Reduce Tax Revenue Expectations for FY 2021

Kentucky cities could lose as much as $1 billion in tax revenues in Fiscal Year 2021, based on worst-case scenarios presented by U.S. Treasury Secretary Robert Mnuchin. Although such a result is not likely, the coronavirus may have a lasting impact on city tax revenues, and cities need to adjust their budget expectations for next year.

The U.S. economy has not had a recession since the Great Recession of 2007-2009. Kentucky city tax revenues generally are not impacted for several months after the start of a national recession. That is largely because unemployment is a lagging indicator, meaning the economy may be in a recession well before most employees get laid off. As a result, city tax revenues typically are impacted around 18-24 months after the official start of a recession. [A recession is defined as two consecutive quarters with negative growth of gross domestic product (GDP), and it is designated after the fact.]

Fifty-nine percent (59%) of city tax revenues come from occupational license taxes, which are levied on payroll and/or business net profits or gross receipts. Of that, 50% of total city tax revenues come from the payroll tax, which is a tax on employee earnings within a city. For cities with a population of 20,000 or greater, occupational license taxes account for 64% of tax revenues. Occupational license taxes are strongly correlated with unemployment, which has remained below 5.5% in Kentucky since the start of 2016.

The coronavirus has already substantially impacted tourism, food services and entertainment industries, which will result in lower transient room and restaurant tax collections. More businesses will be required to cease operation to prevent community spread of the illness, and other businesses will likely fail due to significantly reduced consumer spending. Many job losses are expected, and net profits and gross receipts will decline. Cities reliant on these tax bases will face negative impacts much more quickly than a typical recession.

U.S. Treasury Secretary Robert Mnuchin warned members of Congress that the unemployment rate could skyrocket to 20% as a result of coronavirus impacts, and he argued for a $1 trillion economic stimulus. If the unemployment rate increases to Great Depression levels (as high as 24.9%), Kentucky cities could lose as much as $1 billion in tax revenues. That represents a decline of around 45% of tax revenues currently collected. Federal intervention may prevent this worst-case scenario; however, returning to Great Recession levels would reduce city tax revenues by around 25%. Many economists are projecting an even worse economy, so city officials should prepare for a significant reduction in tax revenues soon.