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State tax collections increased $50.2 billion (19.6%) in the
third quarter of 2020, compared to a year prior. Nearly the entire
third quarter increase (99%) came from income tax revenue alone,
which surged 47.8% year-over-year (y/y). However, these third
quarter income tax receipts were inflated by the widespread
postponement of income tax filing deadlines from April to July due
to the COVID-19 pandemic, thus boosting third quarter collections
with revenue that would normally have been received in the second
quarter of the year. Income tax revenues from April to September
were down 6.6% y/y, which gives a better view of its actual
performance. Sales tax revenue rebounded solidly in third quarter,
too, posting slight y/y growth of 0.6% following a decline of more
than 16% in the second quarter compared to year earlier levels.
Severance taxes, on the other hand, remain well below 2019 levels
(down 44.5% y/y), as energy markets remain subdued following the
collapse that occurred in the second quarter.
Given the data distortions caused by the later than normal
income tax filings, it is more insightful to look at the second and
third quarters combined to get a truer trend in regional tax
collections. During the period from April to September, state tax
collections fell 7.8% y/y in 2020, with declines occurring across
all major revenue sources. Severance tax revenue saw the largest
decrease (down 51% y/y) as energy markets remained depressed
throughout the spring and summer, while income tax collections fell
6.6% below year earlier levels despite the significant rebound that
occurred during the third quarter. Even with a healthy uptick in
consumer spending in the third quarter fueled by federal stimulus
payments and the initial reopening of state economies, gross sales
tax collections from April to September fell more than 8% compared
to the same period in 2019.
Overall declines were particularly steep in the Pacific region,
including y/y losses in Hawaii, Alaska, and Washington of nearly
30%, and in New England, where Connecticut and Massachusetts saw
36.9% and 19.4% y/y declines, respectively. Southern states, on the
other hand, fared better than their coastal counterparts. In
addition to Arkansas and Alabama seeing positive y/y growth during
the first six months of the pandemic, Georgia, North Carolina, and
Tennessee all experienced declines of 2% y/y or better.
Outside of regional patterns, states with comparable tax
structures also experienced similar changes in total revenue over
the first six months following the onset of the COVID-19
pandemic.
While all major revenue sources declined in the second quarter
due to the initial impacts of the pandemic-induced downturn,
severance tax revenue was the only one that did not see a sizeable
quarter-over-quarter rebound in the third quarter, with revenues
remaining essentially flat.
Following severance taxes, gross sales tax collections saw the
next steepest decline across the second and third quarters compared
to 2019. In turn, those states most dependent on sales tax
collections largely saw steeper-than-average declines in total
revenue over the six months from April to September. Excluding
energy-reliant states, the ten states most reliant on sales tax
revenue averaged a 10% y/y decline in total revenue over the second
and third quarters of 2020 compared to an average decline of 5% in
the ten states least dependent on sales tax revenue. This
difference in outcome is even more striking when considering
consumer activity was stronger, on average, in the most sales
tax-reliant states over the first six months of the pandemic.
Of the most significant sources of tax revenue, income taxes
proved most resilient during the first six months of the pandemic,
as a significant amount of income tax revenue in the first half of
the year is derived from liabilities from the previous year. In
addition, the enhanced unemployment benefits included in the CARES
Act were considered taxable income, further buoying income tax
collections over the spring and summer. States without a personal
income tax, however, were unable to reap the benefits of these
circumstances and saw overall revenue suffer as a result. Outcomes
differed within the group of income tax-collecting states, as well.
Indeed, of the forty-one states that collect an income tax, the ten
states with the highest average wage saw an average y/y decline in
revenue of 10.1% compared to a 1.2% average contraction in the ten
states with the lowest average wage level.
Federal spending
In addition to enhanced benefits paid out to individuals, the
CARES Act passed in the spring of 2020 also provided more than $200
billion in aid to state governments. When comparing the amount of
federal spending received by states to changes in tax revenue
during the period from April to July, the states that saw the
steepest revenue declines generally saw more substantial levels of
aid on a per capita basis. The revenue declines in North Dakota,
Alaska, and Hawaii, for example, rank among the five deepest
contractions, and they also ranked in the top quintile of federal
aid received on a per capita basis. On the other hand, states such
as Arkansas, Alabama, and North Carolina, whose revenue collections
proved relatively resilient over the spring and summer, saw federal
inflow levels among the lowest in the country.
The Coronavirus Relief Fund established by the CARES Act
provided a minimum of $1.25 billion to every state regardless of
changes in tax revenue, which caused multiple states with smaller
populations to serve as outliers to this trend. Due to the
combination of this funding floor and their small populations,
states such as Delaware, Montana, and Vermont saw substantial
inflows on a per capita basis despite tax revenues faring
relatively well. Cases such as these might lead one to think
federal aid per capita is more heavily influenced by population
rather than revenue changes. When pairing states by population
sizes, however, the state that saw a deeper y/y decline in tax
collections from April to September saw a greater amount of federal
aid per capita 68% of the time, showing that a relationship between
revenue and federal aid still holds. These data do not yet include
funding related to the COVID relief bill passed on December 27th,
but we will include during a future commentary as the state
distribution are tabulated.
Outlook
With economic activity still well below year-prior levels, state
tax revenues are expected to remain below pre-pandemic levels in
the near term. While income tax revenue proved relatively resilient
over the second and third quarters of 2020 owing to the fact that a
significant amount of collections are derived from prior year
liabilities, significant employment contractions across the country
due to COVID-19 indicate collections likely face an uphill battle
in 2021 to return to pre-pandemic trends. While the mining industry
continues its recovery, production is not expected to return to
pre-pandemic levels in the near term, likely keeping severance tax
revenues subdued for some time as well. We expect to see that the
second round of federal stimulus payments passed in December 2020
increased consumer spending in early 2021, likely benefitting sales
tax collections over the same period. That being said, consumption
levels will cool over the first half of this year as the stimulus
fades, followed by pent-up demand for consumer services leading to
a strong increase in spending over the second half of 2021,
assuming widespread vaccine distribution by the summer. The
prospect of additional federal stimulus currently being discussed
in Congress, however, could provide further upside potential for
state revenues in the near term.
Posted 12 February 2021 by Fran Hagarty, Economist, US Regional, IHS Markit