The University of Tennessee, Knoxville.

Impact of COVID-19

on Local Government Finances 

A Policy Brief by the Howard H. Baker Jr. Center for Public Policy

in Partnership with the Coronavirus-19 Outbreak Response Experts (CORE-19)

April 3, 2020
Tennessee State Capitol and Flag
Using publicly available data from emerging research on COVID-19, this brief was written and reviewed by the Coronavirus-19 Outbreak Response Experts (CORE-19) at the University of Tennessee, Knoxville. It provides insights into the economic ramifications of the COVID-19 response.  

Impact of COVID-19 on Local Government Finances 

While the focus surrounding the COVID-19 pandemic has appropriately been on the health and safety impacts, this brief discusses one aspect of the economic impacts: the pressures placed on local government revenues. 
There is no question that the virus is negatively affecting revenue streams for county and municipal governments. We discuss the three major sources of this downward pressure on local revenues: the reduction in overall economic activity (arising in part from individual action like self-quarantine, resulting impacts on compliance and the timing of tax payments, and actions taken by the state and federal governments.

Is an Economic Recession in Progress? 

Those who track the macroeconomy have had a difficult time keeping up with the rapidly-changing forecasts. One consensus is arising, however: we are heading towards, and likely already in a recession unlike any other in our nation’s history.  
Most macroeconomic forecasters are predicting negative growth in Gross Domestic Product (GDP) during the second quarter of 2020, and those estimates range from -10 to -35%. 
These analysts are also calling for unemployment in the range of 8 to 32%.  While the ranges of these estimates are quite broad, the estimates are large, bad and believable. The silver lining on this rather bleak economic news is that most forecasters expect a relatively short-lived recession. 

Importantly, this depends on the extent to which individual behavior and public policy can combat the transmission of COVD-19 in Tennessee and in other states. If efforts to combat the spread of the virus prove ineffective or if the economy re-opens too soon, there is the threat of a resurgence of infections and deaths that would lead to another economic slowdown.

In addition, there is the real threat of a second wave of infections later this year that could do additional damage to the economy. Barring such outcomes, the more optimistic projections have growth turning positive as early as the third quarter of 2020, but the majority seem to be looking at the fourth quarter of 2020 or first quarter of 2021 as the time when we return to positive economic growth.  
The depth of this recession will exceed the Great Recession and the Great Depression, but unlike those devastating periods, the COVID-19 recession will be much shorter in duration.
 The economic recovery will be constrained by the expected loss of wealth and savings as well as the uneven pattern of impact and recovery across the states, mirroring the virus’ own impact as it rolls across the nation.

We anticipate that the recession and recovery will be most severe in urban areas with higher population densities and stronger business presence. Rural locations should fare better economically, although those that are more dependent on tourism, or leisure and hospitality more broadly, will suffer significant short-term impacts.

Furthermore, community spread of COVID-19 through rural locations would put tremendous strain on the already resource-deficient communities which could have profound negative effects on both their economies and the health of their populace.
Local Revenue Impacts
This kind of deep and relatively short-to-medium length recession is rare and places a number of unique pressures on local government revenue streams. 

The usual time lag between the taxable event (e.g., retail sales), collection of taxes by the state, and distribution of tax revenues to the local government will provide some needed immediate-term relief to local governments, as March and April revenues are based on activities in prior months. 

On the same note, even if a strong economic recovery begins as early as the third quarter of 2020, local governments will be feeling the revenue pressure in those same months. 
As a result, we expect to see a larger drop in revenues in the third quarter of 2020 than in the second quarter.
On a fiscal year basis, then, FY2020 revenue growth will weather the storm to some extent. A significant portion of the year’s collections are already on hand, and economic impacts over the final few months of the fiscal year will not entirely show up in reduced collections until the next fiscal year.
With that in mind, we expect the first three to six months of FY2021 to be particularly challenging for local governments.  The second half of FY2021 should provide needed relief, but we would not anticipate positive revenue growth in FY2021 relative to FY2020.

Sales Taxes

One of the most important revenue streams for local governments are sales taxes, both in terms of shared revenues from the state general sales tax and also from local option sales taxes. 
This is where we will see the most significant negative revenue impacts from the shutdown of a wide array of economic activity in the effort to slow the spread of the virus, including government action and the individual actions of business and people.  While consumers will shift some of their consumption away from impacted sectors like restaurants and brick and mortar retail stores towards grocery stores and online shopping, the net impact on sales tax collections will certainly be negative.
Fortunately, the negative impact from fewer sales of big-ticket items like home appliances and automobiles will likely be made up as many of those purchases will take place at a later time.
This pent-up demand will provide a welcome boost to collections at some point in FY2021 or FY2022, but some of the foregone taxable sales activity will never be made up.
It is important to recognize that sales to businesses (rather than consumers) represent a significant portion of local sales tax bases, and those sales will also suffer from the slowdown or shutdown of economic activity in response to the virus.  As with business-to-consumer sales, some of the foregone business-to-business activity will eventually be made up while others will be lost forever.

Local governments that are more dependent on tourism will see even sharper declines in sales tax collections, driven by the absence of the tourists themselves as well as the income they provide for that locality’s residents. 

Property Taxes

The story should not be nearly as bleak for the other major component of local revenues:  the property tax. There will be two possible sources of downward pressure on property tax collections. First, if the economic recession causes a longer-lasting reduction in property sales, this could place downward pressure on sale prices and thus property values, which could then reduce property tax collections unless the tax rate is increased. 
This is likely to be more important story line when it comes to commercial rather than residential property since commercial property was already under stress. The expected depth of the recession could certainly place short-term pressures on property transactions, but the short duration should bring needed recovery in FY2021 or FY2022. 

The second source of downward pressure is perhaps more meaningful for local governments in the immediate future:  impacts on compliance and the timing of property tax payments.
To be sure, a significant portion of FY2020 property taxes have already been collected. The question remains as to whether the remaining portion will be paid in full and on a timely basis. This could create significant cash flow problems for local governments who need to pay their own bills but will likely have a sincere interest in working with their residents to ease the local economic burden created by the virus. Liquidity-constrained businesses and households may have problems meeting their property tax liabilities in FY2021.

Other Revenue Sources and Issues 

Many local governments depend on revenues from gasoline and motor fuel taxes. On one hand, the sharp reduction in consumer mobility as a result of social distancing and Safer-at-Home guidelines will certainly lead to reduced revenues from gasoline taxes.
This could be muted somewhat if residents make greater use of food delivery options from their favorite restaurants. On the other hand, to the extent that residents become more likely to shop locally for groceries and other necessities and also more likely to shop online for needed items, delivery truck traffic will increase and provide needed relief in the form of motor fuel tax collections that do not fall as much. 
The depth of the COVID-19 recession has created sharp drops in activity for a large segment of the economy.
The most significant impacts thus far involve hotels, restaurants, bars, tourism, and other hospitality services and to a slightly lesser extent retail trades and the manufacturing sectors.  These industries will have a very difficult time making their regular tax payments, so it is feasible to expect some of them to seek discretion from local governments in order to allow later or reduced payments. 
Indeed, one of the first revenue-related responses from the federal and state governments has been the extension of tax payment deadlines, most famously with the extension of the federal income tax deadline from the traditional April 15 to July 15 as well as a similar state-level extension of the Hall income tax and franchise and excise tax payments.  
While these extensions provide important and needed cash flow benefits to taxpayers, these actions place considerable revenue strain on local governments that depend on shared revenues from higher levels of government.  Several local government revenue streams are passed through the Tennessee Department of Revenue following state-level collection, and it remains to be seen whether the state will make efforts to keep those funds flowing even as collections slow significantly.
Assisting these possible efforts will be the massive federal stimulus efforts. The most recent CARES Act legislation includes a considerable amount of funding for state and local governments that are most heavily impacted by COVID-19.
Tennessee stands to receive approximately $2.6 billion from this pool of funds, which will certainly reduce some of the state and local revenue strain. 
Local government officials are wise to consider the various pressures that will confront their primary revenue sources in the near term. Local tax collections will surely show signs of recession over the next few months, and will become very significant in the first few months of the next fiscal year.
State and federal actions will hopefully provide some needed support for local governments that see sharp drops in funding, such that they can continue to provide vital services in health care, safety, education, and other areas. 
Fortunately, the negative economic impact of COVID-19 should begin to reverse course during calendar 2020 or early-2021 and allow local governments to get back on track thereafter. Our general expectation as of this writing is for negative revenue performance through FY2020 followed by flat revenues in FY2021 before resuming to trend. 
More information can be found here: http://core19.utk.edu
    This brief is part of a series that will be produced by the CORE-19 team over the next few weeks answering questions and forecasting the health and economic impact of the virus. The Department of Health for the State of Tennessee is also providing ongoing updates. As this is an emerging issue dealing with a novel virus, information included here is potentially subject to revision as new research and data emerge. 

    Coronavirus-19 Outbreak Response Experts (CORE-19) 

    Dr. Matthew Murray

    Dr. Matthew N. Murray, PhD 

    Murray is the Director of the Howard H. Baker Jr. Center for Public Policy. He also is the Associate Director of the Boyd Center for Business and Economic Research and is a professor in the Department of Economics in the Haslam College of Business. He has led the team producing Tennessee's annual economic report to the governor since 1995. 

    Dr. Donald Bruce, PhD

    Bruce is the Douglas and Brenda Horne Professor of Business in the Haslam College of Business at the University of Tennessee with a joint appointment in the Department of Economics and the Boyd Center for Business and Economic Research

    Dr. Lawrence Kessler, PhD

    Kessler is an Associate Professor 
    in the Haslam College of Business at the University of Tennessee at the Boyd Center for Business and Economic Research. His research interests include health economics, education, and public policy. 
    Dr. Kathleen Brown

    Dr. Kathleen C. Brown, PhD, MPH

    Brown is an Associate Professor of Practice in the Department of Public Health and the Program Director for the Master's in Public Health (MPH) degree. Her research focuses on the health and well-being of individuals and communities. She has experience in local public health in epidemiology, risk reduction and health promotion.
    Dr. Katie Cahill

    Dr. Katie A. Cahill, PhD

    Cahill is the Associate Director of the Howard H. Baker Jr. Center for Public Policy. She also is the Director of the Center's Leadership & Governance program and holds a courtesy faculty position in the Department of Political Science. Her area of expertise is public health policy. She leads the Healthy Appalachia project. 
    Dr. Kristina Kintziger

    Dr. Kristina W. Kintziger, PhD, MPH

    Kintziger is an Assistant Professor in the Department of Public Health and the co-Director of the Doctoral Program. She has worked in academia and public health practice, and comes to Tennessee from the Florida Department of Health, where she worked as an epidemiologist and biostatistician. She is an environmental and infectious disease epidemiologist.
    Dr. Agricola Odoi

    Dr. Agricola Odoi, BVM, MSc, PhD

    Odoi is a professor of epidemiology at the University of Tennessee College of Veterinary Medicine. He teaches quantitative and geographical epidemiology and his research interests are in population health and impact of place on health and access to health services. He was a public health epidemiologist before joining academia.
    Dr. Marcy Souza

    Dr. Marcy J. Souza, DVM, MPH

    Souza is an associate professor and Director of Veterinary Public Health in the UT College of Veterinary Medicine.  Her teaching and research focuses on zoonotic diseases and food safety issues. 
    Disclaimer: the information in this policy brief was produced by researchers, not medical or public health professionals, and is based on their best assessment of the existing knowledge and data available on the topic. It does not constitute medical advice and is subject to change as additional information becomes available. The information contained in this brief is for informational purposes only. No material in this brief is intended to be a substitute for professional medical advice, diagnosis or treatment, and the University of Tennessee makes no warranties, expressed or implied, regarding errors or omissions and assumes no legal liability or responsibility whatsoever for loss or damage resulting from the use of information provided.

    Howard H. Baker Jr Center for Public Policy
    1640 Cumberland Avenue
    Knoxville, TN 37996
    Phone: 865-974-0931
    Email: bakercenter@utk.edu
    Online: bakercenter.utk.edu
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