Why COVID-19 is Devastating for Sales Tax-Dependent Cities

We’ve written already about how the economic effects of the coronavirus pandemic are likely to wreak fiscal havoc on thousands of local governments, from the biggest cities to the smallest towns. A lot of factors affect which places will be worst hit, including their existing revenue structures, reserve funds, and what outstanding debt and liabilities they had before the downturn began (including pension obligations and infrastructure maintenance needs, the latter of which are rarely accounted for as on-paper debt).

Another factor, though, that may prove to be important is whether a city has a diverse set of revenue sources, or is cripplingly dependent on just one or two. Especially if that dependency happens to be on retail sales taxes.

Every type of tax has its pros and cons on multiple fronts (such as revenue stability, political feasibility, fairness or equity, and ease or difficulty of administration). The main upside of sales tax is political: you can collect taxes in many tiny increments at a time, which is a lot less visible and less likely to provoke ire than, say, a large annual property tax payment. You can also collect taxes from people who live outside your borders and won’t vote you out of office. (As the late Senator Russell Long is purported to have said, “Don’t tax you, don’t tax me: tax the fellow behind the tree.”) But the main downside is that sales tax revenue tends to be far more volatile in economic swings than property or income tax.

And “volatile” doesn’t even cover the current situation. Cities that are dependent on sales tax will find themselves in a particularly precarious spot at this moment in history, because retail sales have taken a monumental plunge. Here’s the national data, courtesy of our friends at Urban3:

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The sharp drop-off in April 2020 is so pronounced compared to anything in historical memory that it looks like a glitch in the data. Adjusted for inflation, the conclusion looks even starker: under the wave of stay-at-home orders and business closures in March and April, retail sales nationwide dropped to their lowest level since before the 9/11 attacks.

There was a significant rebound in May, as many states “reopened” their economies to some extent. But that rebound may be threatened, as much of the U.S. that did not experience the horrific wave of cases that New York and a few other cities experienced early on are now (as of this writing) seeing record-busting COVID-19 spikes. Here’s a graph of monthly sales showing the May rebound. June’s data is not out yet:

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The lesson for municipal finance here? Don’t put all your eggs in one basket. (And that’s mostly a lesson for state governments, which often rigidly restrict how their cities are or are not permitted to raise money.)

And in particular, for a Strong Towns advocate, it reinforces the importance of building truly productive places that generate lasting local wealth. Whenever we make this point—and especially when we use property value per acre as a measure of productivity—we meet a persistent critique: “What about sales taxes?” The reality is that sales tax is no panacea. If the claim is that you can build a place that prospers not by making valuable use of its own land, but by devoting a lot of land to retail and selling stuff to people who don’t live in town (i.e. the “just score a Costco or a Walmart and win the big-box arms race” model of growth)…well, the current pandemic illuminates the fragility of that strategy.

Cover image via Kelly Sikkema on Unsplash.

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