While no one knows exactly how COVID-19 will impact Kentucky’s economy, one thing is certain: the longer the economy is shutdown, the bigger the hole we will find ourselves in once we get to the other side. Like most states, Kentucky’s coffers receive most of their revenues (i.e., total general fund revenues) from individual income and sales taxes, two sources that are highly sensitive to the current state of the economy. The remainder of revenues – about 1/3 – are made up of other taxes (e.g., property and cigarette taxes) as well as other revenue sources (e.g., fund transfers).

The most intuitive way to think about what will happen to our state budget as a result of COVID-19 is to look back ten years to the Great Recession of 2009-2010. Compared to many states, the impact of the Great Recession on Kentucky’s state budget was relatively mild.

The table below shows Kentucky’s experience during the Great Recession in terms of revenue growth rates for key sources of income.

Table 1: Kentucky Revenue Growth Rates, Great Recession

Like many other states, Kentucky’s fiscal year does not coincide with the calendar year but runs from July through June (rather than January through December). The left-hand column delineates each of the fiscal years of the Great Recession, while the right hand column shows the equivalent time period in terms of today’s COVID-19 crisis.

What can Kentucky’ experience during the Great Recession tell us about the potential impact of COVID-19 on Kentucky’s budget?

First, it is helpful to take a look at the state’s most recent budget information. Table 2 displays Governor Beshear’s executive budget from January 28th, 2020. I have updated the numbers to include recently released March 2020 tax receipts. Thus, the only thing for fiscal year 2020 still left uncertain are 4th quarter tax revenues (we are currently in Q4).

Table 2: Currently anticipated budget (millions of dollars)

The key takeaway here is that if things go according to plan, the balance from FY20 to FY22 will be $186.7 million. This amount, plus the Continued Appropriations Reserve Fund ($222.8 million at the start of 2020), would bring the total balance to a surplus of $409.5 million.

Scenario 1: Half as Severe as the Great Recession

Let’s now assume that both the declines in tax revenues during the Great Recession and the growth coming out of the Great Recession were cut in half. (For these scenarios, we’ll leave “All other” taxes the same for FY20 Q4 since they are already forecast to fall significantly; also, we’ll assume that “Other revenue sources” such as fund transfers will continue to change as planned).

Table 3 shows what happens if we apply these reduced rates of decline/growth from Table 1 to the 3 categories of general fund revenues starting with the (currently taking place) FY20 Q4 as Year 1.

Table 3: Scenario 1 (millions of dollars)

This gives us a balance of -$418.3 million across FY20 to FY22. Factoring in the Continued Appropriations Reserve Fund gives a total deficit of $195.5 million by the end of FY22.

Scenario 2: The Same as the Great Recession

Table 4: Scenario 2 (millions of dollars)

This results in a $238.7 million deficit by the end of FY22.

Scenario 3: Twice as Severe as the Great Recession

Table 5: Scenario 3 (millions of dollars)

This brings us to a $352.6 million deficit by the end of FY22.

Notice that assuming larger declines by moving from Scenario 1 to 3 also comes with assuming a faster recovery. However, this growth does not make up for the larger declines in Years 1 and 2. As growth is always relative to its starting point, the larger recovery cannot make up for the increased losses.

Conclusion

Unless changes to appropriations are made, we should expect large budget deficits from COVID-19 if it even moderately resembles the Great Recession. Moreover, this analysis did not consider the impact of increased appropriations for COVID-19 related services such as healthcare, declining investment performance for Kentucky public pension systems, increased costs for Medicaid and other entitlement programs, and increased use of public services.

Dr. Steven Gordon is a Associate Fellow at Pegasus Institute

References

Office of State Budget Director, Budget Briefs for 2018-2020 and 2020-2022, as well as March 2020 Tax Receipts.

Kentucky Department of Revenue, Annual Report 2010-2011.