Unexpected business income tax increase drives $10.9 million surplus, but inflation and recession risks remain

June 2, 2022

Multnomah County budget experts said Wednesday that an unexpected surge in business income tax revenue has driven the FY 2022 budget forecast higher by $10.9 million. But uncertainty over personnel costs and the growing risk of recession could offset those gains in future budgets.

Last year, an increase in the tax rate and unanticipated strength in the COVID-era economy caused a big jump in collections. In fact, U.S. companies posted record profits in 2021, even in the midst of rising inflation and supply-chain disruption. 

“This is another year in which every jurisdiction in the country that gets either business income or personal income tax was surprised by the amount of revenue they have received,” said Jeff Renfro, the County’s economist. 

Inflation threatens to eat into surplus 

With revenue coming in higher than expected, the County Budget Office is forecasting a return to normal as record profits come back down to earth and the federal government ends pandemic-era direct support. However, inflation has major implications for the County’s financial outlook.

The word has dominated the news: inflation. Right now, inflation is at its highest level in the past 30 or 40 years. The key question is: how much can the Fed do to bring inflation back to normal levels without causing a recession? The Fed (the Federal Reserve System) is the nation’s central bank that conducts monetary policy to promote employment, stable prices and moderate interest rates. When inflation is too high, the Fed can raise interest rates to slow the economy — and inflation — down.

Right now, the County Budget Office predicts inflation to remain high through fiscal year 2024 before returning to a normal level. However, uncertainty over food and energy prices, coupled with world supply chain issues, have implications for inflation.

“By the end of the summer or early fall, we need inflation to be moving in the right direction,” Renfro said. “Every month that goes by, if inflation is not moving in the right direction, that will increase our assumption about the risk of recession.”

Inflation is tied to County employees’ cost of living adjustment (COLA) which is dictated by labor contracts. Higher inflation means the County’s personnel costs — a major drive of the County’s overall costs — will be higher.

Given the uncertainty around inflation, the Budget Office simulated two scenarios predicting how personnel cost increases would influence the forecast. The scenarios imagine if personnel cost growth were higher by 1% to 2% than expected right now. 

Factoring in an additional 1% increase in personnel costs each year, the Budget Office predicts a $3 million deficit in FY 2024. By FY 2027, the budget surplus would be about $3 million—significantly less than what was predicted before inflation took hold.  

If personnel costs grew 2% higher in each year than anticipated, the County would face a $7 million deficit in FY 24. That would translate into a $13.4 million shortfall by FY 27.

The current forecast assumes labor contracts settle at the status quo. In that scenario, if inflation returns to normal by FY 2025, the County could see a much different picture. Instead of a deficit in FY 27, the County would see a $20.6 million surplus.

Commissioner Jessica Vega Pederson asked whether a market-based sourcing system would affect the outlook differently.

Nationally, many jurisdictions have changed the way taxable net income is allocated.  Right now, Multnomah County’s Business Income Tax (BIT) requires most firms to allocate taxable net income based on where they incur the cost of providing services.  

Under market-based sourcing, the taxable net income would be allocated based on where the customer receives the benefits of the services.

“At a very high level, I think that the impact would be negligible,” Renfro said, adding that the City of Portland has looked at what happened in other jurisdictions that have made the switch. “In every case, there has been a very small impact.”

At this time, it’s too early to see which scenario will play out. By November, the Budget Office expects to have a clearer picture of the County’s financial outlook. While it’s too soon to assume a recession, Renfro said it’s time to think about what it would mean to the County if it happened. 

“Obviously, that’s the big question,” Commissioner Lori Stegmann said. “The risk of recession.”