Preliminary assessment of pandemic’s effect on state budgets; California anticipates drop in capital gains revenues.

Gov. Inslee’s new “stay home – stay healthy” order underscores the rapidly evolving policy responses to the coronavirus pandemic. Economists anticipate the order will accelerate the economic downturn. At the same time, experts agree that resolving the public health crisis is a necessary precondition to restoring economic health. 

In The Seattle Times, Paul Roberts reports,

Economists and business owners said Monday that Gov. Jay Inslee’s order for state residents to stay at home will land hard on a local economy already reeling from weeks of closures and declining business.

The order, which closes the physical locations of all nonessential businesses in the state, seemed largely supported by business leaders as a critical step in minimizing the economic fallout of the pandemic.

“We can’t allow certain nonessential activities to undercut our collective efforts to mitigate the spread” of the coronavirus, said Jon Scholes, CEO of the Downtown Seattle Association.

Similar actions have been taken in other states. A recession is virtually assured; the critical questions are how deep and how long. The toll on workers, business owners and others will be mirrored in the hit to public sector budgets. Funding for essential government services will be affected, possibly severely, and policymakers are already considering how to respond. 

In City Journal, Steve Malanga writes in a short piece we recommend reading in its entirety,

Even before any recession actually hits, states are tapping their reserves to pay for resources in the fight against Covid-19, meaning that they’ll have even less of a budget cushion should an economic downturn become severe. Washington State legislators, for instance, authorized drawing $200 million from their surplus fund for added health-care spending and to help pay for looming unemployment claims.

He highlights how tax structures will influence the revenue impacts.

Some states have designed their tax structures to collect a disproportionate share of revenue from upper-income residents. That makes their receipts volatile, especially during turbulent times, when so much of the income of high earners comes from capital gains, which have vanished suddenly. Income tax accounts for 70 percent of California’s general-fund revenue, and the state’s top 1 percent of earners pay almost half of all taxes. Among those earning $500,000 or more a year, capital gains account for 25 percent of their income. The state bases its current budget projections on the S&P 500 stock index trading around 3,120—but the index is currently at about 2,304, and instead of reporting fat gains, many of those tax filers may claim large capital losses, which will reduce their tax payments.

In addition to California, the states with the most financial-market sensitivity in their tax structures are New York, Connecticut, Massachusetts, and Oregon, according to a recent S&P Global Ratings report.

Progressive tax policies are notably volatile. The California Legislative Analyst’s Office has a preliminary analysis of the pandemic’s budget impact. With respect to capital gains:

Even in “normal” times, capital gains income is difficult to forecast because it correlates with stock market performance. The Governor’s budget projected tax revenues from capital gains income of about $30 billion across 2019‑20 and 2020‑21. This estimate assumed that the average price level for the S&P 500 stock index would remain relatively flat from late 2019 through the first half of 2020, with gradual price appreciation thereafter. Similar to our November Fiscal Outlook, the Governor’s budget acknowledged that a market correction represented a significant downside risk to the forecast. Although we do not know how the market will perform going forward, the recent price drops give us tangible information about one way in which COVID-19 could affect California’s budget…

…absent a more rapid recovery than has occurred in any modern market downturn of this severity, it appears likely that the average price level will wind up lower than the budget assumption. A preliminary analysis conducted by our office indicates a very high likelihood that tax revenues from capital gains income will be several billion dollars lower than what the Governor’s budget assumed.

The Washington state budget will, of course, be negatively impacted by the economic slowdown. Still, proponents of progressive income taxes and capital gains taxes may find reason to temper their enthusiasm as the crisis shows the fragility of tax structures that rely on tapping the gains of upper-income taxpayers.