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COVID-19’s Impact on State and Local Taxes



— June 10, 2020

The fiscal ability of local municipalities to maintain public health and economic stability in the face of COVID-19 remains unclear


COVID-19 has been identified as a virus that can be as economically destructive as it is medically contagious. The stock market has already plummeted. The sensible steps that are being taken to prevent it from spreading, such as restricting travel and public meetings, are slowing the economy.

The economic impacts of COVID-19 are already shaping up to be substantial but irregular across the world. Not only jobs and companies impacted but also the fiscal capability of governments that rely on a stable economy for their income.

Sales revenues offered a fairly steady pool of taxation for countries in recent downturns, helping to offset the ups and downs of revenues generated from more unpredictable economic practices, such as capital gains, business profits, or oil production. But the coronavirus pandemic and its unexpected economic effects could be different.

State budget officials are worried about the effect of COVID-19 on sales taxes

Despite consumer demand significantly constrained by societal barriers and demands for individuals to sit at home, sales tax income is expected to drop, causing large gaps in state budgets.

Global, U.S. Census Bureau announced on 15 April that from February onwards, retail sales declined by 8.7% on a seasonal basis, the largest monthly decrease ever. Such a sharp decline in consumer spending creates challenges for states and their policymakers, as general sales taxes collect about one-third of their general tax collections, according to recent census survey estimates.

To explain whether cities will forecast the bulk of COVID-19’s effect on their overall revenue from the fund, we looked at the degree to which the city depends on general tax streams that respond rapidly to economic volatility. A significant consideration is that the city’s core industrial economy is made up of businesses that are more directly vulnerable to coronavirus-related work losses.

The results show an unequal fiscal impact geographically, with many cities expected to be struck more severely and quicker than others.

City’s tax system will impact its short term outlook

Cities in the U.S. raise much of their income by creating their own tax and fee systems under the limitations set by their jurisdictions (e.g. land tax limits, debt limitations, constraints on access to other forms of tax). As a result, city tax systems differ throughout the country, with some heavily dependent on property taxes and others mostly on sales taxes.

Just a few cities depend much of the time on income or salary taxes.

Budget paper and pen with silhouettes of two men walking away from each other and the word “Tax” in bold red letters; image by Geralt, via Pixabay.com.
Budget paper and pen with silhouettes of two men walking away from each other and the word “Tax” in bold red letters; image by Geralt, via Pixabay.com.

Federal funding contributes to about 5 percent of overall local revenue, while State assistance contributes about 20 percent to 25 percent. In other words, the city’s tax system pays for between 70% and 75% of what it will expend to satisfy the health, education, and security needs of its residents and visitors.

However, a city that depends on property taxes does not suffer such an absolute fall in its revenues. Local valuation strategies allow governments to wait to determine the value of land and buildings before the property is sold on the market or an appraisal is made.

Solid intergovernmental relationships are vital

At all, the fiscal ability of local municipalities to maintain public health and economic stability in the face of COVID-19 remains unclear. The federal government has dedicated itself to delivering much-needed assistance to communities to address the urgent needs of residents, families, and small enterprises at economic margins.

It provides expanded support for Community planning block grants, infrastructure, healthcare, broadband and housing, and homelessness. In fact, cities with a population of more than 500,000 will now provide direct financial aid through a stabilization funding initiative, the Coronavirus Relief Fund.

Under the new law, states and cities will collaborate in innovative ways to ensure that municipal fiscal capability mechanisms are taken into consideration in the allocation of funds.

American cities will experience very different circumstances as the economic effect of COVID-19 is apparent. The most successful response to this extraordinary crisis must take into account the unequal size and pace of the fiscal effects that cities must face around the world.

Effect on federal tax audits and disputes

States pursuing additional revenue are expected to speed up investigations of high dollar value problems, such as the selling of transportation rights, the taxability of electronic applications, residency investigations, remote sales tax linkage, and the incorporation of foreign income in state consolidated returns.

Audits initiated in 2020 will typically cover earlier ‘boom years’ in which the stock market was consistently growing and many people and companies had higher net profits.

In the case of old and new state tax appeals; some states may prefer to negotiate the deal in order to obtain immediate payment rather than continue to allow the old conflict to move slowly through the administrative appeals system.

Audit sessions, appeal conferences, and hearings may need to be delayed or be done by recording. That would slow down the appeals process and can add a backlog or even contribute to an already current one.

Extension of time limits for filing

In reaction to COVID-19, Member States are beginning to propose amendments to the tax filing deadlines. It should not be believed that all time limits on all state taxes should be extended or that all extensions are mandatory (in some situations it will be appropriate to ask for an extension).

Hopefully, states will suspend fines if reports are filed late due to a taxpayer’s usual tax return preparer (or in-house accountant) having COVID-19-like symptoms that hinder routine work during the filing season.

In the past, States have usually accepted that the serious disability of a taxpayer offers a “just excuse” to suspend fines for late returns, but have not necessarily provided the same exemption if the tax return preparer becomes sick.

Provided that most states have declared a “state of emergency” due to COVID-19, one would expect that all states will be lenient to suspend penalties if there is a supportable COVID-19-related ground for a late-filed appeal.

Local businesses play a part, too

To explain the effect of tax regimes on city-revenue responses to COVID-19, Florida tax lawyer measured the share of regional jobs in high-risk sectors (mining/oil and gas, tourism, job infrastructure, transportation arrangements, leisure, and hospitality) and the share of general fund revenues from sales and income taxes across 139 towns.

Cities with both a fragile economic makeup (more than 15% of jobs in high-risk industries) and a tax system that is heavily contingent on volatile sources of income (more than 25% of general fund income) would experience a fall in taxes sooner than cities with alternate economic and fiscal systems.

This study indicates that many of the most fiscally troubled cities in the shorter term are in the center of America. For example, 76% of Columbus, Ohio’s general fund comes from income taxes, and 16% of area jobs are in highly distressed industries. Cities in Ohio depend heavily on flat income tax, which directly coincides with increases in wages.

Immediately impacted cities — those dependent on sales and income taxes with a large share of weak industries — are expected to suffer fiscal decreases in the next month or two. Others are more likely to experience the economic impact of COVID-19 over the next few quarters to a year.

While greater reliance on property tax income is usually more beneficial in the short run, a less diversified system would decrease the long-term flexibility of city budgets.

Revising State Tax Income Figures Downward

Economists have been downgrading government tax collection estimates for 2020. It’s not shocking. Member States typically earn much of their tax revenue from sales taxes, excise duties, and federal income taxes. Any of these could have a detrimental effect from COVID-19.

With respect to sales taxes, major retailers are gradually shutting their shops, and many states and cities have also forced the closure of restaurants and other businesses; as a result, customers are expected to make fewer taxable transactions, placing a downward impact on sales tax collections.

With respect to excise taxes, with the majority of workers operating from home and nearly all big activities postponed, it is expected that people will minimize their driving time, which means that they will consume less fuel for their vehicles, resulting in collecting less fuel excise tax than expected.

In turn, decreased travel would mean a reduction in hotel stays, which would result in collecting considerably less hotel excise tax than anticipated.

Enhanced focus on Amnesty and State Voluntary Disclosure 

Amnesty and voluntary disclosure initiatives are excellent tools for producing immediate revenue (i.e. revenue in 2020) in economic years. States will not need to raise this money anyway, because taxpayers “come out of the woodwork” to register for these programs.

Thus, both schemes provide the opportunity for immediate revenue to be “shot in the arm” in return for the waiver of at least some of the fines and interest on tax issues revealed in the programs.

Given the view of the immediate advantages of these programs, it is possible that States will propose new amnesty programs and will more actively promote their current voluntary disclosure programs.

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