Facing the COVID-19 aftermath: Impact on municipal revenues

Cities and counties have been responding to the pandemic and keeping the rest of us safe during these challenging times. How has your government changed as a result of the COVID-19 pandemic? How will it need to change in the near future? If you haven’t yet, now is the time to start thinking about what your municipality will look like in a post-COVID-19 world.

Three phases of adaptation

Local governments are adapting in three stages:

• React: This is the phase we’ve been in for the past month — crisis management. You’ve been focused on immediate concerns: keeping your residents safe while continuing to provide municipal services to the extent possible.
• Adapt: As you move through the crisis management phase, your focus will shift to the upcoming year as you address budgetary and operational challenges. Many governments are finalizing their new budgets in May and June without a clear understanding of the full impact on primary sources of revenue. You may have to start the new fiscal year with a budget that lacks clarity on key revenue assumptions and the necessary expenditure reductions to compensate. More than ever, you’ll need to be prepared to make adjustments on the fly. In many situations, these decisions will be painful to the municipality and the community it serves.
• New normal: As a result of the pandemic, your municipality, the provided services, and the ways in which those services are delivered will look very different from what they do today.

Understanding the revenue picture will — across the board — be one of the greatest challenges in the upcoming year.

Local governments will move through these three phases at their own pace, but understanding the revenue picture will — across the board — be one of the greatest challenges in the upcoming year. Most municipalities get their revenues from a combination of sources: property taxes, income taxes, various state and federal sources, fees for service, etc.; and each of these revenue sources will be impacted differently. Your municipality will need to adapt accordingly. Here’s a breakdown of revenue types and the related risks we see:

• Sales tax: This includes other consumption taxes like hotel/motel tax, fuel tax, gambling tax, and others. People are spending less, and your share of these receipts will be less as well. The reductions will be felt immediately. Many projections predict a recovery later in 2020, but others predict a longer recovery timeline. Either way, the overall impact will be felt through 2021 and perhaps beyond.
• Income tax and business tax: Like sales tax, the impact from these will be felt soon and substantially. Federal action through the CARES Act and the Families First Coronavirus Response Act can help alleviate some of the income loss. Also, as with the sales tax, many economists predict that loss of income will continue through 2021. In some states, income taxes are the source of revenues shared with local government. Distributions to local governments in these states will be negatively impacted (see below).
• Licenses and permits: These are directly tied to a service and should be easier to track than other revenues. If residents and businesses are pulling fewer permits, then fewer inspections are required, and revenue will be adversely impacted.
• State sources: These vary considerably from state to state. In most states, revenue distributed from the state to local units of government is derived from a particular source, such as sales tax or income tax. If the state is vulnerable to reductions in that revenue source, then the distribution to municipalities may be similarly in jeopardy. As an example, revenue tied to a gasoline tax that’s transferred to local units for road repair will be significantly impacted until travel increases again.
• Property tax: Given the timing and duration of the property tax cycle, there won’t be an immediate impact on property tax revenues like there will be with revenues derived from sales or income taxes. And we can’t yet predict the effects of COVID-19 pandemic on the housing market, home values, or taxable values, and therefore on the resulting property tax revenue. A quick economic recovery could have a negligible impact on property tax revenue; a sustained recession or prolonged recovery could affect property taxes in the future. Constituents are already missing lease and rent payments, which makes timely property tax payments less certain. And, one thing that isolation has taught us is that office space and shopping centers are less necessary than we previously thought, so demand for commercial real estate may fall.
• User fees: These include waste removal, utilities, and other fee-based services. To some degree, these are the least at risk. Social distancing may even yield a surplus as people stay at home and increase household water or electrical consumption, but these revenues are often tied to property tax payments and could be similarly affected.

How to prepare

Leadership matters the most right now. You’ll need to guide your organization through a post-COVID-19 transition so it can continue to serve your community, minimize the negative economic impacts, and maximize economic recovery.

Japanese philosopher Miyamoto Musashi once said, “In strategy, it is important to see distant things as if they were close and to take a distanced view of close things.”

It’s difficult to see past the current crisis, but leaders need to think about tomorrow while managing through today.

It’s difficult to see past the current crisis, but leaders need to think about tomorrow while managing through today.  Think hard about your services a year or two down the road. What you can do — or not do —  will be dictated largely by your revenue picture. Consider the following steps:

1. Assess your revenue streams. What revenues are at risk in the short term? Which are long-term risks? You need to understand what’s temporary and what’s likely to be permanent.
2. Develop estimates. You may have good data related to some revenue streams but a lot more uncertainty about others. Establish ranges and multiple possible scenarios. A program evaluation and review technique (PERT) analysis can help you develop your ranges. Google it — it’ll help you capture uncertainty. There are more advanced tools, but this should help set you on the right path.
3. Vet your estimates. Share them internally and also seek external validation. What does your homebuilder’s association forecast? What are your statewide municipal organizations anticipating? Have national think-tanks addressed these revenue sources in their publications? Community economics will have a large impact on your estimates. How is your state incorporating tax changes into its budget? What federal relief programs are available, and do you have access to them? Collaborate with your colleagues in the region to understand their revenue estimates. Is their analysis convincing? Be sure to document your sources — policymakers may question their validity.
4. Incorporate estimates into your current budget and your five-year projections. If your organization hasn’t prepared a five-year projection previously, now is a good time to start. For each year, your estimates should include a best-case estimate, a worst-case estimate, and a likely estimate. You need to understand what must be addressed immediately as well as what needs to be addressed structurally. Each will require you to use different tools.

If your organization hasn’t prepared a five-year projection previously, now is a good time to start.

To be successful in the coming year, you’ll need to stay in front of your revenues and articulate the rationale behind your projections. Once your policymakers understand the scope of the problem, it’ll be easier to gain consensus on the difficult decisions that follow.