Effects of pandemic will slam state, local tax receipts

Indiana state and local governments are set to lose tens of millions of dollars in tax revenue—maybe hundreds of millions—as the COVID-19 pandemic closes restaurants, stores and casinos and companies begin laying off workers.

The drop in sales, income and gambling tax revenue could wreak havoc on government budgets, first at the state level and later for cities and counties, just as the demand for government assistance like Medicaid is expected to ramp up.

And it’s too soon to know just how bad the fiscal hit will be.

“Obviously, we’re in uncharted territory here,” said Chris Watts, president of the Indiana Fiscal Policy Institute, which tracks state tax and budget issues.

Rep. Tim Brown, the Republican chairman of the budget-writing House Ways and Means Committee, acknowledged the pandemic will have “a very dramatic impact” on revenue, which funds the state’s $34 billion, two-year budget.

Consider that:

– Sales tax revenue makes up roughly 50% of state tax collections. In March and April, a time when thousands of restaurants and retailers have been or will be closed, the state was projected to collect $1.3 billion, with some of that now at risk.

– Individual income tax collections are the state’s second largest source of revenue, making up 37% of state tax receipts. But that revenue is highly susceptible to recession. In 2009, at the start of the Great Recession, income tax revenue dropped by more than $500 million—or about 11%. The following year, it dropped another $438 million.

– State regulators have closed Indiana’s casinos and horse tracks for two weeks, with an extension likely. To put that in perspective, in February, the last month for which data is available, those gambling operations generated $60 million in revenue for the state and local governments.

Still, Indiana might bear a downturn better than some states. It finished fiscal year 2019 with $2.27 billion in reserves, or nearly 14% of expenditures. Lawmakers voted in January to spend $291 million of that money on a number of construction projects—money that could still be withheld from spending.

According to data from the Pew Charitable Trusts, Indiana has enough reserves to fund state government operations for about 32 days if no other revenue came in. That’s higher than the median for all 50 states, which is about 28 days.

“I feel like Indiana is going to do better than most,” said former longtime Indiana Senate Appropriations Chairman Luke Kenley.

But Kenley said state budget writers should remember the surplus can quickly run out, like it did during the Great Recession.

“We burned through $2 billion in 18 months or less,” Kenley said. “It was just astounding.”

And Kenley predicts this downturn could be worse.

If so, that could ravage the state budget. Over a two-year period that included the Great Recession, the state’s tax receipts dropped 15%. If that happened today, state revenue would drop $2.5 billion.

Local impact

Indianapolis officials are also bracing for revenue shortfalls.

Mayor Joe Hogsett said Wednesday that the impact to the city’s budget “could be significant.”

“It’s a little bit premature for me to say what kind of effect it will have on negotiations and budget considerations for operating year 2021, but I can’t imagine that we will not be grappling with that,” Hogsett said.

The city is already in a tough financial position with hardly any cash available in its rainy day fund, after deciding in 2018 to direct most of the money to street repairs. The city does have about $20 million of unrestricted cash reserves. With a $1.2 billion budget, the reserves wouldn’t go far.

Larry DeBoer, an economist at Purdue University, said local governments are buffered from feeling the immediate impact of a recession by a built-in delay in tax distribution.

The state collects income taxes one year and then pays them out to local governments in the following year. So the reduction in income tax revenue caused by fewer people working or people working fewer hours won’t hit until at least next year.

Property tax revenue also falls a year behind. So any drops in property values won’t be felt until 2022 or later.

Local governments should begin planning now for how any shortfalls might be addressed, DeBoer said. Cash reserves and rainy day funds vary wildly from city to city, but those that have them will certainly be in a better position to weather a recession than those that don’t.

“The biggest question right now is, ‘What kind of recession is this going to be,’” he said. “It never hurts to look ahead. It never hurts to try to anticipate.”

Hogsett said he’s anticipating a drop in revenue along with a need to allocate more resources to help the local economy and the community recover from the fallout of the pandemic.

“It’s both the supply side and the demand side, and it’s just a little bit too early to say with any definition how that’s going to play itself out,” Hogsett said.

How bad could it be?

Josh Goodman, a senior officer at The Pew Charitable Trusts, said economic conditions have a direct effect on state budgets. So the deeper a recession, the bigger the effect on tax collections.

“Right now, states are dealing with a lot of uncertainty in that regard. For one thing, nobody knows the outcome of the pandemic. Nobody knows how long businesses will be shut down,” he said. “How the pandemic itself affects the economy will determine how the economy affects state revenue.”

For example, the state won’t know how much sales revenue was lost this month until the end of April or later because there’s a delay between the time that consumers make purchases and businesses remit that money to the state.

It’s possible some of the tax revenue will rebound once authorities lift coronavirus restrictions. But experts say it’s impossible to know when that will be or whether the rebound will be strong enough to make up for the losses.

Goodman said the pandemic’s economic fallout will test whether states have adequately built their cash reserves. Following the Great Recession, many states saved more money than they ever had before.

He said states should be running stress tests to determine whether their rainy day funds or cash reserves can handle different scenarios. That will help officials identify areas where cuts might be necessary.

Brown, the Ways and Means chairman, said the big question he’s pondering is how long Hoosiers could be without jobs and what impact will that will have on the state’s unemployment trust fund, Medicaid spending and funding for housing assistance.

“I do not think it will be like 2009, but yes, it will have a very dramatic impact,” Brown said.

Holcomb’s administration declined to make anyone available for this story.

“We are in the early days and things are changing rapidly,” Holcomb’s spokeswoman Rachel Hoffmeyer said in an email.