Tennessee Advisory Commission on Intergovernmental Relations (TACIR)
Harry A. Green, Executive Director

Fiscal Impact of Economic Slowdown on Local Governments in Tennessee

by Stanley Chervin, PhD

This report will be updated as new information becomes available.

Introduction

Tennessee’s economy deteriorated beginning in 2007, continued its slide through 2008, and appears to be heading lower yet in 2009. After eighteen months of a recession that officially began in December 2007, the U. S. economy in May 2009 showed few signs of reaching bottom.¹ As this point in time, the current economic contraction will be longer than during both the recession of 1973-75 and the recession of 1981-82.² A rough consensus believes that the combination of federal economic stimulus program spending and the normal but eventual bottoming out of most recessions will result in a turnaround before the end of 2009. Unfortunately, while many measures of economic activity are expected to bottom out before the end of the year, employment will likely continue to decline well into 2010.³

Much of what has happened was driven by a credit meltdown that is having significant negative repercussions on real estate values and sales across the country. The impact of the declining real estate market continues to spread over into the general credit market, and predictably onto the general economy. One of the positive signs is a somewhat tentative improvement in the stock market⁴ that hopefully reflects a belief by many players in the market that the worst is over and the economy will be improving in the months ahead. The stock market is often a barometer of things to come. The appendix contains material documenting the economic slowdown in both Tennessee and the nation as a whole.

The recession has had a severe negative impact on the state’s fiscal year that is just ending and is expected to negatively impact next year’s budget as well. Governor Bredesen dealt with the FY 2009 $1 billion plus revenue shortfall using a combination of increased agency efficiencies, cancelation and delaying of capital projects, redirection of various program and agency reserves to the general fund, and the use of a portion of the rainy day fund. In addition, over $400 million in American Recovery and Reinvestment act (ARRA) funds were available during the end of fiscal year 2009 to help fund TennCare and foster care and adoption assistance programs.

Dealing with the anticipated shortfall in fiscal year 2009-2010 is more problematic and will require program reductions (over $782 million) and the use of non-recurring state and federal (ARRA) funds. The Governor expects that the ARRA funds during FY 2010 will help fill the expected ongoing shortfall in state tax receipts and provide an opportunity to rebuild the rainy day fund back to its prerecession level of $750 million; however, fiscal year 2011 will still be in imbalance and require the use of approx $150 million of the rebuilt rainy day fund to close expected tax shortfalls in fiscal year 2011. Belt tightening will continue until expenditures and revenues are again back in balance (by fiscal year 2012). Such balance will leave the state government in fiscal 2012 and later smaller than in the past.

The 3-4 year plan to trim state government recurring expenditures (education the main exception) into balance with recurring future revenues assumes certain benchmarks that may or may not occur over the next 3 years. The overall scenario for Tennessee state government is similar to many restructuring scenarios facing many overextended private businesses. The fiscal benchmarks assumed in the Governor’s original budget outlook include passage of certain legislation including the ending of a franchise and excise tax exemption for family-owned non-corporate entities (FONCE), state tax revenues growing again by FY 2011 and into 2012, and an HMO premium tax increase. Fortunately, most of the revenue enhancements included in the Governor’s original budget for fiscal year 2009-2010 were included in the final budget that finally passed during the third week of June 2009. The Governor was given additional discretion to further trim spending if June and later month revenues continue to underperform.

Many local governments have limited "rainy day reserves" and the outlook for them is more "grim" than for the state. Local governments are fiscally dependent on two primary local taxes, the property tax and the local option sales tax. While much of the federal stimulus money that is being distributed now will help maintain state and local services during the months ahead, these federal funds will ultimately end. Local governments also receive substantial amounts from the state government, and growth in this revenue source is unlikely in the current economic environment.⁵

Sales Tax Trends

Local option sales tax collection behavior has consistently mirrored that of the state sales tax, and the lackluster behavior of state sales tax collections sets the stage for local sales tax collections. National retail trade and food service sales are continuing their decline that started at the end of 2007, and so far show few signs of recovery. Light vehicle sales (autos and light trucks) are at levels last seen in 1982. The primary reason local sales taxes have not performed as badly as state sales taxes is due to the smaller importance of vehicle sales in the local sales tax base (only the first $1,600 of a single article sale is subject to local taxes). The accompanying chart reflects that relationship between the growth in state and local sales taxes each fiscal year since fiscal 2000. State sales tax data are adjusted for the rate increase from 6% to 7% effective 7/14/2002 (rate on food stayed the same).⁶ Data for 2009* reflects collections through May 2009.

The data for each county was not adjusted for tax rate increases that occurred each year in various counties. The historic data show that the mostly common tax base results in similar patterns of growth for state and local sales tax collections.⁷ In fiscal years 2006 and 2007, only four counties experienced negative growth in local sales tax collections. During fiscal year 2008, the number grew to twenty-two. During fiscal year 2007, local sales taxes grew 4.8%. Last fiscal year local sales taxes grew only 1.8%. This fiscal year (2009 through May), local sales tax collections have declined 2.9%.

County-Wide Tax Collections (YTD July-May 2009 versus prior year)

Fifty-eight counties are experiencing declines in their county-wide collections through May 2009. Thirty-seven counties have higher collections through May; however, five of the counties experiencing positive growth had increases in either the country tax rate or in city rates during the fiscal year. For the fifty-eight counties with declines, total sales tax collections are down $72.1 million. Sixty-four percent of this amount occurred in the four largest counties of the state, all of whom experienced declines (Davidson, Knox, Hamilton, and Shelby). Declines in county-wide sales tax collections create immediate problems for county school systems that depend, at least initially, on the mandated earmarking of 50% of local sales tax collections to education. The impact on other general government functions depends partly on whether the sales tax collection declines occur in cities within a county, or in the county-area outside cities.

Responding to such declines will be difficult. As of June 1, 2009, 41 counties impose the maximum rate of 2.75%. In seven additional counties (Cheatham, Gibson, Giles, Hamblen, Humphreys, Morgan, and Tipton), cities within the county (that represent more than 50% of the county sales tax base) impose a rate of 2.75%. Effectively, 48 counties in Tennessee (over half) have no further local option sales tax potential other than the natural increase in their sales tax base than occurs (or does not occur). In addition, twelve other counties impose a rate of 2.5%, only slightly below the state-restricted maximum of 2.75%.

Property Taxes

In almost all counties in the state, property taxes represent the single largest source of local tax revenue. This works to the advantage of local governments during recessions since property tax collections are less volatile than sales tax revenue;⁸however, the serious national credit and housing slump have left many local officials concerned with the possibility of falling real estate values and assessments. At present, it appears that the real estate market in Tennessee, while experiencing a serious slump in sales, and rising inventories of homes for sale, has avoided the more serious real estate price declines seen in such markets as California, Florida, Arizona, and Nevada.

Any actual impact from price declines awaits the results of reappraisals being performed in 18 counties this year,⁹including reappraisals in the four largest metropolitan areas of the state. Property owners in Metro Nashville-Davidson County have already been notified of their new appraisals (May 2009). Tentative evidence suggests that overall property assessments are up, primarily due to property value increases during the 2005-2007 period. While residential building values are down in many locations in the county, land value appraisals are up.

Officials in Davidson County expect a larger than usual number of appeals this year as a result of the new appraisals.¹⁰ Since the 18 counties going through a reappraisal this year represent over 56% of total state assessments,¹¹ the results will be anxiously watched by all local government officials. While Tennessee avoided the worst of the national housing slump, Tennessee still ranked 11th highest in foreclosures in 2007, and 12th highest in 2008 (Memphis area especially hard hit),¹² and continuing real estate foreclosures in 2009 may forebode some property tax problems in areas most impacted by these foreclosures.

Endnotes

¹There have been only a few signals identifiable as “positive.” See Tennessee Business and Economic Outlook, Spring 2009, Center for Business and Economic Research, UT-Knoxville, May 2009, p. 1.

²In both prior recessions, the contraction (number of months between the prior economic peak and the recession’s trough) lasted 16 months.

³Employment is generally one of the last economic areas to recover after the end of a recession.

⁴See the S&P index in the Appendix.

⁵Over 60% of state-shared taxes come from shared sales taxes and shared gas and motor fuel taxes. These tax sources are not expected to grow much, if at all, during the next fiscal year. The Hall Income Tax, 3/8 of which is shared with local governments, not only declined 23.7% in fiscal year 2009 (through May), but will most likely decline again during the next fiscal year.

⁶Data for prior periods were adjusted up (prior to FY 2003). The state data for FY 2008 and FY 2009 (through May) are adjusted for the reduction in the state sales tax on food from 6% to 5.5% that became effective on January 2008.

⁷The major exceptions are the maximum single article limitation of $1,600, and the exemption of all energy sales from local taxation.

⁸TACIR draft report.2008. Importance of the Property Tax among Tennessee Counties.

⁹ Bradley, Davidson, Fayette, Gibson, Hamilton, Hickman, Know, Lake, Loudon, Montgomery, Perry, Rhea, Shelby, Stewart, Sullivan, Sumner, Van Buren, and Washington.

¹⁰Appeals must first be taken to local boards of equalization, and then may be filed with the State Board of Equalization.

¹¹ Based on the 2007 Tax Aggregate Report, Comptroller of the Treasury, Division of Property Assessments.

¹² Tennessee Housing Development Agency data at http://www.thda.org/Research/fctrends/cy08.pdf.
Appendix