This is an excerpt of the 2021 State of Business Report: Building Back. Download the full report [PDF] from the D.C. Chamber of Commerce.
Over the past year and a half, the COVID-19 pandemic has placed unprecedented burdens on the District’s residents, establishments, and economy. As businesses were forced to adjust to a new way of operating under a rapid shutdown of the city and the nation, the pandemic induced a historic spike in unemployment, with an added challenge of many residents exiting the labor force altogether due to personal health concerns or lack of childcare. By May 2020, employment numbers had hit a low point with 43,747 residents out of work. Businesses continued to operate at a reduced capacity, and mobility patterns hit a low point of 30 percent below pre-pandemic levels.
Because of continued uncertainty, there has been a sluggish and uneven recovery since the city lifted its stay-at-home order in May 2020. While the full range of economic impacts of the pandemic and how it will change cities remains unknown, near-term data highlight some of the challenges to recovery, as well as new opportunities that the District might be able to seize to build back better.
What risks and opportunities exist as the city builds back?
As more people received vaccinations, public health restrictions adjusted, and businesses reopened, the District began to recover.
As reported in the previous section, employment in the city is growing, foot traffic is increasing, and revenue, while still depressed compared to pre-COVID projections, is showing signs of recovery. In the near-term, however, it will remain a challenge for the city to maintain economic activity, support local businesses that are accustomed to greater foot traffic, and recover jobs under the threat of residents who are able to leave due to remote work opportunities. The new Delta variant added another barrier to the recovery, as it increases uncertainty around public health guidelines and potentially delayed return-to-office to early 2022.
The full spectrum of the economic impacts of the pandemic and how preferences for urban places will change as a result remains unknown. Near-term data highlight some of the challenges that the District has faced over the past 18 months and the importance of recovery. First, there has been a permanent shift of economic activity away from the District’s core employment, hospitality, and entertainment centers following increased remote work. Second, these shifts have forced businesses and the federal government reassess their space needs and put a dent in lease activity, further weakening the already soft demand for office space. Third, increased preference for suburban life, combined with the ability to work remotely, has sent some residents away from the city. Importantly, weaker economic activity and sluggish growth have deeply impacted the city’s finances, and fiscal risks remain real for future years, especially when federal fiscal aid that has helped support robust government spending disappears in future fiscal years.
On the upside, there is renewed entrepreneurial activity in the District, suggesting that many see new business opportunities in the post-COVID era. Despite numerous business closures, the total number of business establishments increased through 2020, and even the most negatively impacted sectors, such as restaurants and retail, have seen new businesses open or move into the city. These suggest that despite some of the near-term challenges, the District continues to be an attractive destination for some entrepreneurs and workers in the long-term.
Risks to recovery
An immediate concern for the District is longer-term loss of commuter activity in the District. As noted in the first part of this report, a large share of jobs in the city can be worked remotely. A pre-pandemic survey of commuters in the region showed that 35 percent worked remotely at least occasionally, and an additional 25 percent reported they could and would telework if given the opportunity. While telecommuting was steadily increasing during the pre-pandemic era, COVID-19 related restrictions triggered to a swift shift for most. In fact, by the summer of 2021, nearly half of adults in the region reported that there was at least one person working continuously from home in their household.
There is good reason to think that remote work impacts the District greatest among all jurisdictions of the Washington metropolitan region. The average household income of those who work in and commute to the District is routinely above $100,000, and based on what households at this income level report, the share of residents and commuters who are working from home regularly is at or above 70 percent. These numbers are confirmed by office-entry data, which show that the share of workers who show up in an office in the District on a given day has been stuck at below 25 percent since the spring of 2021. In the Washington metropolitan region, the share of workers who are in their offices on a given day has been below other key office markets across the nation throughout the pandemic, and it declined by 1.2 percentage points after the surge in the Delta variant.
The surge in cases due to the Delta variant has caused many employers to delay their return-to-work plans. A survey of major employers in the region, conducted in July of 2021 before the rush of the Delta variant cases, showed that a majority of employers had developed hybrid work plans, and Labor Day was a commonly shared point to switch from remote to hybrid or in-person work. Since then, many employers in the region have either indefinitely postponed their return to work or have shifted to a new target date, frequently in early 2022.
The implications of this delay in return to work are profound. In the short-run, lack of foot traffic ordinarily accompanying commuters will continue to dampen revenue for retail and restaurants, and consequently the District’s tax revenues. In the long run, however, if remote work takes hold, it will permanently impact the demand for office space and housing. This would have dire consequences for the District’s revenue base.
The first order impact of increased telework is flexibility on where one can live while working for a District-based company. In fact, recent research from the District’s Office of the Chief Financial Officer (OCFO) shows that remote work has resulted in a higher than typical number of individuals and families moving out of the District, either temporarily or permanently. According to this research, which uses change-of-address data from the United States Postal Service, 17,822 more residents moved out of the city in 2020 than in 2019. Among this group, approximately 9,300 indicated that the move was permanent and approximately 8,500 noted that the move was temporary.
Figure 11 – Value appreciation in single family homes in the Washington metropolitan area
This trend of relocating away from employment centers can also be confirmed by comparing housing value appreciation data for the entire region during the 18 months prior to the pandemic and the 18-month period beginning in January 2020. While the District’s residential properties, and especially single-family homes, saw a surge in demand during the pandemic, the value appreciation in the city has fallen behind appreciation in suburban locations, reversing the trend from pre-COVID years. For example, between December 2010 and March 2018, single family homes across all counties in the Washington metropolitan region appreciated by 6 percent, but the appreciation was significantly higher in urban and dense central locations, including the District (8 percent) and Arlington (11 percent). During the period between January 2020 and July 2021, housing values appreciated faster in the District compared to the pre-COVID period (10 percent), but this growth fell behind the regional average of 16 percent. As Figure 11 shows, locations further away from the central employment districts appreciated particularly fast, and in many cases twice as fast as the District.
Figure 12 – District of Columbia monthly withholding revenue and resident employment
A curious puzzle with respect to moving trends is the continuous increase in withholding taxes throughout the pandemic that began in December 2020 despite no corresponding increases in resident employment numbers. Data published by the OCFO shows that withholding revenue never declined below November 2019 levels during the pandemic. Since January 2021, withholding revenue has been 24 percent above November 2020 levels. In contrast, resident employment has never recovered above November 2019 levels and has hovered consistently around 96 percent of pre-pandemic levels since January 2021. It is unclear why withholding revenue and resident employment are moving in opposite directions, but one possible explanation is the recovery in high-wage jobs that tend to have disproportionately higher withholding taxes. Another possibility is that the residents who have moved out of the District have not consistently reported to their employers where they live and adjusted their withholding accordingly. If this is the case, the strong income tax collections could be undone by non-resident adjustments at the time of 2021 tax filings in April 2022.
More direct fall-out from reduced commuter activity is a potential decline in the demand for office space in the District. Immediately after the COVID-19 pandemic began, leasing activity came to a complete standstill. It began showing some signs of improvement in the second quarter of 2021, with increased interest both from the private sector (accounting for 61 percent of new leases executed in the quarter) and the federal government. The leases followed increasing property-touring activity after widespread availability of vaccinations in March 2021, but overall, lease activity remains stagnant.
Due to the halt in leasing activity, office vacancy rates have been rising. Even before the pandemic, office vacancy rates were at historically high levels, hovering around 11 percent across the city and as high as 15 percent in the downtown areas. Since the pandemic began, vacancy rates across all submarkets have increased to 15 percent, and vacancy in the central business district is projected to exceed 17 percent by the third quarter of 2021. Similarly, rent growth was negatively impacted during the pandemic, and in fact, rents have declined compared to 12-months prior since the fourth quarter of 2020. It is not clear how the new Delta variant will impact the demand.
Figure 13 – Indicators of office demand in the District of Columbia
The commercial, and especially office, market continues to face risks given the uncertainty around how much office space is needed if many workers continue to work remotely. Additionally, a significant factor in the health of office demand in the District is the federal government. Despite strong leasing activity from the federal government in the second quarter of 2021 (704,000 sq. ft.), there are indicators that remote work will become more frequent among federal workers. In June 2021, the Biden administration directed federal agencies to draft long-term policies for their workplace and remote work strategies, and it told them to provide maximum flexibility. Because the federal government leases a significant amount of space in DC, the impacts of any footprint reduction would be felt greatly.
Figure 14 – Tourism related projections
Finally, the tourism industry, another key source of economic activity and tax revenue in the District, is recovering at an extremely slow pace. According to Destination DC, in 2020, the number of visitors who came to the District declined by more than half compared to pre-pandemic levels, because of a slower-than-expected reopening. Significantly, all indicators of the tourism sector’s health—the number of visitors, average daily rate, and overall hotel revenue—are projected to remain far below pandemic levels in 2022 and are not expected to recover through 2024. This is a significant change for the District: given a combination of tourist attractions, the presence of the federal government, and a strong business and professional services sector, the District’s tourism and visitor activity have remained relatively stable in previous recessions. But during the pandemic, the losses experienced in the District and the surrounding metropolitan areas have followed other large metropolitan areas.
These risks, when combined, increase the revenue risk for the city. Since the beginning of the pandemic, tax revenues that are reliant on DC’s ‘destination’ status have taken the greatest hits. As tourists and commuters disappeared, the city lost nearly one third of its general sales tax revenue in Fiscal Year 2020, and current projections show that it will end Fiscal Year 2021 with an additional decline of 9 percent. Parking taxes, which are dedicated to WMATA, have taken an estimated 56 percent hit. Even traffic fines collected through automated enforcement have declined by an estimated $39 million, or 26 percent.
The District’s tax revenue is projected to return to pre-pandemic levels in fiscal year 2022, but there is still considerable risk to projections. The revenue estimators also recognize that a permanent reduction in business and leisure travel, greater demand for telework or suburban locations, or continued discomfort about congregating will have lasting impacts on the amount and composition of the revenue that the city receives, and the risks associated with each revenue base. At present, the city’s reliance on income tax revenue is increasing relative to general sales and real property tax revenues. The city’s reliance on income taxes will be even greater starting in 2022 due to recent increases in income taxes for high-income earners in the District. This tax base is much more volatile than real property taxes, which should be a concern for the city.
Figure 15 – Composition of revenue and housing market indicators
Another concern is apparent from projections is that the housing market could become tighter and costlier through the recovery. The OCFO is estimating that housing starts will decline to levels that are a third of what the city experienced in Fiscal Year 2019. This will lead to more expensive housing and can potentially be a bigger push factor than it is today, dampening household and population growth. This would add further risks to economic recovery and revenue.
The bright spot: Increased entrepreneurial activity
With more workers and consumers staying home, revenue has been down for many establishments, making it difficult for them to stay open. Despite these challenges, data do not show a loss in establishments since the beginning of the pandemic. In contrast to the dip in consumer spending, preliminary annual data through Q4 2020 shows there was a 5 percent increase in total private establishments in the District between 2019 and 2020, up from a 2.6 percent increase between 2018 and 2019. This trend conflicts with the region. Within the Metropolitan Statistical Area (MSA), excluding the District, there was a 0.1 decrease in establishments between 2019 and 2020, down from a 0.4 percent increase between 2018 and 2019.
Figure 16 – Change in establishments and total business applications in the District of Columbia
The District’s increase in establishments could be due to a lag in the data, particularly if the federal Payroll Protection Program enabled some businesses that would have closed in a normal year to remain open. However, data on business applications confirm there has been more entrepreneurial activity as well. Business applications, which have a high likelihood in transitioning into a business with a payroll, were up by 8 percent in 2020 compared to 2019. This trend continued into 2021as applications climbed by 37 percent in June 2021 compared to June 2019.
The increases in the number of establishments and business application filings are welcome news for the District. Turning business ideas created in the aftermath of the pandemic into wage-paying businesses and eventually brick-and-mortar enterprises would not only bring back vibrancy but could also create chances for residents who find themselves excluded from opportunity.
Early research on the impact of the pandemic on small businesses found that closures were more common for businesses owned by entrepreneurs of color, and women- or immigrant-owned businesses. These outcomes are partly related to the findings that Black-, women-, and immigrant-owned businesses are more likely to have low profit margins, lack access to capital, and be in consumer-facing industries. These businesses are more deeply impacted by the pandemic. There is now evidence that businesses located in low-income and non-white neighborhoods were less likely to benefit from the PPP.
If past is prelude, many of the new business applications are by the District’s Black, brown, female, and immigrant residents. These entrepreneurs are less likely to borrow, and more likely to start their businesses with smaller start-up capital funded by their own money. They will also be less likely to benefit from federal or local tax incentives available to businesses, given their size and the structure of their businesses. To aid these entrepreneurs in successfully launching and growing their businesses and turning them into brick-and-mortar establishments that can increase vibrancy, the District could take a few simple steps that would come at relatively low costs, especially compared with the potential economic hits from a distressed downtown. These steps include making it easier to start a business: eliminate barriers such as Clean Hands requirements, investing in infrastructure, especially in high-speed Internet availability and access, and offer supporting initiatives to turn online and remote businesses into brick-and-mortar businesses.
About this report
This report was prepared and produced by the D.C. Policy Center for the DC Chamber of Commerce. It was originally released by the DC Chamber of Commerce on October 1, 2021. This version has been adapted for web.