Various reporters, economists, and prognosticators have characterized the Covid-19 pandemic as both a “black swan event” and a “perfect storm.” While it is debatable whether the current situation meets the technical definition of either of those terms, it cannot be debated that six factors associated with the Covid-19 pandemic converge to apply tremendous pressure on state budgets. As a result of the significance and timing of these factors, taxpayers should focus their attention on state legislative actions over the next several months. Working together, candidly and civilly, taxpayers and legislators have an opportunity to make the post-Covid-19 world better than before.
The six factors are:
1. State balanced budget requirements. Unlike the federal government, almost every state’s respective constitution, statute, or practice requires it to balance its budget annually or biannually. See generally State Balanced Budget Provision, National Conference of State Legislatures, October 2010. While the specific balancing requirements “vary greatly from state to state,” it may be said that “balancing the general fund is what is commonly meant by balancing the state budget.” Id. at 6, 7. “The general fund budget receives more attention than the rest of state budgeting in part because there are few annual decisions to make about the rest of the budget.” Id. at 6.
2. Restrictions on state issuance of debt. Except for a handful of states, each state is subject to various constitutional or statutory restrictions on the amount of debt it may issue. The states without debt limits are Arkansas, California, Montana, New Hampshire, New Mexico, Oklahoma, and Oregon; see also, e.g., The Budget Process in Pennsylvania.
3. States collect a significant portion of their revenue in April. “Last year, states collected $65 billion in income tax revenue in the month of April, almost 18% of the annual total.”
5. Federal government extension of income tax payment due date. Almost every state that imposes an income tax ties its payment due date to the federal filing date, and the federal government has recently extended by 90 days (to July 15, 2020) the income tax payment due date.
6. The Covid-19-related and general decline in wages and spending. These declines will cause a concomitant reduction in state income, sales, and other types of tax collections for the fourth quarter of FY20 for June 30 year-end states and for at least part of FY21 for all states.
State tax officials are already feeling—and predicting greater—budget pain
The convergence of these factors already has state tax officials concerned. Some state tax officials have recently referred to the situation as “grim, bloody” and anticipate “bloodshed.” Jared Walczak, director of state tax policy at the Tax Foundation, acknowledged that the unpredictability of the situation makes it “unlikely that any state is fully prepared for what they are about to face[.]”
Looking through the prisms of California, New York, and Pennsylvania, by way of example, we see just how dire the situation is.
Just last week, California State legislative analyst, Gabriel Petek, projected to the State Budget Committee a budget deficit that could be as much as $35 billion.
New York has already revised its revenue estimates for the fiscal year ending March 31, 2021. New York State Comptroller Tom DiNapoli stated that this “is an extraordinary time that we are going through, and it makes estimating the revenue impact of the pandemic very, very difficult.” It’s so difficult that in the period between Feb. 14, 2020, and March 17, 2020, DiNapoli doubled to $13 billion his estimated budget deficit for FY21.
Dan Hassell, secretary of revenue in neighboring Pennsylvania, acknowledged recently that it’s “clear that state revenues are softening pretty dramatically at the moment [and that it’s] a huge challenge for all of us as we try to figure out where we go from here.” Secretary Hassell says that he’s “watching the economic forecasts that have been coming out and honestly they vary so widely that it’s difficult to know what to make of it.”
The cash flow strain caused by the deferral to July 15 of income tax payments is a problem for the current fiscal year. However, the effects of Covid-19 extend beyond the short term. For instance, some people will never be able to make up their Covid-19 losses and therefore may never be able to pay the 2019 tax liability. New York State Budget Director Robert Mujica understands that the Covid-19 impact is not limited to the short-term decrease in cash flows, and acknowledges that any reductions in wages and increases in unemployment (and unemployment insurance costs) will make it more unlikely that people will be able to pay their deferred 2019 personal income taxes. This, in turn, could lead to “negative growth,” in which case “taxes don’t appear to be the answer [because] you can’t get blood from a stone.”
The Covid-19 impacts on state budgets is not limited to the short term
Any general economic decline flowing from Covid-19 will decrease wages and income tax revenues and will also lead to a decrease in sales tax and other types of revenue. For instance, Governor Wolf of Pennsylvania has ordered the closing of the state’s liquor stores and casinos, which eliminates the nearly $2 billion tax revenue—about 5.5% of the governor’s $36.1 billion proposed annual budget—generated annually by these operations. Further, to the extent wages decline, taxpayers will have less money to spend. This will likely lead to a decline in sales tax revenues, particularly in a state like Pennsylvania, which does not impose sales tax on food, clothing and other necessities.
Expect a tense atmosphere during state budget season.
The vast majority of states will be tasked with passing a balanced budget this spring. The decline in personal income tax revenue caused by the federal government extending to July 15 the deadline for payment will decrease cash collections in the current fiscal year. State legislators will have to take that into account when considering the budget for the upcoming fiscal year.
In addition to, and likely more important than, making up that shortfall, states will need to anticipate the longer-term impact of Covid-19 on revenue collections. Some factors that will impact those calculations are how long casinos, entertainment venues, and eating establishments will remain closed, how much wages will decline, how consumers will modify their discretionary spending habits and how much business profits will be affected.
As noted above, states—unlike the federal government—are not able to freely issue debt and are required to balance their budgets. These factors force state governments to address the Covid-19 impact on tax revenues immediately.
Partnering for the greater good is the solution.
Just about this time in a normal budget year, taxpayer advocates, state legislators. and governors discuss the current state of fiscal affairs and debate what, if any, tax changes will be made. In many states, these discussions began several months ago, but this year’s entire landscape has been uprooted. As a result, no state budget and tax discussions will be the “same as last year.” In a certain sense, this tax year is “open season”—one in which every idea and every voice should be heard.
Having been intimately involved in the deregulation of Pennsylvania’s electric industry in 1996, I learned that it is critical to bring together all stakeholders to solve a complex issue effectively. After Governor Tom Ridge identified and assembled every interested party, he took another bold and essential step by informing each stakeholder that it needed to: (a) candidly express its goals and concerns, and (b) acknowledge that it would not get everything it wanted and would also have to give up something it did want.
With these ground rules, the parties collaborated—occasionally with loud voices, but always with civility—to achieve an outcome that was for the greater good of the whole—and of each individual stakeholder. The Pennsylvania Electric Deregulation Act is recognized as a successful model of electric deregulation that continues to provide substantial benefits to those original stakeholders as well as to new market entrants and consumers that had not been anticipated over two decades ago. (“A 2007 report by the Electric Power Supply Association credits competition-driven efficiencies at nuclear plants with providing $450 million in benefits annually to the mid-Atlantic region”).
The states’ fiscal needs and constraints are pretty clear. For a productive conversation to take place, however, taxpayers need to identify and prioritize their specific goals. Once that happens, I am hopeful that all interested parties will civilly and candidly dialogue to solve the state tax issues that will necessarily flow from the Covid-19 pandemic.
This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.
Michael Semes is of counsel at BakerHostetler in Philadelphia.