The economic impacts of COVID-19 are already shaping up to be significant, yet uneven, across the country. Yes, workers and businesses are affected, but so too is the fiscal capacity of governments that rely on a healthy economy for their revenue. As the crisis unfolds, the impact on cities’ bottom line will be driven not only by overall economic conditions but specifically the parts of the economy where revenue is generated: retail sales, income and wages, and real estate.
To understand when cities can anticipate the brunt of COVID-19’s impact on their general fund revenues, Brookings examined how much a city relies on general tax sources that respond quickly to economic swings. An important factor is whether the city’s underlying regional economy is composed of industries that are more immediately exposed to coronavirus-related employment declines.
Cities in the U.S. generate the majority of their revenue by designing their own tax and fee structures within the limits imposed by their states (e.g., property tax limits, debt limits, constraints on access to some tax sources). As a consequence, cities’ tax structures vary across the country, with some relying heavily on property taxes and others primarily on sales taxes. Only a few cities—approximately one in 10—rely most on income or wage taxes.
After less than a month of shelter-at-home edicts, retail sales have plummeted and unemployment is skyrocketing. A city that generates the majority of its revenue from sales or income taxes will be hit hard and immediately. A city that relies on property taxes, however, will not experience such an immediate collapse in its revenues. Memphis sits in the middle of the Brookings rankings and will likely feel the effects of the downturn in several months.
In addition to taxes, approximately one-third of city-sourced revenues are derived from fees and charges for services such as trash collection and water. Although COVID-19 will adversely affect some fee-driven services, services like water, sewer, etc. will be impacted less severely, as residents remain in place and continue to use them.
LOCAL INDUSTRIES WILL PLAY A ROLE, TOO
To illustrate the impact of tax structures on city-revenue responses to COVID-19, we evaluated the share of regional employment in high-risk industries (mining/oil and gas, transportation, employment services, travel arrangements, and leisure and hospitality) and the share of general fund revenues from sales and income taxes across 139 cities. These cities are diverse in their geographies, economies, and revenue structures.
Cities with both a vulnerable economic composition (greater than 15% share of employment in high-risk industries) and a tax structure that is highly reliant on elastic sources of revenue (greater than 25% share of general fund revenues) will feel a dip in revenues more quickly than those with alternative economic and fiscal structures.
The immediately impacted cities—those reliant on sales and income taxes with a high share of vulnerable industries—are likely to feel fiscal declines within the next month or two. Others are more likely to feel COVID-19’s economic effects in the next few quarters to a year. Although higher reliance on property tax revenue is generally more favorable in the short term, a less-diversified structure will limit the resilience of city budgets in long term.
States should also allow their local governments to modify tax structures so they are in line with their underlying economic bases. Flexibility to collect a better mix of sales, income, and property taxes will offer cities the tools they need to respond in the short and long term as economic conditions and the needs of their residents change. This flexibility will be especially important in the months ahead, as state revenues and aid to cities begin to take a hit.