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News Releases: 2009

OCTOBER 29

St. Louis Fed Analysis: Recession Takes Toll on Region’s Tax Revenues

ST. LOUIS — While local governments cope with sharp declines in tax revenues due to the recession, the severity of the decline varies from state to state throughout the Eighth District, according to a recent research report from the Federal Reserve Bank of St. Louis.

In his article “Recession Takes Toll on Eighth District Tax Collections,” economist Thomas Garrett examines the declines in sales tax, personal income tax and corporate income tax collections across the seven states that have regions covered by the St. Louis Fed’s Eighth District:  Arkansas, Illinois, Indiana, Kentucky, Mississippi, Missouri and Tennessee.  

Garrett’s article appears in the October 2009 edition of The Regional Economist, the St. Louis Fed’s quarterly journal of business and economic issues.

All seven states experienced a decline in total tax revenues between fiscal year 2008 and fiscal year 2009, with Illinois experiencing the steepest decline at 9.56 percent, and Mississippi experiencing the smallest decline, at 2.23 percent. In between were Tennessee, down 8.63 percent; Kentucky, down 4.58 percent; Missouri, down 3.87 percent; Indiana, down 2.73 percent and Arkansas, down 2.30 percent.

Combined, the Eighth District region experienced a 5.95 percent decline in total tax revenues, slightly less than the 6.09 percent decline reported across all 50 states.

Economic downturns affect each of the three main tax bases differently, which is one of the reasons the magnitude of the decline can vary, Garrett said.

“The degree to which an economic contraction affects consumption, employment and income in each state can explain part of the difference in the performance of the three tax revenue sources across the states,” he said.

For instance, a reduction in retail sales will in turn reduce sales tax revenues, while a reduction in employment will more likely influence personal income and corporate income taxes.

In addition, each state relies upon these revenue streams to varying degrees, Garrett explained.

“A related reason is the degree to which each state relies on, as a percentage of total tax revenue, each source of revenue,” he said. 

As an example, he cited the difference between Missouri (which derives 25 percent of its total tax revenues from its state sales tax) with Tennessee (which derives more than 78 percent of its revenues from its state sales tax.)

“Thus, equal drops in retail sales activity (assuming constant tax rates and exemptions) will influence total tax revenues much more in Tennessee than in Missouri,” he said.

On the other hand, Missouri derives 69 percent of its total tax revenues from personal income tax, while Tennessee relies on only 3.3 percent.

States will continue to face budget pressures until economic conditions improve, since improvements in tax revenue streams rely on increased consumer spending, greater employment and increased business investment.

“Slow or stagnant growth in one or more of these areas will hinder growth in total tax revenue, especially in those states that generate the majority of their tax revenue from only one or two taxes,” Garrett said.

While other factors such as the American Recovery and Reinvestment Act reduced spending on state-funded programs, and tax increases may help to improve state fiscal health, these actions alone cannot generate revenue recovery, he said.

 “As long as state governments rely on revenue sources that are linked to economic performance and fail to adequately save during prosperous times, it is certain that states will once again find themselves facing budget shortfalls during the next economic slowdown,” Garrett said.

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With branches in Little Rock, Louisville and Memphis, the Federal Reserve Bank of St. Louis serves the Eighth Federal Reserve District, which includes all of Arkansas, eastern Missouri, southern Indiana, southern Illinois, western Kentucky, western Tennessee and northern Mississippi. The St. Louis Fed is one of 12 regional Reserve banks that, along with the Board of Governors in Washington, D.C., comprise the Federal Reserve System. As the nation's central bank, the Federal Reserve System formulates U.S. monetary policy, regulates state-chartered member banks and bank holding companies, provides payment services to financial institutions and the U.S. government, and promotes community development and financial education.