The immediate effects of COVID-19 are clear. We see them on the news and social media every day, and it’s having an impact on almost everyone in the country. But there are effects we can’t necessarily see right away that could have a lasting impact on states and municipalities. One major issue that states are starting to grapple with, while balancing the need for safe policy to protect their citizens, is revenue.

The month of March in particular represented a sharp drop in revenue consumer spending down nearly 20% between February and April during the height of the economic shutdown and mandated quarantine. Those numbers improved in May with an 8% increase, but we remain well below the highs we saw at the start of the year.

In Texas, a 9% drop in state sales tax revenue equated to $320 million in just one month – the lowest since 2010, and Florida estimates peg the drop as high as $700 million over March and April. Some cities in California reported revenue drops as high as 16%, and smaller municipalities that rely on the busy spring months to buoy sales tax revenue for the year have seen drops as sharp as 30% year over year. And in almost all of these locations, COVID-19 cases are surging again, begging the question of whether we’ll see similar shutdowns in the future.

The bottom line is that states and cities that rely on sales tax as a significant percentage of their funding are being hit exceptionally hard by the decreased economic activity caused by the coronavirus pandemic. And while most local economies have at least partially reopened, a surge in cases in late June and early July has already led to the shuttering of restaurants, bars, and other businesses in the hardest-hit states.

What Revenue Shortages Mean in the Future

The majority of state revenue comes from income and sales taxes. In Florida, sales tax alone is 70% of general revenue, which directly funds local schools, healthcare facilities, and social services among many other endeavors. A sharp drop in revenue has a significant impact on how states are run and what services they can offer.

The Broward Schools Superintendent cited a likely 20-25% cut in the school district’s budget in the coming year. In Connecticut, a state that only saw a 7% drop in revenue from sales tax during The Great Recession, double-digit drops are expected. State and local governments throughout the country are struggling to identify how to close historic budget gaps as residents stay home, businesses are closed or operating at only partial capacity, and travel is almost non-existent.

Sales tax frequently goes into a general fund that is used for police and fire department funding, public schools, transportation and infrastructure, children’s health insurance, parks, and recreational facilities, medical facilities, and more. The loss of that much revenue and the requirement to balance the budget each fiscal year will force these governments to make some hard decisions.

How States Might Recoup Lost Revenue

Which brings us to the big question – how will states make enough money to minimize the damage to social services? Schools still need to run. Healthcare facilities are a must right now.

There are a number of concepts under consideration, some of which will have a direct impact on local businesses that are also struggling right now. Things to consider as the crisis stretches on include:

  • A Potential Increase in Sales Tax Audits – Resources may be funneled to audit accounts at a higher rate than in the past to capture lost revenue and identify potential issues in ways that may not have been considered a priority before. Especially for economic nexus situations, this could increase.
  • Stronger Enforcement of Economic Nexus – In the last three years almost every state has implemented some form of economic nexus law, but compliance and enforcement vary. Some are still in the process of implementation; others have smaller revenue departments incapable of following up with out-of-state entities. Others still have narrow definitions of economic nexus and the products and services subject to tax. All of this could change.
  • New Sales Taxes – Some states, like Maryland, have already started exploring new taxes on digital advertising – something that would generate $100 million in revenue. There are questions of whether Maryland’s bill would hold up in court as some say it violates the Permanent Internet Tax Freedom Act (PITFA), but they, along with New York and Nebraska are exploring it as an option. Other services long exempt from sales tax might soon come up for consideration as well to cover these massive gaps.

What All of This Means for Small Business Owners

We are months away from any kind of resolution to the current economic crisis. Even if states all stay open and operational as COVID-19 case numbers increase, many consumers are opting to stay in. Factors like school reopenings, restaurant, and public services restrictions, and eventually budget shortfalls could make this even more of an issue.

For your part, pay close attention to the impact of these revenue drops and the actions of your state and any states in which you operate to address it. We are in uncharted waters, and new initiatives will be on the table that would have never been considered before, likely with accelerated timelines. Through careful compliance and regular updates you can be ready for anything that comes your way.

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