Bridging the Gap (3): Leveling the playing field on sales tax collections

As Oklahoma faces record budget shortfalls, the threat of massive cuts that would slow the state’s economic recovery and, in the Governor’s words, “have irreparable and damaging effects on our state services infrastructure,” looms large. This post is the third in a series that discusses some of the most promising policy ideas for a balanced approach to closing the budget deficit that includes new revenue sources.  Previous entries examined the vendor sales tax discount and the deduction for state income taxes.

The sales tax is the single largest revenue source for state and local governments in Oklahoma, providing more than one out of every four dollars that helps pay for such core public services as school teachers, police officers, environmental protection, and medical care. When purchases of taxable goods are made in-state, sales tax is collected directly by the retailer. When purchases are made of the same taxable goods out-of-state – whether via the Internet, catalogs or other sellers – taxes, in this case known as a use tax, are still legally owed by the purchaser. However, as a result of a pair of Supreme Court cases, the most recent of which was Quill vs. North Dakota, retailers who lack a physical presence, or nexus, in a state can not be required to collect and remit use tax owed to the state.  That has meant that an online retailer like Target.com, which has brick-and-mortar stores in Oklahoma, collects sales tax on online purchases from Oklahomans, while other online retailers, like Amazon.com, do not.

The challenge states face in collecting taxes legally owed to them has several unfortunate consequences.  The most significant, perhaps, is that the differential tax treatment puts local Main Street retailers at an unfair competitive disadvantage compared to their online counterparts. In Oklahoma, the permanent sales tax holiday on remote sales makes a $50 pair of shoes ordered at Overstock.com $3 to $4.50 cheaper than the same shoes bought at Dillard’s. Since lower income people are less likely to own computers and make purchase online, differential treatment also worsens the inequities of the sales tax.

For state and local governments, the inability to collect taxes that are due has led to considerable and increasing lost tax revenue.  A 2009 study by economists at the University of Tennessee estimates that state and local governments lost $7.5 billion in sales tax to e-commerce in 2009 and that this amount would rise to at least $13.4 billion in 2012. For Oklahoma, lost state and local revenue was estimated at $92.7 million in 2009, rising to $156.3 million in 2012.

States have made various efforts to level the playing field for businesses and consumers by collecting taxes that are legally owed on remote purchases. Oklahoma, for example, encourages self-remittance of use taxes by including a line and lookup table on the state income tax form to remind taxpayers of their obligations. However, as long as the primary onus for remitting the tax remains on the consumer, no one doubts that evasion will remain widespread. Several states, therefore, have taken more aggressive action in recent years to enforce collection.  The Supreme Court has made clear that the “physical presence” requirement can be satisfied by the in-state presence of third parties working on behalf of the remote seller. States  such as New York, Rhode Island and North Carolina have recently passed laws asserting that relationships such as an affiliate program – in which a company like Amazon pays independent web sites commission for providing hyperlinks that result in sales – are sufficient to establish nexus.  Last month, Colorado passed legislation requiring large Internet retailers to inform customers of their sales tax obligation and to tell the state each year the total dollar value of items purchased by each purchaser.

Some online retailers have fiercely resisted these enhanced collection efforts, with Amazon having gone so far as to discontinue its affiliate programs in several states in retaliation.  Thus far, however, courts have upheld the states’ efforts to require or strongly encourage them to collect sales tax. As Michael Mazerov of the Center on Budget and Policy Priorities has argued, if states hang tough against threats from Amazon and the like, they are likely to prevail:

Internet retailers that suspend their affiliate programs likely will make fewer sales in those states, and some of the sales they lose will shift back to in-state stores (thereby boosting the local economy) or shift to other Internet retailers that have always collected the state’s sales tax or begin doing so under the new law.

Governor Henry in his FY ’11 Executive Budget proposed enhanced compliance efforts to collect taxes owed on remote sales, which would likely require amending Oklahoma statutes to specify an expanded definition of nexus. Although the budget book doesn’t spell out exactly what mechanisms would be pursued to enforce collections, the revenue estimate provided in the Governor’s budget from this initiative – $95 million – seem quite optimistic given the figures cited above of lost state and local revenue due to E-commerce and New York State’s projections of $33 million in additional revenue in FY ’10 from its nexus law. However, even if the revenue potential is more modest, leveling the playing field for Oklahoma businesses and generating additional revenues to help pay our teachers and protect our neighborhoods makes this an initiative well worth pursuing.