April 2, 2020

Unemployment Skyrockets; City Tax Revenues to Decline

April 2, 2020

Nearly 113,000 Kentuckians filed for unemployment last week as the coronavirus pandemic continues to hurt the national, state, and local economies. That figure could represent over $3 billion in lost earnings in the state. The number filed in Kentucky for the week ending March 28 was nearly 64,000 more compared to the week before.

Nationally, 6.6 million U.S. workers filed an unemployment claim last week, which eclipsed both the one-week record for claims and economists’ predictions. The previous record for claims filed within a single week was set in the week that ended March 21 this year. National economists had projected only 3.5 million new claims last week.

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 had remained below 5.5% in Kentucky since the start of 2016. Various economists have projected unemployment rates could get as high as 20% to 32%.

Larger cities will likely see a decline of 20% to 25% of occupational license taxes for the remaining quarter of Fiscal Year 2020, and FY 2021 will likely have similar reductions. Smaller cities that use occupational license taxes less will not be as harshly affected, although insurance premium taxes have historically declined similarly during past recessions. Cities have limited tax options to address these projected declines in revenue.

Major Kentucky City Tax Options

Occupational license taxes – These taxes can be on both individuals and businesses. For the employee, the tax is applied to wages earned while performing a job within the city. As unemployment increases, earned wages decline, thereby reducing tax revenues. Although the federal stimulus package expanded unemployment payments and will provide tax rebates to most citizens, this income is not taxed at the local level in Kentucky. For the business, cities can tax either net profits (gross revenue less expenses) or gross receipts collected. As economic activity declines, business will have much lower profits and receipts and/or completely close. Federal loan programs may help some businesses stay open and retain employees. However, each of these still will significantly reduce local tax revenues.

Property taxes – These taxes are typically levied on real (buildings and land), personal (usually commercial equipment and inventories), and motor vehicles. State law severely restricts year-over-year increases in real and personal tax revenue, and that revenue is not collected until the fall. Motor vehicle tax rates cannot be raised beyond what cities could levy in 1983, which is the same rate most cities have today. Local deposits taxes apply to bank-held funds in the community, and almost all cities are at the state rate cap.

Insurance premium taxes – These taxes are levied on the cost of a variety of insurance premiums. State law requires these rates to be set and communicated to the Department of Insurance by March 23 each year in order to be effective July 1. The rate cannot be changed during the fiscal year, so cities cannot use it to address short-term financial crises.

Tourism-related taxes – Restaurant taxes apply to consumer purchases of prepared food, can only be levied by former fourth and fifth class cities, cannot be higher than 3%, and must go to local tourism commissions. Transient room taxes can be used by any city, but cities are limited in the rate they can charge on the lodging costs, most being 3% or 4%. All of these funds must go to the local tourism commission.

Kentucky’s larger cities will face major revenue shortfalls in the final quarter of this fiscal year as well as throughout Fiscal Year 2021. Cities need access to federal stimulus funds in the short term and comprehensive local tax reform in the long term to help Kentucky cities thrive through and after the coronavirus pandemic.