The next economic crisis will hit states and cities
Illustration: Eniola Odetunde/Axios
America's economic crisis soon may expand to its states, cities and towns.
The big picture: State and local tax revenue is falling, particularly in areas heavily reliant on sales taxes, while spending is up due to added unemployment and medical obligations.
Just look at Arizona, which is near the middle of the pack when it comes to sales tax as a percentage of total state revenue. It's been projecting a $1 billion surplus by the end of its fiscal year in June, but now expects a $1.1 billion deficit for the year ending June 2021.
- Arizona has a relatively large rainy day fund, but it's not enough to cover the likely tax shortfall.
Or Nevada, which is more reliant on total sales tax than is any other American state, due to its lack of income tax and its outsized gaming and tourism industries.
- Nevada Gov. Steve Sisolak on Friday asked all state agencies to prepare budget cuts of up to 4% for the fiscal year ending at the end of June, and between 6% and 14% for the following fiscal year.
The most critical cases may be Florida and Louisiana, which both are in the top 10 for sales tax dependency and have rainy day funds that represent less than 5% of annual expenditures.
- Both have been hit hard by the coronavirus. Louisiana is believed to have peaked last week, but Florida isn't expected to peak for a couple more weeks.
- They also have large tourism and oil industries and are at particular risk for hurricanes — opening the possibility of simultaneous state emergencies.
- "There's no playbook," Louisiana State Treasurer John Schroder tells Axios. Past state emergencies and budget crises have been regional "and then the rest of the country comes in to the rescue. That ain't going to be happening this time."
Even states with relatively low sales taxes will experience revenue declines, particularly as layoffs eat into income tax revenue and some residents and landlords are unable to pay their property taxes.
There also will be shortfalls in cities, counties and towns — many of which haven't yet debated or approved fiscal 2021 budgets because of bylaws that didn't anticipate governance-via-Zoom. Bankruptcies are a very real possibility.
- "States aren't usually obligated to bail out a city if it goes under, but they do so anyway because of the signal it would send if they didn't," one tax researcher tells Axios. "But if suddenly a lot of them needed help all at once, I don't see how states could afford it."
- Brookings recently analyzed the immediate fiscal impact of COVID-19 on cities, including tax types and at-risk jobs, and found that four of the top five most vulnerable were in Ohio.
- There also are ancillary public entities like university and transportation systems, both of which are hemorrhaging revenue at a time when they'll be asked to cut budgets.
Many state governments have only just begun to develop economic crisis plans, either because they were slow to recognize the problems or because their attention was consumed by health care issues.
The initial response, like in Nevada, will be steep budget cuts — with officials and researchers telling Axios that K-12 education will often be first on the chopping block.
- Many of these cuts will be immediately applied to the 2020 fiscal year, which ends in June, because most states are legally required to balance their budgets. Also expect various budgeting gimmicks, such as pulling some 2021 taxes backward into 2020 or extending the 2020 fiscal year (as New Jersey just did).
- All of this is further complicated by extended tax filing deadlines.
- "You can only cut so much," explains Louisiana Lt. Gov Billy Nungesser. "I don’t think you’ll ever make up what you need to make up in the losses of oil and gas, sales tax, and those things with cuts right out the gate."
Some states and cities also may try to issue new bonds, or refinance old ones.
- It had become difficult even before the crisis to find buyers for “general obligation” bonds. Issuing these kind of bonds for operating expenses “just doesn’t happen post 2008,” Katie Sabo, state and local leader at Aon Public Sector Partnership, told Axios. But the Federal Reserve has implemented some emergency programs that could help create a market.
- Key here is that credit ratings agencies have not yet re-rated any U.S. states, all of which are considered investment grade, despite the obvious fiscal calamities.
- But any successful bond issuance will come with particularly high interest rates, thus creating its own set of budgetary difficulties.
- "Some short-term borrowing might help states out somewhat," says Brian Sigritz, director of state fiscal studies for the National Association of State Budget Officers, "but they will still have to rely on so many other strategies."
Then there are federal bailouts, which is what many state and local officials are not so secretly banking on.
- The CARES Act included $150 billion for state and local governments, which no one seems to think is nearly enough.
- More aid could come via a CARES Act 2, although Senate Democrats last week tried tying it to an expanded small business loan pot. At present, neither program expansion has passed.
The bottom line: Individuals and companies were the first to feel the economic pain of COVID-19, but they may be just the tip of the spear.