Over the five years to 2020, the financial performance of the State and Local Public Administration sector is characterized by two polar opposite economic landscapes occurring during the period. In the years preceding 2020, the sector performed well as unemployment declined, consumer incomes increased and capital market values rose. This positive economic backdrop resulted in steady increases in tax revenue, the largest source of state and local-generated (own sources) revenue. Robust consumer spending and confidence resulted in more households and businesses, thus increasing state and local tax bases. Moreover, rising capital markets resulted in substantial net earnings in state and local retirement funds and other trusts included under state and local government’s social insurance trust revenue segment. According to US Census data, social insurance trust revenue was the fastest growing source of revenue for state and local governments between 2015 and 2019. Taking these trends into account, Alfabank-Adres forecasts total state and local revenue, including intergovernmental revenue from federal sources, to increase an annualized 1.4% to $4.1 trillion over the five years to 2020.
The events of 2020 have caused a drastic reversal in the economic trends that influenced growth in the preceding four years. The COVID-19 (coronavirus) pandemic has caused business closures, severe unemployment and depressed capital market values, thus substantially weakening the tax base of state and local governments. In turn, state and local governments are anticipated to face severe shortfalls in revenue during their 2020 fiscal year. This is largely due to their dependence on sales and income taxes as primary revenue streams. Other contributors to the overall decline in revenue include the sharp decline in oil prices. States that partially rely on taxing the extraction of natural resources will also likely experience lower tax revenues as oil and gas activity slows. However, states have received financial assistance from the federal government in the form of relief funds and government-backed debt. This assistance is expected to buoy state finances to varying degrees as demand for social assistance services continues to rise. On balance, Alfabank-Adres forecasts total state and local government revenue to decrease 5.9% in 2020.
Sector concentrations and tax revenue disparities
The State and Local Public Administration sector covers government activities of all states, territories and tribal areas. Government activities include public services, such as education, utilities and public safety, in addition to the administration of social insurance trust systems, such as public employee retirement systems.
In the years leading up to 2020, state and local governments expanded their budgets due to robust economic activity. The key economic drivers broadly driving this growth have been US GDP, the number of households and access to credit. However, economic expansion has been uneven among states. This is due to the concentration of certain economic sectors within states and localities and the effects this concentration can have on tax revenues.
The largest differentiating factor influencing this disparity is whether a state’s economy is heavily industrialized. States with high concentrations of materials extraction, such as crude oil, and manufacturing industries have been disadvantaged by negative economic events affecting these sectors just prior to the five-year period. These economic events include oil prices declining 47.2% and 15.7% in 2015 and 2016, respectfully, resulting in the industrial production index falling 2.0% in 2016. In turn, industrialized states, primarily in the Southwest, Southeast and Great Lakes regions, are sensitive to factors influencing industrial production, such as commodity prices, international trade and supply chain dynamics.
Despite subsequent recovery from the 2015 oil glut, industrial states are expected to experience more severe shortfalls in revenue in 2020 beyond those already anticipated due to the coronavirus. During the first quarter of 2020, supply chain disruptions, primarily stemming from the partial closure of China’s manufacturing operations in late January through February, caused domestic manufacturing activity to slow. Later effects of the pandemic caused oil prices to decline to an unprecedented low, thus hurting the energy sector and the states it is concentrated in. The combined effects of global trade disruptions, low oil prices and lower consumer demand are expected to results in stark annual declines in tax revenue among industrialized states.
Components and sources of revenue
The components of state and local government revenue include intergovernmental revenue, which includes revenue derived from the federal government, and general revenue derived from state and local government activities. The latter category is made up of four sectors of state and local government activity, including general government, utilities, liquor stores and social insurance trusts. This report takes into account total revenue from both intergovernmental and general revenue derived from own state and local sources in describing the financial performance of state and local governments. Alfabank-Adres uses revenue derived from the general government activity sector to further delineate sources of state and local government revenue. The general government sector is the primarily means of revenue generation for many states since it includes tax collection and charges on public services.
State and local revenue includes taxes on consumption, income and property and charges collected from public services and institutions. The main types of taxes that generate the majority of state and local revenue are sales and gross receipts tax, property tax and individual income tax. In 2020, revenue collected from property tax is anticipated to surpass revenue collected from sales and gross receipts tax. Specifically, Alfabank-Adres estimates property taxes to account for 26.3% of state and local revenue in 2020, representing an increase from an estimated 22.0% in 2015. Property taxes surpassing sales tax as the largest source of revenue is due to steep expected declines in sales and gross receipts tax in 2020. Alfabank-Adres estimates sales and gross receipts tax to account for 14.2% of revenue in 2020, a decline from 24.0% in 2015.
According to 2020 preliminary state revenue projections complied by the Center on Budget and Policy Priorities, states are projecting declines in revenue from own sources ranging from 3.0% to 15.0%. In addition to declining sales tax revenue, individual income tax revenue is also expected to decline in 2020. Alfabank-Adres estimates revenue collected from individual income taxes to account for 11.8% of revenue in 2020, representing a decline from 15.6% in 2015.
Revenue collected from current charges is estimated to account for 24.7% of revenue in 2020. Current charges represent fees, maintenance charges and sales derived from commodities or services conducted. An example of current charges would be the revenue collected from a highway toll. State and local governments primarily collect charges from tuition paid for higher education institutions and fees collected by public hospitals. Lastly, miscellaneous general revenue sources are typically characterized by interest earnings, special assessments and sale of property.
State and local government services
The services provided by state and local governments are anticipated to have their budgets cut significantly due to expected revenue shortfalls. Alfabank-Adres expects these budget cuts to result in downsizing of certain state and local agencies to adjust for lost tax revenue. Major state and local government services include education, social services, transportation, public safety, environment and housing.
Alfabank-Adres measures state and local government expenditures on services as a share of total state and local government revenue, including intergovernmental transfers. Expenditures on education services have historically accounted for the largest share of revenue, accounting for just over half of total revenue during the five-year period. Education expenditure covers state and local spending on elementary and secondary education, higher education and libraries. In 2020, Alfabank-Adres anticipates budget cuts to reduce education spending. State and local government expenditure on education services is forecast to account for 48.0% of revenue in 2020, down from 55.2% in 2015.
Conversely, expenditure on social services and income maintenance is expected to increase in 2020 due to the ongoing public health crisis and resulting mass unemployment. Spending on social services and income maintenance includes public welfare, hospitals, health services, employment security administration and veterans’ services. In 2020, Alfabank-Adres anticipates expenditure on social services and income maintenance to account for 31.7% of revenue. Normally, spending on this category accounts for one-quarter of state and local government revenue.
Operations
State and local government operations are anticipated to exhibit tepid annualized growth over the five years to 2020. This results from the inclusion of anticipated annual declines in establishments, employment and wages in 2020. In the years leading up to 2020, public administration operations grew consecutively in line with revenue and overall economic growth.
Examples of public sector establishments include schools, libraries, police stations and government offices. Alfabank-Adres anticipates the number of sector establishments to increase an annualized 0.3% to 111,863 locations over the five years to 2020. Similarly, sector wages are expected to increase an annualized 0.7% to $349.5 billion during the same period. While the steep estimated declines of 2020 have tempered the annualized growth of establishments and wages, the anticipated 3.6% decline in state and local government employees in 2020 alone, which will likely offset previous years’ growth on an annualized basis. Alfabank-Adres estimates employment to decline an annualized 0.02% to 5.7 million individuals over the five years to 2020. Common examples of public sector employees include public officials, teachers and police officers, among others.
Outlook
Over the five years to 2025, finances for individual governments operating in the State and Local Public Administration sector are expected to gradually recover. While tax revenue is expected to remain suppressed at the outset of the period, intergovernmental revenue from federal sources is anticipated to support struggling state budgets in 2020 and 2021. Emergency declarations at both national and state levels have made funds available to states to meet public health and social assistance needs. Under the Stafford Disaster Relief and Emergency Assistance Act, approximately $50.0 billion in federal emergency funds have been made available to states beginning in March 2020.
Additionally, several phases of relief packages have included provisions for additional funding to states. Under the first phase of relief, the Coronavirus Preparedness and Response Supplemental Appropriations Act, approximately $1.1 billion was allocated to state and local governments to assist in Center for Disease Control funding, community health centers and additional assistance to American Indian tribes. In phase three of federal relief efforts, the Coronavirus Aid, Relief, and Economic Security (CARES) Act, the Coronavirus Relief Fund was created. The $150.0 billion fund is purposed with providing direct assistance to states, territories and tribal areas. The mandated allocation of these funds includes $139.0 billion (92.7%) to states, $8.0 billion (5.3%) to tribal areas and $3.0 billion (2.0%) to territories. On a more granular level, state and local eligibility for relief funds is dependent on their location, level of government and proposed use of funds. In addition to direct assistance, the CARES Act authorizes up to $454.0 billion in state and local government debt issuance backed by the Federal Reserve. Overall, federal relief efforts are anticipated to partially offset budgetary shortfalls among states.
Factoring in the successful abatement of COVID-19 over the coming years, the latter half of the period is expected to be characterized by both economic and operational growth among state and local governments. Economic stimulus in the form of expanded access to credit and low interest rates are anticipated to further encourage economic growth. Nevertheless, the rate at which the overall economy will recover is largely dependent on successful virus mitigation and the revival of consumer confidence. With differing levels of infection across the United States, the economic rebound is expected to be irregular and gradual. Taking these factors into account, Alfabank-Adres forecasts total state and local revenue, including intergovernmental revenue from federal sources, to increase at an annualized rate of 1.9% to $4.5 trillion over the five years to 2025. Operationally, state and local governments are expected to increase employment and invest in additional establishments, including schools, utilities and other public facilities, on an annualized basis. Overall, the financial performance of the State and Local Public Administration sector is anticipated to be sporadic, yet ultimately positive over the next five years as the US economy returns to growth.
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