By Jackson Brainerd
Happy new fiscal year! Fiscal Year (FY) 2020 ended on June 30 for most states, closing the books on a difficult year of budgeting and kicking off what portends to be another.
States began FY 2020 with budgets in healthy fiscal shape, continuing to build on the longest economic expansion period in US history. However, the coronavirus outbreak in March, along with a global energy crisis, quickly sapped them of their strength.
The pandemic and subsequent economic shutdowns caused school closures, event cancellations, travel bans, restaurant restrictions and stay-home orders, which put a screeching halt to daily commerce. The temporary end of “business as usual” brought a steep plunge in state revenues, seemingly overnight. By the end of April, projected state revenues for the final quarter of FY 2020 had fallen more than 50 percent. Annual revenue projections fell anywhere from 10 to 25 percent. Moody’s Analytics estimates that states could lose $498 billion through fiscal year 2022.
States derive two-thirds of their revenues from income taxes and sales taxes. Both tax categories have taken big hits. Income tax revenue dropped as people lost jobs and business profits suffered. States also delayed income tax filing dates from April 15 to July 15. While helpful for taxpayers, this action pushed revenues into the next fiscal year, adding even more uncertainty around revenue collection to state budgets.
Sales tax revenues dropped when consumers stopped going out for entertainment or shopping. In fact, people started eating at home and buying more at the grocery store, which affects revenues because groceries are generally exempt from the sales tax.
Revenues tumbled even more for states that rely heavily on tourism and energy production. Business conventions cancelled as large gatherings were banned. Leisure tourism slowed as attractions across the country shut down. States reliant on severance taxes felt the pinch as oil and gas prices went into freefall--crude oil prices actually went negative for a short period in April.
On the bright side, states entered the pandemic with reserve funds as high as they have ever been. The Great Recession in 2009 caught states off guard and unprepared to address unexpected budget gaps. States learned their lesson, and since then, they have been setting aside funds in rainy day and other reserve funds. Although experts expect most state rainy day funds to be exhausted by the end of the summer, states have managed to balance their budgets through a combination of budget cuts and reserve funds. Lawmakers have largely avoided tax increases to date, although this will likely change as the revenue picture clears. (NCSL is monitoring state actions to close budget shortfalls here.)
In addition to marking the end or midway point in state spending plans, which provide appropriations on an annual or biennial basis, the end of fiscal year is often the effective date for tax code changes made in previous years. Due to interrupted legislative sessions and an economic crisis, FY 2020 was not a particularly busy year from a tax actions perspective, but there are still many noteworthy changes across the country taking effect July 1. Louisiana, for example, will join 42 other states in requiring the collection sales taxes on internet sale made by out of state retailers.
In Virginia, the cigarette tax rate will double from 30 to 60 cents a pack. Perhaps the most consequential change (from a state revenue perspective) taking place today is the expiration of the federal Internet Tax Freedom Act’s grandfather clause. While most states have been prohibited from taxing internet access since this law was adopted in 1998, a few with existing taxes on internet access were temporarily allowed to continue levying them. Six states (Hawaii, New Mexico, Ohio, South Dakota, Texas, Wisconsin) generate an estimated $500 million dollars in revenue from these taxes. While these they’ve all have all had ample time to wean themselves off this revenue source, it comes at a very inopportune time when many state budgets are in crisis.
FY 2021 will be plagued with further fiscal uncertainty. As of July 1, states have reopened their economies in varying degrees and revenues have rebounded slightly. However, the virus is still spreading, causing some policymakers to push the pause button. How this plays out and whether the economy will have sustained rebound remains to be seen.
States are also hoping that the federal government will step in to provide financial relief to help cover anticipated budget shortfalls. (Absent adequate federal assistance, economists are predicting required state and local budget cuts could trigger an economic depression. Finally, severance-tax-dependent states will also have to keep a weather eye on the health of the US oil and gas industry. Here’s to hoping for better days ahead!
Jackson Brainerd is a senior policy specialist with NCSL’s Fiscal Affairs Program