How The K-Shaped Recovery Affects The Taxes We Pay

As the Covid-19 crisis wears on, it’s clear that those with means are recovering much faster from the recession than others. This K-shaped recovery, a term coined by economist Peter Atwater, also plays out in the taxes we pay.

To be sure, the recession is hurting state tax revenues across the board. But just as it has affected workers unevenly, it has not treated all tax streams equally and it’s creating some weird data. For example, according to the latest analysis from the Urban Institute personal income tax revenue in September actually increased by 6.2% compared with September 2019. And that’s in the face of a 6.4% decline in total employment.

The institute’s Lucy Dadayan explains: “The disconnect between the employment and personal income tax revenues is largely due to the reality that the pandemic is heavily affecting lower-income earners, mostly employed by service industries.” She goes on to note that California accounts for a good portion of the reported growth, and that the Golden State’s strong growth in income tax revenues is partially due to the stock market rebound after March. (For more on the unemployment rate/stock market disconnect, see Sergei Klebnikov’s story here.)

Sales tax revenue, which takes a heavier toll on lower-income Americans, is down nearly 1%. That’s more in line with what one would expect in a recession and also shows how the downturn is having a bigger impact on lower-wage workers.

The pandemic’s total impact

Looking at the first seven months of the pandemic (between March and September), compared to the same period a year earlier, state revenues are down 4.8%. In other words, the pandemic has so far cost states $28 billion in revenue.

That’s a worrisome picture, but on the bright side it’s less than what was expected a few months ago. In fact, last month the institute’s figures showed the pandemic had so far cost states $31 billion. So, states are gaining some ground here.

Again, the recession’s uneven impact upon workers is paying a role. Dadayan notes that, “declines in income tax revenues, particularly in withholding tax, are not as steep as initially forecast in part because most of the Americans temporarily or permanently out of work are lower income earners.”

That also shows up in sales taxes, which tends to collectively be the largest state tax that lower income workers pay. According to the latest figures, sales tax revenue accounts for the largest portion ($9 billion) of the overall revenue decline.

Looking ahead, it’s important to remember that a shortfall is still a shortfall even if it’s smaller than expected. What’s more, as spread of Covid-19 reaches new heights, the cost to governments and county hospitals is rising. Governments have used federal aid to buy the necessary equipment and protection, but that money is now all accounted for and new support beyond December isn’t yet a reality.

Falling revenues and increased spending means budget deficits. While some states have approved tax hikes — a millionaire’s tax in New Jersey, for example — most will likely try first to avoid the added strain on taxpayers and aim for spending cuts first.