Falling Tax Revenues: A Bad Sign For Economic Recovery

As federal and local governments increase spending to stimulate the economy, their revenues through taxes continue to fall. According to the Wall Street Journal state and local tax revenues are falling due to lower consumer spending while property taxes are sure to decline as property assessments catch up to the depressed home values. See the following discussion from Moses Kim at Expected Returns.

I'm becoming increasingly wary of news of a nascent economic recovery, especially with news from the WSJ that state and local tax revenues declined 7%. Declining tax receipts evidence the weakness in both the labor market and consumer demand. All signs point to this weakness to persist as credit continues to contract for consumers who are deemed by banks to be less and less creditworthy.

State and local tax revenues fell 7% in the third quarter of 2009 from a year ago, the Census Bureau said in a report underscoring how the economic downturn is stressing government collections.

Sales taxes declined 9% to $70 billion in the third quarter compared with the year-ago period, the Census Bureau said. Income taxes plunged 12% to about $58 billion. Together, sales and income taxes make up roughly half of state and local tax revenue.

"We expect continued weakness well into 2010 if not further," said Lucy Dadayan, an analyst at the Rockefeller Institute of Government at the State University of New York.

What more objective indicator is there of economic conditions than sales tax receipts? The consumer is conspicuously not participating in this "economic recovery". There is hardly room to spin this glaring hole in the recovery thesis, but that probably won't stop permabulls from trying.

Property Tax Receipts Rise...For Now

Property taxes increased 3.6% in the third quarter compared with a year ago. But as property assessments catch up with falling residential and commercial real-estate values, property-tax revenues are expected to be weak. That will have a particularly severe impact on local governments, which fund much of their operations from property taxes.

Property taxes were the only bright spot in this report, but don't expect that trend to last. Housing assessments, which determine property tax receipts, haven't fully accounted for the decline in housing prices yet.

Keep an eye on the real estate market. The latest Case-Shiller report shows that housing is flatlining, and suggests further downside risks. The government, through its homebuyer tax credits, has effectively crushed future demand, which should weigh on housing in the months ahead. Of course the government has the option of repeatedly extending tax credits to artificially inflate prices and cause the next major housing crisis, but they can't be that stupid, can they?

States in Crisis Mode

State and local tax revenues tend to lag behind the downturns as well as the upturns in the economy because of the time it takes for collections to catch up with depressed store sales and diminished incomes. The third quarter was the fourth consecutive quarter in which tax collections were below year-ago levels.

Through the first three quarters of 2009 state and local tax revenues totaled $875 billion, nearly 8% below the $951 billion collected in the first three quarters of 2008. In the same period, federal receipts were down nearly 19%.

While the recession appears to have ended during the summer, government revenues are expected to continue to be weak. State and local governments employ 15% of American workers outside of agriculture.

States are about to face some tough choices. Declining tax revenues, which are at depression levels, will force states to cut services and layoff more employees. We are facing a huge fiscal crisis at the state and federal level that is being patently ignored. 2010 should bring these key issues to the fore as deteriorating balance sheets of governments become too much to ignore.

This post has been republished from Moses Kim's blog, Expected Returns.