City weighing options to fill payroll tax shortfall

COVINGTON, Ky. – The work-from-home trend pervading America’s office culture since the beginning of the pandemic in 2020 has crashed down on the City of Covington’s tax revenues.

Covington leaders are faced with filling significant holes in the City’s General Fund budget caused by decreases in payroll tax revenue as major employers in Covington are permitting employees to work from home and thus – if they live outside Covington – to pay their local taxes elsewhere.

The challenge for Covington is both short term and long term. With one quarter left in the 2023 fiscal year, the City faces an anticipated hole of $5 million to be filled by June 30. As City leaders put together the budget for the 2024 fiscal year, which starts July 1, they anticipate a $7.2 million hole. The impact in the 2025, 2026 and future fiscal years is unknown.

The shortfall was discussed briefly at the Board of Commissioners meeting on Tuesday, when Finance Director Steve Webb gave a presentation on Third Quarter Year-to-Date Fiscal Performance.

Three quarters into the fiscal year, the City has collected just 63 percent of the anticipated payroll tax revenue, compared to 76 percent at this point last year, Webb said.

“We’ve fallen off the pace due to implications of remote-work situations with our largest employers,” he explained. “As remote work has become normalized, these employers are withholding and remitting a portion of the occupational license tax to the jurisdictions where their employees are physically working.”

City leaders acknowledge the long-term implications of the trend but suggest the City can fill the gaps for the time being without affecting services to the public.  

“We have intentionally structured our finances to have reserves for the unexpected,” Mayor Joe Meyer said. “This approach also enables us to avoid a crisis reaction, like layoffs. In the short term, the City can deal with this turn of events, but in the future we will have to rethink our strategies.”

Covington Finance officials began noticing the size reduction in payroll tax revenue late last year.

“Initially, we thought the downturn in payroll tax revenues was an ebb-and-flow anomaly related to the COVID 19-influenced economy,” Webb said. “But as the gap grew and as we investigated further, we realized that it reflected a more permanent challenge that ran much deeper.”

For example, the City discovered that Boston-based Fidelity Investments – which has 5,700 employees in Covington and thus is the City’s largest employer – had changed the way it withheld local payroll taxes.

In Kentucky, local governments assess payroll taxes based on where someone works. That tax is withheld by companies from the employees’ paychecks and forwarded to the local government. Individual employees who spend a significant amount of time working elsewhere can seek reimbursement of a portion of their taxes, but that requires proof that they paid other jurisdictions.

Fidelity decided last fall to do that en masse by withholding tax from its Covington employees only for the amount of time they worked at the Covington office, a policy that Fidelity officials eventually confirmed this spring.

As a result, Webb said, Covington is receiving only about 14 percent of the payroll tax it had been receiving from Fidelity employees. A small portion of that decrease has been offset by payroll tax revenue from new jobs created in the City, but that growth isn’t enough to offset the loss of revenue from 5,700 employees.

“That’s a pretty big hole in the General Fund,” he said.

In most years, payroll tax revenue accounts for more than 50 percent of the General Fund, which is the basic operations fund that pays for City services ranging from putting out fires to patrolling streets to filling in potholes. Thus Covington’s elected leaders must take steps to account for that loss of revenue.

In the long term, City officials will continue to create more jobs, and the eventual development of the former IRS site will help. In the short term, Covington’s elected leaders have several options:

• Expanded use of American Rescue Plan Act funds. One of the stated purposes of that federal program was to help local governments overcome the negative impact of the pandemic on revenues, and Covington could simply increase the amount of ARPA funds being used for that purpose.
• Stripping the new 2023-24 budget to bare essentials when it comes to non-personnel spending.
• Continued efficiencies.
• Dipping into reserve accounts the City has expanded in recent years for just such an occasion.
• Exploring taxing options.

Clarity will come soon, Webb said. The City is required to have a balanced budget passed in time for the July 1 start of the 2023-24 fiscal year, as well as to make adjustments to finish the current fiscal year in a balanced situation.

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