact and keep their reserves from going into the red.
Governments must first focus on cutting as many expenditures as possible before they turn to any other action or risk political turmoil from residents and businesses alike. Governors and legislatures must immediately review revenues and compare that with the budget to determine what expenses can be trimmed or cut.
Because personnel account for a large majority of a state’s budget, many states will likely freeze hiring and then conduct an inventory of open positions and employees eligible for retirement. From the list of current openings, states will need to identify which positions are mission critical and must be filled. Positions that aren’t mission-critical will not be filled, and perhaps never will be. A state should also estimate which employees are eligible for retirement, close to retirement or could be financially incentivized to retire to determine the potential number in the workforce that could be decreased by attrition.
Governments should also evaluate their current and pending contractual obligations. At a minimum, states should identify which new contracts to put on hold. Contracts already in progress can be evaluated to see whether they can be postponed or suspended to save additional money for more high priority projects. One current example of this includes Wyoming Gov. Mark Gordon’s decision to have department heads halt general fund contracts over $100,000 and review spending on facilities maintenance.
Planning the Tax Response
Most states have delayed income tax payments, while some have delayed sales tax payments in response to the current crisis. These delays will contribute to state shortfalls, but the greatest contributor to budget gaps will be the lost tax revenue from closed businesses and unemployed residents.
Rule of thumb: tax increases and enforcement should always be a longer-term response. How a state leverages taxes to financially manage the anticipated recession must be approached diplomatically and carefully. The last thing a state wants to do is increase the costs placed on individuals and businesses during a time of economic uncertainty.
However, if a state finds that it must use taxes to financially manage a recession, there are ways that pose less risk. States could follow in the steps of local governments, like Philadelphia, which is increasing rates on permits and licenses among other tax changes to create new revenue raisers. Likewise, there are industries that states do not currently levy taxes on that they might could consider collecting from, like streaming services. While never a popular choice, increased revenue from new or expanded taxes may be critical to help fend off a portion of a budget deficit.
The longer a recession the more likely states will turn to taxes to combat their budget woes, but increasing or broadening taxes isn’t the only option. Some states will look to hire auditors to increase revenue through greater enforcement as South Dakota did this year as part of their enforcement of the 2018 South Dakota v. Wayfair Supreme Court decision. South Dakota’s Department of Revenue approved the addition of auditors to assist in the identification and audit of unlicensed remote sellers.
The current global crisis countries are facing is unlike any we’ve seen in recent history. In previous situations, providing unemployment benefits in the private sector has been the primary cost for state governments. But the unprecedented combined expenses incurred by states today in unemployment, decreased revenue streams and public health obligations is creating a circumstance where many state governments day-to-day expenses are quickly outpacing revenue.
State governments will need to make revenue-related decisions faster than ever before to combat budget shortfalls in response to Covid-19. The impact on every state will vary based on the makeup of their economies. States that rely on sectors that are heavily impacted by today’s circumstances, like tourism, will quickly see tax reductions and need to be prepared for the worst. Additionally, states that rely heavily on income tax will likely feel the impact in the future when those taxes come due. Many states are already proactively preparing for the economic impact and will adjust over the next several months to try and stay ahead of the curve.
Scott Peterson is vice president of U.S. tax policy and government relations at Avalara. Scott spent 10 years as director of the South Dakota Sales Tax Division and 12 years providing research and legal writing for the South Dakota Legislature.