Over a year into the pandemic, Covid-19 continues to impact all facets of life. From a business perspective, we most often talk about remote work and “the new normal.” And rightly so. After more than 12 months of working from home, people want to know what the future looks like. But today, we’re talking about the impact of Covid-19 on taxes. Specifically, the tax revenues of states and local governments. Let’s dive into how individual Covid-19 factors (employment, spending, living situations) affect state and local income taxes.
How Has Covid Affected State And Local Income Tax Revenues?
How does state and local tax revenue materialize? It’s through taxes that you pay daily. These revenue streams are near-invisible since these taxes are usually an afterthought on your paycheck or receipts. Essentially, the state you live in collects tax revenue from you in two major ways.
Number one, through your income. Each paycheck you receive will have some money withheld that goes to the state. You’ll also usually make some final income tax payments when filing a yearly return.
Number two, through sales tax. You pay a little bit of tax to the state from every purchase made, from household staples to plane tickets. The impact of Covid-19 on these passive revenue streams is clear when you consider the current reality of life. Many people have lost their livelihoods (lost income tax) and discretionary spending is way down from normal levels (lost sales tax). That said, states are hanging tough and doing their best to push through as the economy picks up. Let’s look at some specific headwinds and tailwinds.
- Slow recovery for travel and leisure – Even as vaccinations pick up, it will be quite some time before people are spending like they used to. This means less sales tax for states.
- Jobless claims persisting – The job market is improving, but it’s not back to pre-Covid levels. Fewer workers means fewer paychecks to collect income tax against.
- Tax filing deadlines pushed out – When the pandemic broke out, most states pushed filing deadlines out from the usual April 15th. This meant delays on collecting final income tax lump sum payments. Most states have taken similar measures this year.
- Low-wage employment losses – This is generally a negative consequence of the pandemic as it relates to equity and distribution of wealth. But for state tax revenue, the fact that job losses have been concentrated on low-wage workers is actually better. Smaller paychecks missing means smaller income tax revenue lost on a relative basis.
- Stock market resilience – The stock market has remarkably maintained strength throughout most of the pandemic. This sustains taxes on capital gains, another form of state income tax, and is a major reason California achieved a budget surplus in 2020.
- Unemployment benefits and payments to businesses – We’ll touch on this more below, but the federal government has passed legislation to help stabilize taxable income.
States Will Need To Compete For Tax Revenues
So far we’ve talked about tax revenue from an “all of the states” perspective, but what about moving from state to state? As states take a closer look at their tax structures, taxpayers are examining the best states to live in. And not just individuals – businesses too.
For example, it has been well documented that businesses are leaving California for places like Texas due to the lower tax structure. For many, the best states to live in are now the ones with lower state income, property, and sales taxes. Moving from state to state used to be associated with seniors and retirees. As long as the perks of expensive cities (bars, restaurants, flashy high-rise offices) remain closed, those cities will lose their appeal to younger populations. Covid has leveled the playing field, and states must now compete for tax revenue.
What Has The Federal Government Done In Response, So Far?
By the end of 2020, states and localities across the US received over $200 billion in federal government aid. Compared to other recent downturns, the government response to Covid has been speedy. The pandemic officially broke out in March of 2020, and that same month the CARES Act was signed into law. The bill provided billions of aid to state agencies including public transit, K-12 education, healthcare providers, and community centers. These are all institutions that usually depend on tax revenues.
The CARES act bought enough time for the Biden administration to pass The American Rescue Plan. You can read more about that $1.9 trillion relief package here. The government response to Covid has been encouraging, but we are not out of the woods just yet, as aggressive fiscal policy has contributed to the record inflation we are now seeing.
The impact of Covid-19 on tax revenues has been widespread. As it turns out, taxes are everywhere, and nothing in life is free! As the pandemic drives income, spending, and corporate property occupancy down – so too go state tax revenues. This has led to increased competition between states for taxpayer dollars. The government response has been solid, but tax effects will linger until we figure out what the “new normal” is. As an individual, take this time to be mindful about how Covid-19 is affecting the taxes in your life.
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