How far will state tax revenues fall during the pandemic? How far will state tax revenues fall during the pandemic?

Boston Fed economist Zhao develops model for predicting state tax revenue declines Boston Fed economist Zhao develops model for predicting state tax revenue declines

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July 9, 2020

Tax-revenue losses related to the COVID-19 pandemic are forcing state governments in New England and across the country to scrap their initial budget plans for the 2021 fiscal year and find new, reliable revenue projections that they can use to revise their proposals. Bo Zhao, a senior economist with the New England Public Policy Center in the Federal Reserve Bank of Boston’s Research Department, has developed what he describes as an “objective, transparent, simple, and efficient” method for forecasting state tax revenues during the pandemic.

The method is based on the state unemployment rate and an empirically determined time trend, and it can be applied to all but a handful of U.S. states. Using this method, Zhao forecasts large decreases in tax revenues across New England for fiscal 2021, which runs from July 2020 through June 2021.

“(States’) original FY2021 budget proposals, which were discussed back in December 2019 and January 2020, understandably did not account for the economic impact of the COVID-19 pandemic and therefore have become obsolete,” Zhao writes in his report, “Forecasting the New England States’ Tax Revenues in the Time of the COVID-19 Pandemic.”

With reliable revenue forecasts, states can plan their budgets accordingly

Zhao notes that state revenues from individual income taxes and sales taxes will decrease substantially because so many people lost their jobs and so many retail businesses shut down due to the pandemic. States also are collecting less on gasoline taxes, hotel taxes, and meals taxes due to restrictions on travel and restaurants. Although the New England states have been steadily lifting the shutdown restrictions, economic activity is generally not expected to return quickly to the pre-pandemic level in the absence of a successful coronavirus vaccine.

“States need reliable and up-to-date revenue forecasts to make financially sound policy decisions during this public health and economic crisis,” Zhao writes. “With the knowledge of how much tax revenue they can expect, governments can plan accordingly to minimize the disruption of crucial public services and balance their budgets as required by state law.”

Revenue losses could still be large even in a faster recovery scenario

Using his forecast method, Zhao projects that each New England state will experience a tax revenue decrease in fiscal 2020. If the economic recovery is slow and unemployment rates remain high in the region, the year-over-year real tax revenue per capita decline in fiscal 2021 could be greater than 20% or even 30% in some states. Even in a faster-recovery scenario, the decline could be greater than 10% in several New England states.

Such large losses in tax revenue could prove devastating, Zhao indicates. “State budget cuts will be almost unavoidable under the constraints of the balanced budget requirements, and they will carry significant risks and undesirable consequences,” he writes. “These cuts will harm the vulnerable population that depends on public services, and they will destabilize local government finance if they include reductions in local aid. More broadly, they will reduce the aggregate demand and slow the economic recovery.”

Zhao calls for more federal aid, without tight strings attached, to help states address revenue shortfalls caused by the COVID-19 pandemic.

Read Zhao’s full report.

Bo Zhao is a senior economist with the New England Public Policy Center in the Federal Reserve Bank of Boston's Research department. Full bio here.

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