What You Should Expect for State Taxes and Revenue in 2021

This post is adapted from a podcast Morgan Scarboro recorded with CEDIA on how the COVID-19 economy and potential tax changes will affect businesses. Listen to her remarks here.

There is good news and bad news for states when it comes to revenue forecasts and COVID-19. First, the bad news: nearly every state is facing a decline in expected revenue. There is some good news, however: revenue declines are not as severe as experts originally predicted. These declines will likely invoke some sort of revenue response from states, including increased taxes, decreased spending, or, most likely, a combination of both.

Revenue Status of States — Bad, But Not As Bad As Predicted

In April and May, the revenue estimates from states were bleak. Experts predicted drops in revenue of up to 50 percent, a number that seems impossible for legislators to work around. However, since states have collected more data, it’s clear that the revenue impact is not as severe as originally estimated. One factor that played a major role in revenue estimating was the delay in the income tax filing deadline. Earlier this year, the federal government delayed the income tax filing and payment deadline because it was unclear if Americans would be able to file and pay on time given the financial and social distancing impacts of COVID-19. Because state income tax filings rely, to some extent, on federal returns, states followed suit and also delayed their income tax filing and payment deadlines. This caused states to miss out on a large bulk of their revenue that they would generally collect in April and May. However, most of that revenue was eventually recouped a few months later when the delayed deadline rolled around, but it was too late to be included in Fiscal Year 19 (FY 19). This made FY 19 estimates appear particularly dire. 

According to a recent report by the National Association of State Budget Officers (NASBO), after adjusting for the income tax timing changes, FY 20 only declined by 1.6 percent compared to FY 19. When comparing FY 20 to pre-COVID estimates, revenue was only down by six percent. Though a revenue decline is never ideal for legislators, a single digit decline is significantly easier to navigate than earlier predictions. 

What’s Next? 

The bigger challenge for states will likely come in the current fiscal year (FY 21). NASBO is predicting that this recession will be worse than the Great Recession. There are a few reasons for this delayed impact on states: first, the COVID-19 pandemic only affected the last few months of FY 20. It will likely impact all of this fiscal year to some extent. Additionally, states were experiencing increased revenue and strong economies prior to COVID-19, so they had strong receipts for many months prior to the pandemic’s outbreak. For this fiscal year, however, states are going into the year with weak revenues.

There are a number of big questions lingering for states as they head into the next budgeting cycle: will there be a new wave of COVID-19 cases and additional shutdowns needed? Will there be more federal stimulus funds? Will consumer spending pick back up? Legislators will likely be forced to make budget and spending decisions in the new year without answers to all of these questions. 

What Does This Mean for 2021 Tax Policy?

A number of groups and legislators are already discussing new tax proposals to include in upcoming budget conversations. Some are bracing for novel tax proposals. The conversation about taxes on digital goods have continued since the proposals largely failed in sessions this year. There are new conversations about economic nexus as more employees are forced to telework. Sales tax base expansion will likely come up in some states. Those are all things for taxpayers to consider, but don’t forget to keep an eye on the “normal” revenue raisers. States will want revenue quickly and may not want to risk implementing a new tax type that would face litigation and delay revenue collection, so they will likely turn to raising the tax rate on existing taxes to make up for some of those revenue gaps. 

Policy predictions are, however, contingent on state-level elections, where nearly 80 percent of state legislative seats are up for election and the balance of power may shift in some states. Be sure to follow MultiState’s election coverage to get the most up-to-date information about the November elections.