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State and local government finances during the pandemic

State and local governments play an important role in the U.S. economy by providing residents with services such as public education, law enforcement, and road building and upkeep. These subnational governments pay for their services largely through taxes on property, sales, income, and corporate profits.

At the start of the pandemic, there was tremendous concern that subnational governments would receive less tax revenue (with the possible exception of property taxes) and be put in a very difficult position. If the federal government loses revenue, it can issue debt to cover the losses and continue operations; but state and local governments largely cannot. For example, nearly every U.S. state government is prohibited from financing ongoing expenses by borrowing.

The FRED graph above shows us what happened with state and local tax revenue during the pandemic by plotting four series from the U.S. Census Bureau’s Quarterly Summary of State and Local Tax Revenue survey: the national total of state and local government tax revenue and revenue specifically from property taxes, individual income taxes, and general sales and gross receipt taxes (three of the largest components).

The graph tracks revenue from the first quarter of 2009 through the second quarter of 2022.

  • Before the pandemic, total revenue had been growing over time at a fairly steady rate.
  • At the onset of the pandemic in 2020, total revenue fell sharply, consistent with the expectations described above: Second-quarter revenue fell nearly $64 billion below first-quarter revenue. But the losses didn’t persist.
  • By the third quarter of 2020, total revenue had bounced back and surpassed first-quarter revenue.
  • From this point on, total revenue has continued on a generally upward path.

There were two major reasons for the rebound: the brevity of the recession and the magnitude of the federal response.

The recession lasted just 2 months, as shown by the shaded area in the graph. The National Bureau of Economic Research Business Cycle Dating Committee, the unofficial arbiter of recessionary periods, established February 2020 and April 2020 as the start and end dates. Many observers had forecasted a much longer recession.

The federal response boosted subnational governments’ income and sales tax revenue. Many people lost their jobs in the second quarter and remained unemployed for a time afterward, but the federal government augmented regular state unemployment benefits with a $300 weekly add-on. In fact, many people were making more income while unemployed than they had made while they were working. Since unemployment benefits are taxable income, this federal response contributed to the boost in individual income tax revenue seen in the graph. Also, sales and gross receipt tax revenue increased after dropping in the second quarter, although this change is less dramatic. In part, this increase was likely related to payments to households legislated through the CARES Act, the Tax Relief Act of 2020, and the American Rescue Plan of 2021.

State and local government finances were further boosted by the injections of billions of dollars from the federal government. For example, in the second quarter of 2020, the CARES Act increased intergovernmental transfers by about $700 billion more than in the preceding quarter. See more data on federal transfers to subnational governments in this FRED blog post.

How this graph was created: Search FRED for “National Totals of State and Local Tax Revenue: T01 Property Taxes for the United States” and click on the entry to see the series in a FRED graph. Note that searching some suitable subset of those words, such as “national totals state local property,” will also bring up the relevant series. Next, click on the orange “Edit Graph” button just above the upper right corner of the FRED graph. From the dialogue window that opens, click on “ADD LINE.” From here, enter “national totals state local total taxes” into the keyword search box. Click on the entry that is returned to add the data series to the chart. After adding this data series, you will see both the total taxes and the property taxes series in the same graph. To finish creating the chart, repeat the step from the preceding paragraph two additional times: for individual income taxes and for sales and gross receipts taxes.

Suggested by Bill Dupor.

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