With a “shelter-in-place” directive, rising unemployment figures and Coronavirus fears, the biggest component of the US GDP – consumer spending – has taken an unexpected tumble. This is particularly worrisome for local and state governments that heavily rely on sales tax revenues.
For instance, in California the sales tax forecast is expected to decline by 36% in the second quarter of 2020 with only a moderate regrowth in the following quarters.
In this article, we will take a closer look at sales tax forecasts for local and state economies and how they’re likely to affect local and state revenue and expenditure budgets.
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Comparing 2008’s Great Recession to the Coronavirus Recession
Before doing any comparative analysis, it’s important to note that the U.S. economy has never been shut down before, so this is all new for economists and financial experts. Where some are predicting a quick regrowth of the economy and a decline in unemployment numbers as soon as the economy opens up with a viable cure or vaccine for Coronavirus, others are more skeptical and predicting a slower recovery and boost to the consumer confidence.
The Great Recession of 2008, which lasted approximately 20 months, was primarily due to the housing bubble and subprime mortgage crisis. However, the current downturn isn’t due to a fundamental risk factor in the economy – hence, the current drop may not create prolonged damage to the economy, and once a vaccine is in sight and states start to open up, consumer confidence and unemployment numbers can make a rapid recovery. A slower economic downturn would lead to a slower and more prolonged recovery, and would hurt consumer confidence much worse and lead to a longer unemployment recovery period.
Federal Government’s CARES Act and the Reopening of the Economy
The federal government’s revival plan, also known as the CARES act, is certainly an important one to inject capital into the markets and keep people afloat on their various debt payments, but many of its components are one-time in nature and will not be repeated; for example, the one-time grant of $1200 to many who qualify, plus $1000 for children. This capital injection is widely expected to be spent on mortgage or rent payments, food and other essentials, a majority of which are not taxable and will not generate sales tax revenues.
Another important element of the CARES act is the unemployment payment boost of $600 per week, on top of regular state unemployment payments, lasting for four months. The extra unemployment payments may come with unintended consequences. While state unemployment payments vary, the average in the United States is roughly $350 per week. When you add $600 to that, the total is large enough that many low- and moderate-income workers would have an incentive to remain on the unemployment rolls rather than accept job offers. This will create a hindrance in encouraging people to return to work and bring the overall unemployment numbers down.
Joel L. Naroff, for The Philadelphia Inquirer, explains his optimism with the reopening of the economy by stating that, “The standard view is that we will have a V-shaped recovery. We crashed and burned, but once the economy reopens, it will rebound sharply. Indeed, as the argument goes, given the trillions of dollars being poured into the economy, a massive rebound is likely.
“At least in the first couple of months, that could happen. Since enormous numbers of firms closed, their reopening will obviously create an initial surge in activity. Households will likely go on a spending binge, restocking their homes and satisfying pent-up demand for all sorts of things.”
Unfortunately, to keep growth going, everything must go right: the V-shaped recovery requires the pandemic to end fairly quickly and at about the same time across the country. An extended shutdown increases damage greatly and reduces business survival rates. An in-sync recovery is needed to create the momentum required for strong growth. Households will have to become exuberant almost immediately and businesses will have to rehire most of their laid-off workers, keep them on the payrolls, and start investing right away.
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Economic Impact on Other Revenues
Other than sales tax revenues, it’s important to review other areas of revenues for local governments and their sustainability in the current environment.
- Property Taxes: Many counties throughout the United States aren’t allowing any property tax deferrals, and there haven’t been any indicators that show an adverse impact to the property values. This means that property tax revenues are likely in good shape right now, though this may all change if the shutdown persists.
- Transient Occupancy Tax: This is the hardest-hit revenue source for many local governments, and especially challenging for cities and counties that are heavily dependent on the tourism sector. Transient Occupancy tax is primarily charged on hotel stays, and given the impact of the coronavirus on travel, both business and personal, the hotel industry is struggling. Recent data shows that hotels have laid off or furloughed 70% of their staff.
The Bottom Line
As more and more states are starting to open up and ask businesses to hire back their laid-off or furloughed employees, the “new normal” of maintaining a distance, among other rules and recommendations by the CDC, will hinder progress in getting the economy back to normal – especially for businesses like restaurants, cafes, and so on. Since consumer confidence and consumer spending makes up a substantial part of the U.S. GDP, this will have to be watched very carefully. Municipal debt investors should carefully analyze the market trends, as the recovery starts and see how consumers react.
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Disclaimer: The opinions and statements expressed in this article are for informational purposes only and are not intended to provide investment advice or guidance in any way and do not represent a solicitation to buy, sell or hold any of the securities mentioned. Opinions and statements expressed reflect only the view or judgement of the author(s) at the time of publication and are subject to change without notice. Information has been derived from sources deemed to be reliable, the reliability of which is not guaranteed. Readers are encouraged to obtain official statements and other disclosure documents on their own and/or to consult with their own investment professionals and advisers prior to making any investment decisions.