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Impact of Covid-19 on Arkansas Consumer Spending: Implications for Local Government Sales Tax Collections

(Revised and corrected, April 2, 2020)

In a report released on March 23, AEDI presented a preliminary forecast for the Arkansas economy, taking into account the impact of the novel coronavirus disease 2019 (COVID-19).  In addition to disruption of world supply chains, the decline in consumer spending associated with “social distancing” is generating forecasts with significant declines in aggregate demand that make a recession appear inevitable.

In this note, we focus on consumer spending and the outlook for sales tax collections by county and municipal governments.

Social distancing practices are expected to have significant direct effect on consumer spending in the first and second quarters of 2020, with lingering effects due to the impact of declining employment and income later in the year and beyond. Total consumer spending is expected to decline by 5.1% in the second quarter of 2020. While some recovery is expected in the second half of 2020, total consumer spending is expected to remain well below the baseline forecast through the end of 2021. 

Figure 1:

Sources: IHS Markit, Arkansas Economic Development Institute

While the 5% decline in total PCE provides an indication of the overall impact of COVID-19 on overall consumer spending, sub-components show some widely differing trajectories.  Durable goods are expected to suffer the largest decline, dropping 10.4% from 2019:Q4 through 2020:Q2 and remaining below recent levels through the end of 2021.  Services show a smaller decline, 4.7%, and recover to positive territory by the end of 2020.  Nondurable goods (less Gasoline) are expected to increase through the second quarter of the year (+4.2%), driven by an increase in spending on Food & Beverages Purchased for Off-Premises Consumption.

Figure 2:

Sources: IHS Markit, Arkansas Economic Development Institute

Table 1 shows the initial declines expected for components of consumer spending, along with cumulative changes expected by the first quarter of 2021. ( Table 1 is a corrected and extended version of a table presented in our previous forecast analysis.)

Table 1:

Sources: IHS Markit, Arkansas Economic Development Institute

For assessing the impact on county and municipal sales tax collections, the question is how the tax base is reflected in the various components of spending.  Durable goods are taxable and represent a significant share of the sales tax base.  Nondurable goods, excluding gasoline, are also taxable.  Services are generally not taxable, with the exception of some categories that are expected to be hard-hit by the downturn; in particular, Recreation and Food Services & Accommodation.  On the other hand, the surge in grocery sales represent a component of county and municipal sales tax bases, and should help buffer declines in other categories.

As a proxy for local sales tax bases in Arkansas, we take a simple sum of Durable Goods plus Nondurable Goods (less Gasoline and other energy) plus two services components, Recreation and Food Services & Accommodation.  This isn’t a perfect measure.  For example, it excludes the utilities component of Housing and Utilities, as well as some taxable components of Other Services.  Moreover, as a measure of consumer spending, it does not include some taxable business-to-business sales.  Nevertheless, this aggregate measures some of the key components of the tax base. 

Figure 3 shows the trajectory of this measure compared to total Personal Consumption Expenditures. Grocery sales boost this measure into positive territory for 2020:Q1, but by the second quarter the proxy declines by 4% relative to the end of 2019.  Recovery proceeds more slowly than for PCE, with the proxy not reaching recent levels until the third quarter of 2021.

Figure 3:

Sources: IHS Markit, Arkansas Economic Development Institute

In terms of year-over-year growth rates, the first quarter increase in grocery sales (along with growth through 2019) suggest a 6.2% increase for 2020:Q1.  The second quarter sees a decline of 0.6% compared to a year earlier, with the cumulative effects showing up as a 3.9% drop in the third quarter.  Further year-over-year declines are registered through the first quarter of 2021.

Figure 4:

Sources: IHS Markit, Arkansas Economic Development Institute

These comparisons are subject to a great deal of uncertainty.  They do not reflect regional differences in consumption patterns and growth trends.  They should be used only as rough estimates.   

Moreover, as we concluded in our earlier report, there is a great deal of uncertainty associated with any forecast of the current, unprecedented situation. Risks to the forecast are more likely to be on the down-side: The presumed scenario where economic recovery begins by the end of 2020 might prove to be overly optimistic. The declines in consumer spending and income may reinforce one another to create an even more dramatic downturn.  In fact, more recent national forecasts are suggesting far more dramatic declines in economic activity.

There are, however, two additional effects that might make the outlook appear less dire.  First, since 2019:Q3 the state has been collecting sales taxes from out-of-state internet vendors.  This should continue to boost year-over-year sales tax growth in the first half of 2020 (although the magnitude of this change is uncertain).  Second, the federal government has recently approved stimulus spending that will result in substantial inflows of purchasing power to our state.  We estimate that the personal tax rebates of $1,200 per person and $500 per child will result in almost $2 billion in additional purchasing power, representing about 1.9% of annual personal consumption expenditures.  If consumers spend this and other stimulus cash on taxable goods and services, the negative impact on taxable sales could be ameliorated considerably.

Note: A previous version of this report erroneously included an ad hoc adjustment for internet sales tax receipts. The growth rates reported here are more conservative, making no assumptions about how internet sales tax receipts might affect year-over-year growth comparisons in the first half of 2020.

A PDF file of this report is available HERE