Overall Revenue Structure: Expanding and Enforcing Sales Tax

In an attempt to address budget shortfalls some states have proposed expanding current sales tax to include services and strengthening existing tax laws to regain lost revenue from internet sales. By pursuing these actions states could stabilize and grow their current tax bases to alleviate shortfalls in income and property tax caused by the recession.

For years states have been losing out on billions in revenue from online sellers that legally don’t have to collect state sales tax because they don’t have in-state property, employees, or sales representatives - otherwise known as “nexus” - in the state. In 2008, New York was the first state to enact a law to address this problem. A report by the Center for Budget and Policy Priorities highlights New York’s “Amazon law” as an important tool for states to consider in recapturing this lost revenue. The New York law has circumvented normal categories of nexus and extended it to include local web affiliates – bloggers, newspapers, nonprofit organizations and other businesses – that post links on their websites to online retailers and receive a commission when purchases are made through those connections.

Because the law only affects online sellers that operate using affiliates it only tackles part of the problem. A more comprehensive solution would have to come from federal legislation to grant states the ability to surpass the laws requiring physical presence.

Other states have proposed expanding their sales tax base by including services. Robert J. Kleine, the treasurer of Michigan, believes that this type of action makes sense in terms of updating an antiquated system. “The basic thing is that we need to update our tax structure,” he said in a recent New York Times “We’ve got a 20^th-century tax structure based on a different sort of economy. The tax base doesn’t grow as the economy grows.”

The update would create a substantial revenue source for states desperately in need. The Center for Budget and Policy Priorities estimates that a nationwide sales tax on services (excluding health care, education, housing ) is likely to generate $87 billion.

Research by the center also indicates that expanding the tax base to include services might also decrease volatility. While traditional sales tax bases are often dominated by big ticket items (like cars, appliances and furniture) whose sales decrease in times of economic downturn, research has shown that some services would not fall and raise as drastically in response to macroeconomic changes.

Proponents also sight that expanding the tax could increase economic efficiency. The current sales tax on goods subtly distorts the market and gives consumers an incentive to purchase services over goods. The Tax Foundation also notes that because most states have a number of exemptions on goods and services eligible items have to be taxed at a higher rate. By expanding the base, states could lower the the rate overall.

While reasons to tax services make sense to revenue hungry public finance departments and economists, Robert Levine illustrates political obstacles in expanding the tax. Levine was a consultant for a political candidate in Florida in the 1980s who proposed a sales tax expansion on services. Once news of the expansion got out it caused massive mobilization of already politically savvy professional organizations like lawyers, accountants and medical providers. What finally broke the legislation was the ad campaign waged by the advertising and media industries.