U.S. municipalities' increasing dependence on sales tax revenue is putting them more at risk of deep fallout from the coronavirus pandemic, according to a new economic study.

In research published earlier this month in the Journal of Public and Nonprofit Affairs, economists from North Carolina State University and the University of Central Florida examined some cities and counties on the brink of financial of financial distress, finding links between their condition and heavy reliance on sales tax.

Across the country, sales tax accounts for about 24% of local government revenue, though dependence varies widely by jurisdiction. Durham County, North Carolina, for example, receives approximately 29% of its annual revenue from sales taxes, while Rockland County, New York, receives about 57% of its revenue from sales taxes.

Although sales taxes are attractive because they are not restricted to residents and can be designed to be less regressive by exempting necessities such as food, they also tie local governments to economic cycles and other shocks that cause people to buy less and tourism to drop.

“Ultimately, a change in sales tax revenue influences the fiscal health of government,” said co-authors Sarah Larson and Bruce McDonald III in their research.

Larson, assistant professor at the University of Central Florida and McDonald, associate professor at North Carolina State University, used North Carolina for their case study after a colleague approached McDonald and said the state’s municipalities could face fiscal peril because of COVID-19. 

Using financial data from the North Carolina Department of State Treasurer for all 100 counties between the 2008 and 2019 fiscal years, Larson and McDonald forecast the financial data for 2020 and 2021, assuming a 4.5% growth rate for sales tax and expenditures in 2020 and a 3.6% growth rate in 2021. The researchers selected March 1, 2020, as the starting impact date of COVID-19, then conducted simulations to demonstrate the decrease or loss of municipal revenue sources.

In the best-case scenario, in which counties experience a 25% loss in sales tax revenue in the final third of the 2020 fiscal year, counties would lose approximately $38.09 per person in total revenue, Larson and McDonald found. The average North Carolina county has a population of 105,083, bringing the estimated decline in total revenue to just over $4 million, which Larson and McDonald said could pay the salaries of 38 sheriff's deputies or 78 teachers in the average county.

For the worst-case scenario, where counties experience a 50% loss in sales tax revenue in the 2020 fiscal year, counties lose approximately $76.18 per person in total revenue, with an estimated decline of just over $8 million — enough to pay 77 sheriff's deputies or 156 teachers.

Forecasting the 2021 fiscal year was trickier, Larson said, because it’s unclear when the pandemic will end and consumers will be comfortable returning to their routines. Still, if counties see a 25% reduction of sales tax revenue over the first six months of the 2021 fiscal year — which Larson and McDonald said is a conservative estimate — 40 of the 92 counties would be operating with a deficit by June 30.

A decline in the capacity of local government, already a serious issue, is made even more critical by the role that municipalities have played in the fight against COVID-19. With the U.S. federal response “slow and disorganized,” according to Larson and McDonald, and a lack of coordination by states, many local governments were left to respond to the crisis on their own.

Even before the pandemic, though, many local governments were already financially unhealthy; assuming no impact from COVID-19, one North Carolina county is “very stressed” when comparing total revenue to total expenditures, and 13 counties appear to be “fiscally stressed.” Another 38 counties were categorized as “borderline,” meaning they have the presence or possibility of fiscal stress in the near future.

The researchers found, too, that the fiscally unhealthy local governments, such as Mecklenburg and Wake counties, were among the hardest hit by the coronavirus.

“And so it suggest that if you’re not fully prepared for these kinds of things, if you’re not thinking through in terms of your overall fiscal health at a certain point in time, the impact of this can be more dramatic if you’re caught sort of flat-footed,” Larson said. “So remaining fiscally healthy over every fiscal year is key to not having large-scale impacts.”

The purpose of this research, Larson and McDonald said, was not to definitively predict the effect of COVID-19 on municipal budgets, as the full impact will take years to fully understand. Instead, they intended to assist local governments in the planning and preparation process while the pandemic is still underway.

“With this planning and preparation, local governments can begin making adjustments and seeking help from the state to ensure their continued operation,” the researchers wrote.

Larson and McDonald have also conducted similar research for Larson’s home state of Florida, though that research is still a working paper. The duo plans to continue following the impact of the pandemic on local governments, looking at statewide sales tax figures on a daily level rather than monthly or quarterly.

The study “Implications of the Coronavirus on Sales Tax Revenue and Local Government Fiscal Health ,” published Dec. 1, 2020, in the Journal of Public and Nonprofit Affairs, was authored by Bruce McDonald III, North Carolina State University, and Sarah Larson, University of Central Florida.