Budgeting in the Time of Coronavirus: Uncertainty and Surprises

October 09, 2020

The State of Illinois’ FY2020 fourth quarter revenue report contained a surprising result for two of the State of Illinois’ three main revenue sources, which came in higher than had been projected during the spring. Specifically, net sales tax revenue collections were $252 million higher than revised projections and net personal income tax projections were $372 million higher.[1] Given the ongoing economic dislocations related to the pandemic and restrictions on economic activity, this was a surprising result and illustrates how difficult projections are for government budgeteers during this very unusual pandemic recession.

A recent Brookings Paper that examines the fiscal impact COVID-19 has had on the federal, state and local governments discusses the differences between this recession and previous recessions and the many uncertainties involved in making budgetary projections during the COVID pandemic. This blog will look at those differences through the lens of how the State of Illinois’ sales tax projections changed from when the FY2020 budget was enacted through the final FY2020 results.

The Brookings Paper reviewed a number of different projections of state and local revenue losses from the pandemic made by different researchers. It noted that the very different nature of the COVID recession means that a common methodology for projecting recessionary impact that relies on historical relationships between changes in economic conditions and state and local tax revenues could be less dependable. The authors listed some of those differences:

1. Unemployment during the pandemic recession is concentrated among low-wage workers, particularly those in service jobs, even more than during a typical recession. “Data on employment rates by income group from Opportunity Insights suggest that the recession is basically over for high-wage workers, but still very severe for low-wage workers.” They suggest “the unemployment rate may be less consequential for state and local revenues than in the past.”
2. Most recessions are accompanied by stock market declines. However, while the market fell sharply in March, it recovered to be up by about 3% on the year, “suggesting that capital gains tax revenues won’t be significantly depressed relative to a typical year.” This means taxable business income may not be as low as would be expected in a more typical recession.
3. The federal response to the coronavirus recession through the CARES Act has been significant in a way that impacts state and local revenues. The Brookings authors think that the government’s fiscal support of businesses through the payment protection program (PPP) as well as greatly expanded and taxable unemployment benefits could result in more income tax revenue to governments than would usually be expected in a typical recession.
4. Consumption patterns are very different in this recession than in previous recessions. The researchers note that the drop in consumption is far larger than observed in previous recessions, but the composition of consumption is very different. In a typical recession, consumption of services is less impacted than consumption of goods. However, during the pandemic recession, consumption of goods “has shown much resilience” while service consumption has declined sharply because of coronavirus restrictions that closed or limited the hours of many businesses and because consumers fear contracting the virus from in-person interactions. Given that most services are untaxed in the United States, the authors conclude that the decline in sales tax collections maybe less than originally feared.

The authors note a number of additional difficulties specific to making sales tax projections during the pandemic recession. Again, the patterns of consumption and how different states tax different items will make a difference. One of the largest increases in sales during the pandemic has been groceries, but several states—including Illinois—tax groceries at a lower rate than other goods, reducing the revenue impact. Some other declines may have been temporary, such as car sales. Vehicle sales plummeted in March and April but have since recovered. This is likely because some purchases may only have been postponed rather than foregone entirely. So if projections were based on the continuation of trends from the spring, they may be too unfavorable. Declines in certain kinds of consumption may have been related to social distancing instead of drops in demand due to lower incomes, such as for restaurants and driving, which means that they could recover more quickly when social distancing eases. On the other hand, the end of expanded unemployment insurance could mean a drop in consumption through the end of calendar year 2020.[2]

The original projections made by the Governor in February 2019 for sales taxes in his FY2020 proposed budget were based on the economic conditions in early 2019. The State of Illinois’ fiscal year runs from July to June. The Governor’s original proposed budget included an increase in sales tax revenue of 3.7% over FY2019, to $8.5 billion, due to economic conditions and benefit from the U.S. Supreme Court decision in Wayfair v. South Dakota, which allows states to impose sales tax on out of state online sellers. The enacted FY2020 budget included almost the same projection for sales tax revenue as the Governor’s proposed budget, a 0.1% increase. By the time the Governor proposed his FY2021 budget in February 2020, the projection of FY2020 sales tax revenues had risen to $8.7 billion due to a more favorable economic outlook as of February 2020 than had been forecast during the previous year.

However, the growing economic impact of the coronavirus pandemic significantly changed the revenue outlook starting in March 2020 and the Governor’s Office of Management and Budget (GOMB) issued an updated projection for FY2020 and FY2021 revenues on April 15, 2020. Sales taxes in FY2020 were projected to decrease by $743 million, or 8.4%, to $8.0 billion from the February 2020 estimate based on business closures, social distancing and event cancellations, as well as reduced consumer spending due to lost income and lower valued investment portfolios. The updated projection stated, “[e]arly data on retail activity are consistent with a steep decline in taxable spending in the final quarter of fiscal year 2020.” As noted above, in the fourth quarter FY2020 financial review released by GOMB, the actual net sales tax revenues for FY2020 of $8.25 billion came in $252 million or 3.1% higher than the April 2020 forecast. This means that the actual FY2020 results were still $485 million or 5.5% less than the February 2020 forecast.

It is likely that a number of the issues cited above by the Brookings study contributed to the higher than anticipated revenue results compared to the projections made in the midst of the Governor’s shutdown order in April 2020. GOMB highlighted a few in its fourth quarter report, including income stability from federal assistance and the ability of nonessential businesses to transition to work from home.

“Income and price stability have…helped to support continued consumer spending on durable goods, which typically decline during a recession. Low interest rates and modest household savings, coupled with the growth of online shopping and global distribution networks, may have helped to keep the flow of goods steady during the quarter but a prolonged and lackluster recovery could eventually lead to more frugal consumer behavior.”

In the fourth quarter FY2020 report, GOMB increased its projections for sales tax revenues during FY2021 by $393 million or 5.3% while keeping individual income tax projections flat and reducing the projection for the corporate income tax by $83 million or 3.9%. Sales tax revenues are now projected to be $409 million or 5.0% lower in FY2021 than in FY2020. It remains to be seen whether the unusual properties of the coronavirus recession continue to buoy sales tax revenues compared to prior recessions or whether they end up succumbing to significant downside risks. These risks include a resurgence of COVID-19 cases that may force a return to more stringent business restrictions and the federal government failing to come up with additional stimulus to assist businesses, unemployed people and state and local governments.