Bridging the gap (1): Revisiting the vendor sales tax discount

With state revenue collections seeing their steepest plunge in a generation, Oklahoma is enduring a tough year of state budget cuts that are already having a harmful effect on families, communities and the economy. However, while the severity of this year’s cuts has been mitigated, the outlook for next year’s budget is substantially worse. In the absence of new revenue, we should expect additional budget cuts of 10 to 12 percent across the full range of state agencies beyond those cuts already enacted this year. While we know far too little about how deeper cuts will be absorbed by state agencies and school districts, we are certain that if  the budget were to be balanced exclusively by cuts, the impact will be devastating to our schools, safety net programs, infrastructure, and public safety.

In this context, there is an urgent need for a balanced approach to the state’s budget shortfall that includes identifying possible sources of additional one-time or ongoing revenue. Governor Henry, in his FY ’11 Executive Budget,  proposed over $700 million in revenue enhancing measures, along with additional cuts across all of state government, savings from efficiencies and consolidation, and the use of remaining stimulus and reserve fund balances. Not all of the Governor’s ideas are likely to gain traction, but they provide a good starting point for an urgently-needed  discussion. In this and subsequent blog posts, OK Policy will explore some of the most promising policy ideas for generating additional revenue that would go at least part of the way to closing the budget deficit.

One straightforward revenue-generating idea involves limiting the discount that the state pays retailers for collecting the state sales tax. Currently Oklahoma is among 26 states that provides vendors some form of compensation, or discount, for collecting and remitting sales tax. As the policy organization Good Jobs First has noted:

When stores were small and records were mostly kept by hand, a plausible case could be made that retailers deserved some financial assistance from states to offset the costs associated with sales tax collection and remittance. But even then, policymakers in many states never accepted the argument.

Of the 45 states with a sales tax, 19 do not provide a vendor discount, while 26, including Oklahoma, do. Oklahoma provides retailers 2.25 percent of sales tax collections if they file electronically, or 1.25 percent otherwise, up to an monthly maximum discount of $3,300 per sales tax permit-holder.  Among the 13 states that cap the total discount, Oklahoma’s cap is the second highest. Arkansas, by comparison, allows a discount rate of 2.0 percent, with a  cap of $833 per month. The Oklahoma Tax Commission calculates the cost of the vendor discount at $25.9 million for CY 2008, more than three-quarters of which went to the 4 percent of Oklahoma businesses that collected over $100,000 in sales tax.

Even though businesses receive no payment for assisting in the collection of other taxes, such as income tax withholding, a good case can be made for not doing away with the vendor discount entirely, especially since the Streamlined Sales and Use Tax Agreement, of which Oklahoma is a part, requires states to provide “reasonable compensation” to all retailers. At the same time, the improved ease and lower cost of sales tax collection as a result of technological advances argues for lowering the amount of the vendor discount.

One proposal, advanced by UCO Economics Professor Mickey Hepner, would be to maintain the current vendor discount rate but substantially lower the annual cap. Governor Henry in his budget proposes lowering the vendor discount rate to 1 percent for all vendors, while lowering the monthly cap only slightly, to $2,250. The Governor’s budget estimates savings of $10 million from this change. An alternate approach, used in several states, is to provide a higher discount rate up to a certain threshold and a lower rate above that up to the total cap. Such an approach would provide greater benefits to small businesses, while larger retail changes, as Hepner argues, “would barely register the change.”

Reducing the vendor discount would go only a short part of the distance in bridging the budget gap, but it is sensible policy that would align our tax system with modern technological realities. It should be considered and enacted by this year’s Legislature.