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Changes to a long-standing legal precedent could free states to impose sales taxes on more internet retailers, but the immediate revenue gains could be somewhat limited.
Public officials and finance experts don’t expect a dramatic, near-term surge in state and local revenues, even if the U.S. Supreme Court clears the way for greater online sales tax collections.
But a case before the high court involving the tax could have big fiscal ramifications down the line.
The court is set to hear arguments Tuesday in South Dakota v. Wayfair, inc., which offers a chance to reaffirm or scrap a legal standard that blocks states from collecting sales tax from internet retailers that don’t have an in-state “physical presence,” like offices or employees.
“The incremental revenue that would actually be gained immediately by Wayfair is probably relatively small,” said David Hitchcock, a senior director at S&P Global Ratings. “It’s not significant in the short-run,” he explained. “But it could be significant in the long-run."
The court last upheld the physical presence standard in a 1992 ruling in Quill Corp. v. North Dakota, a case involving catalog sales. Across the U.S., 45 states impose statewide sales taxes, according to the Tax Foundation. Local sales taxes are collected in 38 states.
One reason gains from eliminating the physical presence rule could be limited in the near-term is that e-commerce is only a fraction of the nation’s overall retail sales—about 9 percent last year. Another is that states have found workarounds to the rule and are collecting taxes on many sales made by some of the nation’s largest online vendors, including Amazon.
But there is tax revenue being left on the table. And online retail is expanding swiftly.
E-commerce sales increased 16 percent last year in the U.S, while total retail sales grew just 4.4 percent. This growth in online commerce means the physical presence rule, if left intact, could cause deeper erosion of state and local sales tax revenues in the coming years.
“If you project that out far enough, this could be a very significant loss in revenues,” Hitchcock said.
David Schumacher, director of the Office of Financial Management in Washington state, described the possibility of capturing more taxes from out-of-state, online retailers as “closing a loophole rather than adding a new tax” and said it would “definitely be a good thing.”
“We could always use the extra money,” he said. “But it’s not like a budget buster, or it’s not a solution to all our problems.”
Sales tax collections are especially important in Washington, one of seven states that does not have an individual income tax. But Schumacher said that, with Amazon located there, the state has been collecting sizable online sales tax revenues for some time.
Numbers he has seen indicate that if the physical presence rule were nixed, “maybe it’s a hundred million dollars for the budget."
"We have a $50 billion budget,” he added. (Washington budgets on a two-year cycle. Total tax revenues for the state in fiscal 2017 were around $21.9 billion, according to a state financial report.)
“It’s not huge,” Schumacher said of potential new online sales tax revenue. But he added: “I would love to have it for my next budget.”
David Thurman, a budget director in Tennessee’s Department of Finance and Administration, said rolling back Quill could add somewhere around $100 million to $300 million to his state’s revenues. “It’s that big of a range because we just don't know,” he added.
“Everybody’s spending more and more online,” Thurman said. “What this does is kind of shores up your tax base a little bit.” As for banking on extra online sales tax dollars: “we’d want to be very conservative until we started collecting it, to see what it looks like.”
Thurman explained the amount of added sales tax revenue in Tennessee, in the event Quill is reversed, would depend on how the state sets thresholds for collecting the tax. One proposal that’s been floated, he said, is to apply the tax to firms with over $500,000 in sales.
The South Dakota statute that led to the Wayfair case is written to only apply to retailers with over $100,000 of sales, or 200 separate transactions, in the state annually.
U.S. Government Accountability Office estimates released last year show that state and local governments could have gained $8 billion to $13 billion in 2017, if states had the authority to require sales tax collections from all out-of-state “remote sellers,” like online vendors.
Those gains would be about 2 percent to 4 percent of total, 2016 state and local revenues.
“There’s definitely still revenue out there, but how much is something I’m interested to see,” said Richard Auxier, a research associate in the Urban-Brookings Tax Policy Center. “The ability to tax some online sales is not going to solve every state’s budget problems,” he added.
Bob Scott, chief financial officer for Carrollton, Texas, a city of about 130,000 residents, north of Dallas, said it’s difficult trying to predict the local benefits for city revenues if the Quill ruling were to be reversed, noting that “the hardest thing to estimate is what’s not there.”
He’s aware of state estimates for 2016 that show gains could be about 3 percent, which would work out to around an extra $1 million each year for Carrollton’s roughly $200 million budget.
“Would we be able to put another million dollars to good use? Absolutely,” Scott said. “Is a million dollars going to dramatically change what we do? Probably not.” But he also noted that the effects would vary between jurisdictions if the physical presence ends. “In my opinion,” Scott said, “it’s going to be a big help to local governments but it’s certainly not going to be a panacea.”
For some state governments with tight finances, the prospect of new online sales tax collections—however limited—is welcome.
“From Louisiana’s perspective, the Wayfair case is going to be a significant decision,” said Kimberly Lewis Robinson, the state’s secretary of revenue.
Robinson explained the state is currently facing a $600 million to $700 million budget shortfall, and said if the court rules in a way that enables Louisiana to mandate that more online retailers collect sales taxes, it could raise between $200 million and $400 million in additional revenues annually. “That’s a game changer for us, in terms of addressing that shortfall,” she added.
General sales and use tax collections in Louisiana for fiscal year 2017 were around $4.3 billion.
Whatever happens in the Wayfair case, states are finding ways around the obstacles Quill presents for tax collections, as an S&P Global Ratings report from last year highlights.
For instance, New York passed a law in 2013 that says any out-of-state company providing a platform for third-party vendors located in the state establishes a “nexus,” which allows the state to require sales tax collections. Amazon lost a court challenge against the law.
California later passed a similar measure, which led to legal wrangling with Amazon and an eventual agreement from the company to pay taxes on a delayed basis, the S&P report notes.
(Amazon now collects and pays sales tax in all states where the tax is imposed—though the company does not do this for sales by third-party vendors using its platform.)
Meanwhile, a Colorado law mandates that remote sellers that have $100,000 or more in annual sales in the state, and that don’t collect sales tax there, need to report customers making over $500 of purchases per year online. This opens the door for the state to seek taxes on internet purchases from consumers—who generally owe tax on sales when retailers don’t collect it.
“States are making interesting legislation that can help fill in the gaps regardless of where Wayfair comes out,” Hitchcock said as he discussed online sales tax collections.
“It will certainly make it a lot easier if Quill is overturned," he added. "Because then states can just directly say: ‘you have to pay it.’”
Bill Lucia is a Senior Reporter for Government Executive's Route Fifty and is based in Washington, D.C.