Implicit Price Deflator Falls Below 1% for Setting 2021 Property Taxes

As local governments across the state look to set property tax levies for next year’s budget, recent news regarding economic factors such as gross domestic product(GDP), personal consumption expenditures (PCE) and the implicit price deflator (IPD) reflect additional information that will need to be considered during the annual/biennial budget process. This blog provides an update of the latest economic data and considerations needed for setting property tax levies for 2021.

The News on the IPD

Only a few weeks ago we published Budget Suggestions 2021, and at the time of publication, the Bureau of Economic Analysis (BEA) had not yet published personal consumption expenditures (PCE) for the first estimate of the second quarter of 2020, nor had it released the annual updates to the National Income and Product Account (NIPA) tables. These annual updates frequently result in revisions to previously released PCE numbers and the resulting IPD calculations, which are historically within a couple of percentage points. However, the results of this year’s NIPA update when coupled with the July release of the first estimate for the second quarter of 2020 (that include the beginning of the economic impacts of COVID-19) reflects a decline in the GDP of -32.9%, an increase in PCE of 5.6%, and an affirmation of the continued downward trend in PCE for 2020. The results of this data coupled with the BEA’s August 27, 2020 release of the second estimate for the second quarter PCE data equates to an IPD of 0.60152%.

Now you may be asking why we are releasing this information now? Our desire to provide you with advanced notice on the IPD — which will be used for setting your property tax levies in 2021 — is twofold.

• One: We have realized for the past few years that the BEA’s release in September for PCE generally falls after the statutory date of September 25. Our past practice was to wait until the Department of Revenue (DOR) released its notice so that the release was concurrent. While the DOR is constrained by statute, our office is not.
• Second: Early release of the data will allow local governments the additional time to discuss and prepare the appropriate ordinances and/or resolutions to set your 2021 levy this year, and, if needed, to include an ordinance/resolution for substantial need.

The next release by the BEA will be September 30, 2020, which is after the statutory requirement (RCW 84.55.005(1)) for determining the rate of inflation on personal consumption expenditures.

As of August 27, 2020, the rate of inflation on the IPD for personal consumption expenditures over the past 12 months is 0.60152%, which means that local governments with populations greater than 10,000 will need to adopt an ordinance or resolution (depending upon your organization) of substantial need if you wish to increase your levy over last year up to the 1% maximum as allowed by statute (RCW 84.55.005) or to bank this capacity for future use.

This is the first year since 2016 that the IPD inflation factor has fallen below the 1% inflation mark. From a historical perspective, during the past 10 years the IPD has fallen below 1% two times: in 2015 and 2016. Prior to that, the last time the IPD fell below 1% was during the great recession in 2009. For those of you forecasting biennial budgets, the economic recovery may be prolonged due to the pandemic; therefore, the prosect of the IPD falling below the 1% inflation mark in 2022 is a strong possibility. With such uncertainty in the economy and the prolonged nature of COVID-19, it may be prudent to plan for an ordinance/resolution of substantial need for both years of the biennium.  

The Economic Outlook

The current economic indicators from the BEA, the Washington State Economic and Revenue Forecast Council (ERFC), and others suggest a slow economic recovery. There are other factors beyond the COVID-19 pandemic that may also have impacts on the national economy: This is a general election year, there are trade issues between the U.S. and China, and there are additional concerns with the national debt and the U.S. Treasury.  

How Is the IPD Calculated?

The Washington State Department of Revenue (DOR) calculates the IPD using the most recent numbers reported by the BEA. BEA publishes an estimate of the quarterly IPD numbers on a monthly basis. These quarterly numbers are then seasonally adjusted each year in July. These seasonal numbers form the basis for the prior year’s IPD personal consumption expenditure number that is used by the Department of Revenue (DOR) for the calculation of inflation for this year's rate.

This year, like most years, the September release falls after September 25. Why should we care about the date? According to RCW 84.55.005, the definition of inflation for setting property tax levies:

means the percentage change in the implicit price deflator for personal consumption expenditures for the United States as published for the most recent twelve-month period by the bureau of economic analysis of the federal department of commerce by September 25th of the year before the taxes are payable

The rate of inflation is calculated by dividing the Quarter 2, 2020 IPD for personal consumption expenditure (seasonally adjusted) by the Quarter 2, 2019 IPD number, subtracting 1.00 and multiplying by 100. Since the BEA’s next release will not be until September 30, the August 27, 2020 release is used in this year’s calculation. The numbers are as follows:

What Does It Mean for Local Governments?

The only limitation that local government must concern itself with is the 1% levy increase limit set in RCW 84.55.005 (2) (a-c). For many smaller jurisdictions (populations less than 10,000), it will be business as usual, with the ability to adopt a levy that is up to 1% greater than last year plus adding on additional items, such as new construction. For jurisdictions with a population greater than 10,000, there will be additional discussions with the legislative body about the necessity of declaring ‘substantial need’ in order to increase the levy beyond last year for an amount up to the maximum of 1%.

It is important to note that all local government entities must still adopt a property tax levy ordinance stating the increase over last year’s levy in terms of a dollar amount and percentage. The maximum that you can increase the levy is 1% percent. However, there is one other option that your jurisdiction may wish to consider if the maximum of 1% is not needed and that is the option of banked capacity.

The option to bank levy capacity

RCW 84.55.092 allows you to bank capacity for the future if the full 1% is not needed for the next budget period. During the levy setting process a local government has the ability to use all, some, or none of this 1% increase over last year’s levy. If your jurisdiction does not need the full 1% for the next budget period than banking your capacity for the future may be an alternate fiscal tool that will provide a future benefit. These decisions are all part of the budget process and will be unique to each jurisdiction. Should you wish to bank capacity for the future, your property tax levy ordinance or resolution must simply state that you are increasing by a percentage less than allowed (for example, 0.5% rather than 1.0%). This will automatically bank your remaining, lawfully allowed capacity for the future.

Conclusion

With the pandemic showing no significant signs of ending, uncertain economic times, and the normal recurrence of natural disasters such as wildfires, local governments will want to carefully safeguard revenue resources and use all available data to plan a course for the future. My colleague Mike Bailey recent wrote about revenue forecasting with some suggestions on where local governments can find additional data to assist with your budget forecasting and development process. For detailed information about property tax and other city/county revenues, refer to the Revenue Guides for Cities/Towns and/or Counties.

If you have any questions about this blog post or other budget concerns, let us know. You can use Ask MRSC our online inquiry portal or send me an email at tnelson@mrsc.org.