October 11, 2020
The Lengthening Impact of COVID
The COVID pandemic continues to affect commerce and government in what is clearly the worst year for the economy since the Great Depression. We don’t yet know how deep this will be, but there is growing evidence of an increasingly delayed recovery.
There is some good news. The official unemployment rate has dropped significantly and commerce is clearly recovering in many places. Still, in October 2020, the risk of COVID remains significant and depresses consumer spending and business investment.
The most alarming piece of data is the growing number of permanently unemployed workers. The COVID spike in those reporting permanent job losses returned us to 2013 levels. The economic absorption of permanent job losses is a major factor in the duration of recovery. If the re-employment of permanent job losers is twice as fast as it was after the Great Recession, it will take close to four years to recover. I know of no economist predicting a labor market miracle in the wake of COVID.
COVID will continue to cause permanent job disruptions until a vaccine is widely available. It is easy to build a plausible scenario where permanent job losses weigh on the U.S. economy well through the 2020s. Worse still, the administrative data on job losses report more than twice the rates of job losses than do the survey data used to calculate the official jobless rate. Even with double the fraud and error rate, this means we are missing 10 million unemployed people in the preliminary unemployment statistics.
Of course, it is election season and one predictable bipartisan temptation is to spin the economic conditions in ways that are favorable to your side. That’s normal, but believing your own spin is neither normal or healthy. That is particularly true when considering what steps might ease the economic crisis. Failure to take seriously the near certain risk that the underlying US economy is weakening will delay recovery, perhaps for years. Nowhere is that more apparent than in the risk to state and local tax collections.
My colleagues and I just reported results from our analysis of state tax losses across the nation. We used three different scenarios of the economy. Our best scenario, which happens to be almost identical to the official Congressional Budget Office forecast, happens to be the fourth worst year since we started gathering data in 1929.
We estimated impacts to major tax instruments, such as income, corporate income, sales and gaming taxes. One problem we face is that this downturn impacts the more volatile tax instruments than did previous recessions. For example, in a normal downturn of this size, we’d expect Nevada’s gaming taxes to drop by maybe 15 percent. In reality, they are down by more than 75 percent for the year.
Most states end up taxing heavily those things that were most affected by COVID. So, our reliance on historical tax and economic data offers just about the most favorable outcomes. In reality, this year and next will almost surely be the worst two years in state tax collections in history. We estimate that the second half of 2020 will be far worse than the worst year of the Great Recession. Tax revenue losses will be in the 5.0 to 10 percent range across our three different scenarios.
One way to judge the effects is to see how long it takes stats to exhaust their Rainy Day Funds if they continued to spend money as they were in 2019. We use the most optimistic economic scenario to emphasize just how bad the situation really is. By our calculations, six states exhausted their Rainy Day Funds by June of this year and a total of 16 had done so by the end of September. By year’s end, 23 states will have fully exhausted their Rainy Day Funds.
By the end of 2021, we anticipate, that under the most favorable of our scenarios, only 10 states will have any Rainy Day funds remaining. Of those, five are states with heavy natural resource extraction, which normally has huge, sometimes 100 percent reserves.
I don’t think I can say it plainly enough. Nearly every American state faces tax revenue reductions that are so deep and so lasting that they imperil both a broad economic recovery and the continued functioning of state government. Indiana is better than most, making it into the top dozen states. Still, this is a year when we should have been talking about restoring K-12 funding back to 2010 levels. That is not the conversation the legislature will have this year.
Congress must pass a state and local tax supplement. It is not a bailout of fiscally irresponsible states. After all, California will end 2021 with the largest surviving Rainy Day Fund. Moreover, it is not at all clear which states are fiscally irresponsible. It is nice to have a large Rainy Day Fund, but if your K-12 students don’t have the tools to learn remotely you might be less fiscally responsible than you claim.
States have much less budget flexibility than they did in 2007. The expansion of Medicaid and cuts from 2007-2009 leave them very little room to make cuts without affecting public services. So, cuts, especially to education will be deep and likely result in long term economic damage. But, even if states could make personnel cuts to accommodate the looming revenue reductions, doing so will lengthen and deepen this already deep economic downturn. It is time for Congress to help reduce the duration and intensity of this downturn by passing legislation to replace tax revenues lost to COVID.
About the Author
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