The first half of 2023 saw a flurry of state and local sales tax changes, with governments relying more heavily on indirect taxes to fund operations as borrowing becomes more expensive and the overall cost of providing government programs (infrastructure, roadways, etc.) increases.
Vertex's 2023 annual Mid-Year Sales Tax Rates and Rules
This increase was driven by a jump in both new taxing cities and district sales tax rate changes. The first half of 2023 saw 37 new taxing cities, compared to 22 in the first half of last year. Beyond that, during the same period there were 148 rate changes at the district level compared to only 37 in the first half of 2022, with most of those changes representing decreases in sales tax rates.
State and local governments are relying increasingly on sales tax due to a complex mix of reasons including a tenuous economic situation, reductions in federal funding and the ease of collection. Governments have had to navigate the same issues as the private sector over the last three years, from economic and workforce instability to supply chain challenges. In addition, sales tax collection has shifted from traditional brick and mortar to digital services and ecommerce. Coupled with the fact that federal aid around the COVID pandemic will be discontinued in 2024, government budget managers have been working to replenish their funds.
The dynamics and trends that are impacting sales tax and rates changes and the driving forces behind them include:
- Taxing districts require more funding: Through the first half of this year, 101 new district taxes (such as fire & rescue and parks) have come online. This explosion in new district taxes is about funding. Districts have seen the cost of goods and services compound due to inflation over the past several years. Issuing additional debt is more challenging today because interest rates have risen and are likely to stay high for some time. All of this means that taxing districts are expected to continue to enact new taxes to address their revenue needs.
- Exemptions are adding up: State legislatures continue to introduce an assortment of temporary and permanent sales tax exemptions. Combined with a related desire to limit income tax and property tax rate increases, the growing use of exemptions is accelerating the narrowing of the state tax base. This places greater pressure on sales and use taxes as a driver of revenue for state and local tax jurisdictions. Sales tax exemptions pose a range of challenges to indirect tax groups and other stakeholders. According to the
Tax Foundation , tax holidays generally don't increase economic activity because they are targeted toward items consumers will purchase anyway. Because most holidays are temporary, they only complicate sales and use tax compliance for businesses. - A "fee-for-all" trend is rising: Fees in addition to sales tax have become a popular method of funding for state and local jurisdictions. Environmental "green" fees have grown substantially over the past several years, and that trend continues. So far this year, states including Maryland, Maine, Oregon, Colorado and California have enacted legislation that attaches new environmental fees to plastic, paper, glass and metallic packaging materials. Vertex's solutions currently support upwards of 1,000 different fees, the majority of which are "green" fees. Beyond that, state and local jurisdictions continue to come up with new fees, including airport and retail delivery fees. Much like the other trends above, this means additional complexity for tax groups that are already grappling with high volumes of rate changes and new sales taxes.
Other than economic reasons, sales taxes tend to be easier to administer and collect. In fact, over the past 60 years, in times of adverse economic cycles, sales taxes have provided a more resilient method of funding relative to income and property taxes. These circumstances all add up to the fact that rate changes and new taxes will continue to increase into 2024 and beyond.
Organizations must understand that states will get more creative, and indirect tax complexities will likely get more complex and burdensome, creating a patchwork of regulations. We're already seeing this in states like Maryland, which is pushing the boundaries and battling in court over the constitutionality of its digital ad revenue tax. Many states are watching the outcome and will adjust their own plans accordingly. We're still in the nascent stages of ecommerce and jurisdictions will surely be looking for new ways to find consistent revenue streams.
