Through much of 2020, there have been dire predictions regarding the effects of the COVID-19 pandemic on state and local budgets. The health crisis has wreaked havoc on the economy and the general thinking has been that states would have to raise substantial amounts of revenue to balance their budgets. The expected state budget shortfall estimates for fiscal years 2021 through 2023 are over $500 billion and considering second quarter 2020 state tax collections, the predictions are not without support.
The shutdowns of late March and April in many states resulted in mass furloughs and layoffs. As economic stability waned, many employees were either no longer generating income or were concerned about their future. Such concerns had a direct impact on consumer spending. For the second quarter of 2020, sales and use tax collections fell by over 17% compared with the same quarter the year before. That was the first quarter-over-quarter drop in sales tax collections in over 10 years – the last being during the Great Recession. Similarly, state individual income and corporate income taxes also fell, with overall state tax collections falling roughly 29% over the second quarter of 2019. However, individual and corporate income estimated payments and year-end filings were deferred to the third quarter and responsible for much of the reduction. Early reporting and economic data has indicated that revenues substantially improved as deferred individual and corporate collections came through and the overall population began to spend again.
With those early numbers in mind, many prognosticators believed that states would have to substantially increase existing taxes and or adopt new taxes to increase revenue generation. But four states, which recently enacted or introduced budgets, have not yet raised taxes. One of those states has seemingly made it through the spring and summer relatively unscathed.
Idaho’s budget situation is so good that Gov. Brad Little would like to use the projected $530 million surplus for fiscal year 2021 for tax relief. The governor’s office reports that the state is exceeding both income and sales tax collection projections. For the second quarter of 2020, Idaho was one of the few states with state tax collection growth over the second quarter of 2019, including growth in both sales and use tax and individual income tax collections. Surprisingly, the state has a ten times larger surplus than was projected before the pandemic. The specifics of what the governor and legislature will propose to do with the surplus are unclear.
Idaho makes an interesting case study for a number of reasons. According to U.S. Census estimates, Idaho was the fasted growing state by population between July 1, 2018 and July 1, 2019 with a growth rate of 2.1%. Idaho was the second fastest for the period before that. Those numbers likely indicate much more about the state than the plentiful potato crops and beautiful scenery. With low average sales tax rates and moderate corporate income and personal income tax rates, Idaho would not immediately appear to have a significant tax advantage over other jurisdictions. However, its average sales tax rate is lower than both California and Washington and its marginal individual income tax rate is significantly lower than both California and Oregon. Its corporate tax rate is similar to or lower than both California and Oregon. Whether fueled by a more limited stay-at-home order or by overall economic growth, Idaho demonstrates that not all states will be in fiscal trouble in a post-pandemic world.
Holding off on tax increases
It is likely that states will hold off on tax increases as long as possible to appease economically burdened constituents navigating a global pandemic. Several examples of how states may approach that are below.
Connecticut Gov. Ned Lamont released a fiscal year 2021 budget with no new taxes – despite the state’s anticipated $2 billion deficit for that year. Most of the budget deficit is address through spending cuts and rainy day reserves. But unlike Idaho, Massachusetts and Vermont, some businesses will pay more in taxes. Lamont’s budget retains a 10% corporate tax surcharge that was scheduled to expire in 2021. It also delays the elimination of the capital base tax also scheduled to expire in 2021. Corporate taxpayers will likely face higher tax burdens than they would have if Lamont’s budget passes.
Massachusetts Gov. Charlie Baker recently submitted a $45.5 billion budget for fiscal year 2021 that does not include tax increases. The Baker administration did not significantly increase or decrease spending. The governor anticipated a budget short fall of $3.6 billion for fiscal year 2021. The proposed budget makes up for most of the deficit by using enhanced Medicaid reimbursements from the federal government and by drawing $111.35 billion from the state’s rainy day fund. The only tax related revenue raiser included in the Governor’s budget was a renewed proposal to adopt an accelerated sales tax remittance system. Currently, vendors must remit sales tax on a monthly basis. The governor proposes that large vendors (those with more than $150,000 of sales in Massachusetts) remit collection every three weeks. Beginning in 2024, all retailers would be required to remit sales tax (collected on credit card or electronic transactions) on a daily basis.
Vermont enacted a $7.2 billion budget for the remaining nine months of the current fiscal year without any tax increases. There were several tax bills and amendments proposed but they were all ultimately defeated. The budget passed unanimously in the state senate and overwhelmingly in the house. For the short year, the state faced a $200 million deficit. The shortfall was made up by a combination of reserves and federal aid.
Connecticut, Idaho, Massachusetts and Vermont have enacted or are pursuing budgets without tax increases. The circumstances in each state are different. Idaho did not experience the budget shortfalls that virtually all states faced in 2020 and in-fact experienced healthy second quarter 2020 growth in both personal income tax and sales and use taxes over the same quarter last year. Connecticut, Massachusetts and Vermont took advantage of significant rainy day funds to avoid tax increases. Many states will look to rainy day funds to trim anticipated deficits, although many states have already used up their reserves throughout 2020. While the results in these states look promising in terms of avoiding tax increases, they may not be typical.
While the states are collectively considering their budget positions going into 2021, many with decimated budgets, it seems likely that state tax changes are coming. Taxpayers may have an opportunity to take advantage of the various state tax and budget responses to plan for both personal and business growth.