Month: February 2017

So far in this series on tax policy topics to watch in 2017, we’ve covered important state debates in areas such as attempts to weaken or eliminate progressive taxes and needed updates to gas taxes and sales taxes. As if those topics weren’t enough to keep state lawmakers up at night, they will be making these decisions amid a great deal of uncertainty about the future of federal tax and funding policies that are crucial to the states. How those federal debates shake out, and how states prepare for and react to them, will have lasting consequences for families and businesses in every state, and for the very nature of federalism in the United States.

The first example of this is the very high likelihood of reduced federal funding for aid to states and for services such as health care, K-12 schools, and higher education that have historically been provided through a mix of local, state, and federal efforts. Many states are preparing two-year budgets right now with no clear idea of what to expect from Congress. For example, Governing has noted that states are underprepared for the ramifications of federal retrenchment in healthcare. Details are hazy but with leading federal budget proposals taking major cuts as a given – including the possible block-granting of Medicaid and other programs, repeal of the Affordable Care Act, and even completely eliminating the Department of Education – congressional representatives are sending the clear message that they intend to pull back drastically on their portion of those shared investments.

State leaders will have to decide whether they value their residents’ education, health, and safety enough to step up to these challenges as the federal government backs down from them. Stepping up will require replacing lost federal dollars with new state revenues, which will be particularly hard in states where legislators have been attempting for years to slash taxes and cut back on their share of these investments.

And that’s just the spending side of the federal budget. Federal tax changes could have serious impacts on the states as well.

Tax plans laid out by President Trump and congressional leadership include a number of provisions that could impact the states. Ending the deductibility of state and local taxes, creating a new deduction for child care expenses, changing the taxation of carried interest, altering expensing of business investments, and other corporate tax changes such as “border adjustment” could all have ripple effects on state revenue systems.

Another key example is the estate tax. In the 2000s, as federal tax cuts greatly weakened the federal estate tax and eliminated a credit for state estate taxes that was the basis for most such taxes, states had to decide whether to “decouple” from these changes and preserve their role in promoting equality of opportunity and resisting the growing influence of inherited wealth. Most states declined to act and today only 14 states and the District of Columbia have estate taxes. But in many of those states, a relationship between the state and federal tax estate tax codes remains, as exemption levels and other parameters often remain coupled to federal statute. Should Congress decide in the coming years to fully eliminate the federal estate tax or weaken it further, as both President Trump and congressional Republicans have indicated a desire to do, these states would again find themselves having to choose whether to passively accept such changes to their own tax codes or take action to establish a truly independent estate tax.

Similar “decoupling” questions could face states in respect to multiple other federal tax policies. One example to watch is federal treatment of capital gains interest and dividend income. Speaker Ryan has expressed a desire to exclude 50 percent of this income from federal Adjusted Gross Income (AGI), while another approach with a similar effect would be to simply reduce the tax rate on this income. However, if such a cut is enacted in the form of an exclusion from AGI, state revenues would suffer because many states use federal AGI as the starting point for their own income calculations. A rate cut would not ripple down to states in the same way. State lawmakers and advocates should watch such debates closely so they can either decouple from provisions where they are vulnerable to federal changes or encourage their federal representatives to reconsider the policies or adopt a different approach that does not harm the states. States with “rolling” conformity to the federal tax code could also consider switching to “fixed date” conformity to reduce their vulnerability to such changes.

Another approach some states are taking to proactively address some of these issues is to pass bills that automatically decouple from federal tax changes that significantly threaten state revenues. A thoughtful bill introduced in Nebraska, for example, preempts the adoption of any federal changes to the calculation of AGI that reduce Nebraska revenues by more than $5 million and requires a report to be produced on such changes so that lawmakers can make an informed and deliberate decision on whether to couple to the policy.

Other federal changes could increase revenues in some states. A few states still have an ill-advised state deduction for federal income taxes, which means that federal income tax cuts would reduce the size of that deduction and thereby increase state revenues. And if federal tax changes broaden the tax base by limiting itemized deductions, for example, states that couple to those income calculations will see revenue gains as well. In these cases, states may be tempted to “pass on” the benefit to their residents in the form of tax cuts, but it will be important for them to think twice about such tax cuts given the likely federal funding cuts summarized above and the need in many states to build up reserves before the next recession hits.

Before the tea party wave of 2010 that brought Gov. Sam Brownback to power and inspired the disappointing “real life experiment” in tax policy, Kansas was primarily governed by a moderate bipartisan coalition. One thing the last few weeks in the Kansas capital has clearly demonstrated is that this coalition is back and they mean business.

Five years after the legislature enacted the largest tax cut in Kansas history that has wreaked havoc on the state’s budget, the legislature voted to rescind many of these same tax policies—including eliminating the exemption for business pass-through income and adding back a third income tax bracket and higher marginal tax rates.

Like a captain committed to a sinking ship, Gov. Brownback vetoed the bill, to which the House promptly responded with an override—carrying one more vote than needed to do so. While the Senate’s override attempt fell three votes short, the session is far from over. A majority of lawmakers in both chambers voted for the initial legislation and then voted to override the veto. Building on this support, new tax bills have been filed in both chambers, including plans that only slightly vary from the bill that was vetoed (HB 2178). (A plan with lackluster support proposed by Gov. Brownback that would raise alcohol and tobacco taxes has also been filed but unlikely to get much traction.)

When lawmakers pick up the work again the week of March 6, expect to see another wave of efforts to eliminate the business pass-through exemption and to find agreeable adjustments to income tax brackets and rates. The resistance is underway. An improved tax policy will hopefully follow.

An important aspect of a 21st century tax code is ensuring that corporate income taxes are easy for corporations to follow, but not easy for them to avoid. As our newly updated policy brief on Combined Reporting of State Corporate Income Taxes explains, “combined reporting” remains an essential tool for states to achieve these goals. More than half of states with a corporate income tax now implement this common-sense policy to minimize corporate tax avoidance, and at least three more will consider adopting combined reporting this year. Moreover, most states that already require combined reporting can improve it further by taking the policy international through what is known as “worldwide combined reporting.”

Combined reporting works by requiring large companies operating in multiple states to add together all the profits of their various branches and subsidiaries into one single report and then follow existing rules for apportioning those profits to the states in which they operate. Requiring the combined report nullifies certain strategies some businesses use to avoid taxes, such as artificially shifting profits to certain states that tax corporate income at a lower rate or not at all. Because combined reporting renders such strategies pointless, it improves revenue performance of the tax assuring more help to fund services like transportation, education, and public safety, while also simplifying tax compliance for businesses, as they no longer have incentive to engage in behaviors such as creating spin-off companies in new states simply to avoid the taxes they owe.

New Mexico, which has been considering bills to implement combined reporting for more than ten years, will have another chance to take this step to modernize its tax code this year. Pennsylvania’s Gov. Tom Wolf included the policy in his budget proposal earlier this month. And Alabama legislators are making a concerted push to adopt combined reporting as well. As our policy brief explains, these states and others can benefit from combined reporting, and states that have already taken this crucial step can consider additional measures to beef up their defenses against corporate tax avoidance strategies.

In the Tax Justice Digest we recap the latest reports, blog posts, and analyses from Citizens for Tax Justice and the Institute on Taxation and Economic Policy. Here’s a rundown of what we’ve been working on lately. 

Regressive and Loophole-Ridden: Issues with the House GOP Border Adjustment Tax Proposal
In recent weeks, the Republican congressional leadership’s effort to introduce a comprehensive tax reform bill has increasingly faced opposition from major business groups and skeptical lawmakers from across the aisle. The primary source of dissent thus far is that the most prominent tax framework, the House GOP’s “Better Way” tax blueprint, contains a radical provision to apply a border adjustment to pay for a cut in the corporate income tax rate from 35 to 20 percent. A new report from the Institute on Taxation and Economic Policy (ITEP) finds that this border adjustment tax would be regressive and loophole-ridden and would likely violate international trade agreements.
Read the Report
Read the Summary Blog Post

Private School Tax Subsidies Blur the Line Between Charitable Gift and Money Laundering
When is a charitable contribution not a “donation” at all? If a taxpayer manages to turn a profit on the deal, has anything altruistic actually occurred? The clear answer is no. But an ITEP report reveals that the federal government does not always agree, at least with regard to certain gifts to private K-12 scholarship funds. Released late last year, the report’s findings may gain renewed public interest because the newly confirmed Education Secretary, Betsy DeVos, is a proponent of using public dollars for private school education and President Trump, according to reports, is considering a policy that would funnel federal dollars to private schools via federal income tax credits.
Read the Report
Read the Updated Blog Post

What to Watch in the States: Modernizing Sales Taxes for a 21st Century Economy
State lawmakers often find themselves looking for ways to raise revenue to fund vital public services, fill budget gaps, or pay for the elimination or weakening of progressive taxes. Lately, that search has led many states to consider reforming or expanding their sales taxes.
Read the Blog Post

Why, West Virginia, Why?
A recently introduced Senate Bill in West Virginia (SB 335) would ultimately eliminate the state’s personal and corporate income taxes, do away with the sales and use tax, and reduce the state’s severance tax. Under the plan, the revenue lost from this assortment of diverse taxes would be replaced by an 8 percent broad-based general consumption tax. The result: low- and middle-income West Virginians pay more, much more, while wealthy residents heavily benefit.
Read the Blog Post

‘IMPROVE’ Act Fails to Improve Tennessee’s Regressive Tax Code
Tennessee Gov. Bill Haslam’s proposal (dubbed the IMPROVE Act) to raise the state’s gas tax while cutting three other taxes would essentially be a tax cut for the state’s wealthiest residents and a tax increase for the lowest-income Tennesseans.
Read the Blog Post

ITEP State Rundown: Regressive Tax Proposals Multiplying
This week saw a nearly successful attempt to right the fiscal ship in Kansas; regressive tax proposals introduced in West Virginia, Georgia, and Missouri; ongoing gas tax fights in Indiana, South Carolina, and Tennessee; and further tax and budget wrangling in Illinois, New Mexico, Oklahoma, and beyond.
Read the full Rundown
 

If you have any feedback on the Digest or tax stories you’re watching that we should check out too please email me rphillips@itep.org

For frequent updates find us on Twitter, Facebook, and at the Tax Justice blog.

A recently introduced Senate Bill in West Virginia (SB 335) would ultimately eliminate the state’s personal and corporate income taxes, do away with the sales and use tax, and reduce the state’s severance tax. Under the plan, the revenue lost from this assortment of diverse taxes would be replaced by an 8 percent broad-based general consumption tax.

The result: low- and middle-income West Virginians pay more, much more, while wealthy residents heavily benefit.

In analyzing key components of the proposal, we found the plan to be highly regressive. On average, West Virginians earning less than $84,000 will pay more while those in the top 1% would receive an average tax cut of nearly $28,000.

*This analysis assumes a revenue neutral proposal.

For additional detail on the proposal and what it would mean for West Virginia, visit the West Virginia Center on Budget and Policy’s presentation before the Senate Select Committee and their detailed write-up of the impact.

This week saw a nearly successful attempt to right the fiscal ship in Kansas; regressive tax proposals introduced in West Virginia, Georgia, and Missouri; ongoing gas tax fights in Indiana, South Carolina, and Tennessee; and further tax and budget wrangling in Illinois, New Mexico, Oklahoma, and beyond.

— Meg Wiehe, ITEP State Policy Director, @megwiehe  

• Both Chambers of the Kansas legislature approved a tax bill that would repeal the exemption for business pass-through income, restore a third income tax bracket at a higher rate, and remove haircuts to itemized deductions for medical expenses. After the governor’s veto of the bill, the House voted to override the veto but the Senate vote to override fell three votes short.
• Senate Bill 335, proposed last week, would create a general consumption tax in West Virginia (a broader, higher sales tax), eliminate the state’s personal and corporate income taxes and sales and use tax, and reduce the state’s severance tax. The result of such a dramatic shift would result in low- and middle-income West Virginians paying more while wealthy earners benefit. Read more on how this misguided policy would impact West Virginia families.
• All the while, for the third time this past year, West Virginia braces for another credit downgrade. This week Gov. Jim Justice announced Moody’s decision to downgrade the state’s general obligation debt. The state’s growing structural imbalance between revenue and expenditures was cited as a main concern.
• A regressive proposal in Georgia would flatten the state’s income tax to a single 5.4% rate, eliminate the deduction for state income taxes, and create a small non-refundable Earned Income Tax Credit at 10% of the federal credit.
• A proposal has been floated in a Missouri Senate committee to amend the state constitution to slowly eliminate the state’s income tax, which brings in more than 60 percent of general revenues, and place a cap on state spending.
• A proposal to eliminate the personal income tax over several decades has died in the Michigan House, which is now fast-tracking alternative legislation to cut the personal income tax rate from 4.25% to 3.9% over four years.
• Representatives of 16 Nebraska agriculture and education groups joined to push back against attempts by Gov. Ricketts and others to cut income taxes, arguing that property taxes and school funding issues are higher priorities.
• The Indiana House passed a bill that would raise fuel taxes by 10 cents and increase vehicle registration fees to fund improvement to the state’s infrastructure. The bill now moves to the Senate, which may require smaller increases to ensure passage.
• Proposals to raise Tennessee‘s gas tax while cutting other taxes, or instead divert sales tax revenue to infrastructure needs, will be on hold for a week after a procedural maneuver.
• South Carolina business leaders are coming together to advocate for a gas tax increase to improve funding for the state’s roads and bridges, warning of job losses if the state doesn’t act.
• Louisiana lawmakers reached a budget agreement for closing the mid-year deficit of $304 million, through a combination of agreed cuts, use of rainy day funds, and shifting around other revenue. The special session ended Wednesday.
• Delaware‘s revenue shortfall is now a $350 million gap.
• Lawmakers in New Mexico are considering a bill that would eliminate exemptions to the gross receipts tax and enact a flat rate for both personal and corporate income taxes. Democratic House members are wary of the inclusion of food and drugs in the proposed base expansions. 
• Oklahoma Gov. Mary Fallin’s tax plan, which included proposals to expand the state’s sales tax base, eliminate the state sales tax on groceries, eliminate the corporate income tax, and increase cigarette and gas taxes, has been faced with strong opposition. Raising any revenue at all has been described as the last resort for a number of Oklahoma Legislators.
• The Utah Senate has approved a bill to require more businesses to collect sales taxes for online purchases. In the neighboring chamber, lawmakers have proposed a plan for tax reform without much time for debate or analysis.
• Following up on a promise from his State of the State address, Alabama‘s Gov. Bentley has launched a task force to study potentially eliminating the state’s sales tax on groceries. He has no plans to replace the revenue.

Budget Watch

• For his proposed budget to balance, Illinois Gov. Rauner needs $4.6 billion from a “grand bargain” still being worked out in the Senate. But the governor doesn’t support major components of the latest iteration of the plan, such as taxing food and drugs at the general sales tax rate. He also is calling for a permanent property tax freeze in exchange for any increase in the income tax rates.  

Governors’ State of the State Addresses

• Most governors have now given their addresses for the year. The next scheduled address is Gov. Scott of Florida on March 7, followed by Gov. Kasich of Ohio on April 4, with Gov. Carney of Delaware and Gov. Cooper of North Carolina‘s speech dates still to be announced.

What We’re Reading…  

• In a recent, timely report, the West Virginia Center on Budget and Policy explains why a shift away from a personal income tax toward a sales tax is a poor strategy for growing West Virginia’s economy.
• The Oklahoma Policy Institute provides detail on Oklahoma’s experience with triggers, explaining that tax cut triggers are anything but fiscally responsible.
• A new report from the Oregon Center on Public Policy provides 13 policy ideas for addressing the state’s $1.8 billion deficit for the upcoming budget period.

If you like what you are seeing in the Rundown (or even if you don’t) please send any feedback or tips for future posts to Meg Wiehe at meg@itep.org. Click here to sign up to receive the Rundown via email.

In recent weeks, the Republican congressional leadership’s effort to introduce a comprehensive tax reform bill has increasingly faced opposition from major business groups and skeptical lawmakers from across the aisle. The primary source of dissent thus far is that the most prominent tax framework, the House GOP’s “Better Way” tax blueprint, contains a radical provision to apply a border adjustment to pay for a cut in the rate from 35 to 20 percent.  

A new report from the Institute on Taxation and Economic Policy (ITEP) released today finds that this border adjustment tax would be regressive and loophole-ridden and would likely violate international trade agreements.

Under the proposed border adjustment, companies doing business in the United States would no longer pay corporate income tax on revenue earned from exports and would no longer be able to deduct the cost of imports from their corporate income tax liability. Because the United States currently runs a significant trade deficit, applying the tax at a 20-percent rate on imports and exempting exports could raise about $1.2 trillion over the next ten years.

It is important to note from the outset that even assuming the U.S. could raise a substantial amount of revenue from the border adjustment, the House GOP plan would still decimate federal revenue. An ITEP analysis finds that without the border adjustment provision, the House GOP plan would lose $2.5 trillion on the corporate side, and $4 trillion as a whole, over 10 years. In other words, even with the border adjustment the House GOP plan would fall $2.8 trillion short of its goal of revenue neutrality overall and would result in a $1.3 trillion revenue loss from the highly progressive corporate income tax.

The problems with the primary component of the House GOP’s corporate tax proposal go well beyond its revenue effects however. To start, the border adjustment likely would make the corporate income tax substantially more regressive. The inability of companies to deduct the cost of imports could substantially raise the tax rates paid by import-dependent industries such as retailers. To maintain profitability, import dependent industries would be forced to raise prices and pass on the cost of the tax to whatever extent possible. This means that a significant portion of the border adjustment tax would be paid in the form of a regressive tax on consumers. One recent estimate found that the bottom 10 percent of taxpayers may see their taxes go up by 5 percent of their pretax income, while the top 10 percent of taxpayers would only see their taxes go up by about 1.5 percent of their pretax income.

One of the major arguments that proponents of the border adjustment tax make is that it would stop corporate tax avoidance. It is certainly true that the border adjustment would remove companies’ incentive to use certain existing loopholes in our current system, but it would create numerous new opportunities for tax avoidance through the shifting around of sales. For example, Microsoft could avoid the tax by selling its software to consumers in the United States directly from servers in Ireland or another tax haven. At this point there is no reason to believe that following a tumultuous transition to a border adjusted tax that our tax system would end up less prone to tax avoidance than our current system.

And the transition to a border adjustment tax would certainly be tumultuous. Legal experts agree that it would likely be in violation of international agreements. Most importantly, the border adjustment is likely to be ruled illegal by the World Trade Organization (WTO) as an export subsidy. This is because the tax would favor domestic products over imported ones by allowing domestic producers to deduct compensation expenses, but would not allow the same deductions for imported products. A negative ruling by the WTO would mean that the U.S. would have to change the border adjustment tax into a proper tax on consumption, repeal the tax entirely or face retaliatory tariffs.

Given the myriad of problems that it creates, lawmakers should reject the border adjustment tax in favor of fixing the corporate income tax system that we have. The most effective way to accomplish this would be to end the ability of companies to defer paying taxes on their offshore income. While this approach has received less attention from the media, it has gotten a fair amount of high profile bipartisan support from lawmakers in the past. Both Democratic Senator Bernie Sanders and President Donald Trump called for ending deferral as part of their tax reform plans during the 2016 presidential primaries. On the Senate Finance Committee, Democratic Senator Ron Wyden and former Republican Senator Dan Coats introduced a bipartisan tax reform bill that would also have ended deferral. Taking this approach would have the benefits of raising a substantial amount of revenue and curbing tax avoidance without the daunting fairness and legal problems posed by a border adjustment.

Read the full report: “Regressive and Loophole-Ridden: Issues with the House GOP Border Adjustment Tax Proposal”

This week we are following a number of significant proposals being debated or introduced including reinstating the income tax in Alaska and eliminating the tax in West Virginia, establishing a regressive tax-cut trigger in Nebraska, restructuring the Illinois sales tax, moving New Mexico to a flat income tax and broader gross receipts tax, and updating gas taxes in Indiana and Tennessee.

— Meg Wiehe, ITEP State Policy Director, @megwiehe 

• Introduced last week, Alaska HB 115 would reinstate an income tax for the first time since 1980, setting the income tax rate at 15 percent of federal tax liability. It would also draw from the state’s Permanent Fund and change the structure of the yearly dividends provided to Alaskans.
• West Virginia Gov. Jim Justice echoed the sentiment of the state’s Senate President, who is leading a select committee to examine taxes, to eliminate the state’s personal income tax. The governor said his goal is to “… be the eighth state in the country to have no income tax.” However, given the state has a revenue shortfall, the governor’s budget proposes to use spending cuts and tax increases to close the gap this year, potentially putting the income tax elimination plan on hold for now. Tax increases in his budget proposal include a sales tax increase and base broadening, a gasoline tax increase, and the creation of a commercial activities tax.
• Nebraska lawmakers sent $137 million in budget cuts to the governor’s desk in an effort to help close the state’s $900 million budget gap. Also this week, the state’s Revenue Committee will hear testimony on a trigger-based tax cut for wealthy Nebraskans that would worsen the budget gap in future years.
• The latest tax plan out of the Illinois Senate would reduce the general sales tax rate from 6.25 percent to 5.75 percent while taxing food, drugs, and medical supplies at a higher rate and newly taxing services including repair and maintenance, laundry, landscaping, cable, and satellite.
  
• Proposals to increase fuel taxes to better fund infrastructure improvement are dead in Idaho but still under consideration in Indiana and Tennessee. In Tennessee, variations on Gov. Haslam’s attempt to combine the needed gas tax update with other tax cuts are proliferating, including one that would divert sales tax revenues from their intended purposes rather than update the gas tax, and a more responsible alternative that would update the gas tax and other fees without slashing other taxes.
  
• Kansas revenue committees in both chambers are seeing their share of tax reform proposals. A House bill that increases income taxes, eliminates the LLC exemption, and restores itemized deductions for medical expenses advanced by a wide margin today, and could receive a final vote on Thursday. The latest in the Senate—eliminating the exemption for LLC income and restoring pre-Brownback standard and itemized deductions and a third income tax bracket at 6.45 percent–is expected to go to a vote to the full floor tomorrow.
  
• A major tax bill has been introduced in the New Mexico House. House Bill 412 would restructure the state’s gross receipts tax and proposes a flat personal income tax.
  
• Despite higher energy prices, Wyoming’s economy remains flat while job and revenue growth continue to lag.
  
• In Oklahoma, the House Appropriations and Budget Committee passed a bill that would increase the tax on a pack of cigarettes by $1.50/pack. The bill now heads to the full House for consideration.
  
• Pennsylvania’s state supreme court refused to hear the Philadelphia soda tax appeal, arguing that the pending litigation is stopping the tax from funding programs it was created to fund.
  
• An Arkansas bill to collect taxes from online retailers passed the Senate but stalled in House committee. However, Amazon will start collecting and remitting sales taxes in the state this March. A bill to require tax collections for online sales from large retailers is still under consideration in Idaho.
• Another poll shows Iowa voters support paying more in sales taxes in exchange for investments in the state’s water quality and parks system.
  
• Efforts to help fill some of the state’s $1.8 billion budget deficit with increased revenue contributions from corporations are underway in Oregon.
  
• Nevada lawmakers heard a detailed presentation from an economic consultant explaining issues caused by the state’s property tax cap that has held property taxes down but undermined funding for schools and other local services.

Budget Watch 

• Illinois Gov. Bruce Rauner will be delivering his third budget address today. The state has not had a regular budget since FY 2015 due to an ongoing impasse between the governor and a democratic majority legislature.
  
• Wisconsin Gov. Scott Walker’s budget proposal includes a proposed $600 million in additional tax cuts—including elimination of the state’s property tax levy, reducing income tax rates, and restoring the EITC for families with one child. Senate leadership has suggested the more realistic target for tax cuts this session is $100 million.
  
• Connecticut Gov. Dannel Malloy’s budget proposal, released last week, includes a mix of budget cuts, new revenue and shifts of state pension obligations onto municipalities. Elimination of the state’s property tax credit and a cut to the state EITC are among the new revenue sources.

Governors’ State of the State Addresses 

• In the past week, Governors Bevin of Kentucky, Sununu of New Hampshire, and Justice of West Virginia delivered their State of the State addresses.
  
• There are no states with addresses scheduled through the end of next week.

What We’re Reading…

• A new paper out of the Wharton Business School looks at the relationship between “sin taxes” and consumer behavior, as well as ways to offset the more regressive impacts of these consumption taxes on low-income taxpayers.
  
• A study on government pension funds shows combined costs for most jurisdictions appear manageable. Concern is for those outlier states with highest pension burdens—Illinois, New Jersey, Connecticut, Hawaii, Kentucky, Massachusetts, Rhode Island, and Delaware.
• The West Virginia Center on Budget & Policy issued a brief showing that shifting from income taxes to sales taxes is a poor strategy for growing the state’s economy.

If you like what you are seeing in the Rundown (or even if you don’t) please send any feedback or tips for future posts to Meg Wiehe at meg@itep.org. Click here to sign up to receive the Rundown via email.

This is the fourth installment of our six-part series on 2017 state tax trends. The introduction to this series is available here.

State lawmakers often find themselves looking for ways to raise revenue to fund vital public services, fill budget gaps, or pay for the elimination or weakening of progressive taxes. Lately, that search has led many states to consider reforming or expanding their sales taxes.

Sales taxes fall heaviest on lower-income people, but they are an important component of states’ revenue streams. Making sure sales taxes keep up with the changing economy and new technologies is essential for states’ fiscal stability. The legislative areas we’re watching include taxing personal services, online shopping, streaming services, the sharing economy, and taxes designed to “nudge” consumer behavior.

Services

Purchases of haircuts, lawn care, massages, and other services aren’t taxed in many states even though services make up a larger share of consumption than tangible goods. Proposals to expand sales tax bases to some services have come from Louisiana, Maine, and Nebraska this year, among other states. Oklahoma‘s governor recently proposed extending the state sales tax to an exhaustive list of services while eliminating the tax on groceries. Ohio Gov. John Kasich has proposed increasing the sales tax rate and expanding it to more services while also cutting income taxes. The latest plan in the Illinois Senate would lower the existing sales tax rate and apply the tax to a broader range of goods and services including laundry, lawn care, cable, and satellite services. West Virginia’s governor also included a small service expansion in his budget proposal.

Expanding the sales tax to some services would create a more sustainable tax base, but the motivations behind most of the proposals introduced so far this year has been either to raise revenue to plug budget gaps (IL, LA, OK, and WV) or to help pay for top-heavy income tax cuts, shifting responsibility for funding state investments even further onto low- and moderate-income families (OH, ME and NE).

Online shopping

Goods sold online have been caught in a sales tax loophole. Businesses have no obligation to collect sales tax if they are not physically located in a state. Consumers are required to pay sales tax for purchases made online, but most consumers don’t know this and don’t pay it. State revenue agencies have a hard time collecting these unpaid taxes because they don’t know what residents are buying online. States have had some success with large online retailers voluntarily collecting sales tax. In fact, 95 percent of the population currently lives in states where Amazon, the country’s largest online retailer, collects sales tax.

A permanent fix to this confusion would require an act of Congress. In the meantime, many cash-strapped states are losing out on hundreds of millions of dollars of sales tax revenue they are legally owed. While they wait for Congress to act, states are taking various measures to attempt to recoup some of the missing revenue.

The most audacious states, such as Arkansas, Indiana, Mississippi, New Mexico, South Carolina, and Wyoming, are moving bills that would require large out-of-state retailers to collect and remit sales tax. These bills are almost identical to a South Dakota law that is currently embroiled in a legal case, and if passed would likely also face legal challenges from online retailers that do not have a physical presence in the state. The best hope for these bills is that they will draw the attention of Congress and encourage action.

Other methods are also being pursued to ensure that merchants collect the sales taxes owed under current. Bills in Arkansas and Kansas would require online sellers to notify customers that they owe sales tax and provide a list of consumers to the state revenue department, presumably to ease enforcement. New York’s Gov. Andrew Cuomo is urging legislators to expand the state’s online sales tax to online marketplaces such as  Amazon marketplace, Etsy, or eBay (Amazon is not required to collect sales tax for third-party sellers using the Amazon marketplace).  A Missouri bill would add the state to a group of 24 others that could begin collecting online sales tax once federal legislation is passed.

One aspect of tax fairness is treating all consumers similarly. Allowing an online shopper to skip out on sales tax when the same purchase would be taxed in a “brick-and-mortar” store is unfair. But sales taxes fall heaviest on low-income families. It would be nice if there was this much enthusiasm in statehouses for raising revenue in more progressive ways, say by cracking down on corporate tax avoidance.

Streaming services

Streaming services for video and audio content, like Netflix and Spotify, have also grabbed the attention of legislators looking for new sources of revenue. If enacted, Maine would follow the lead of places like Pennsylvania and Chicago in taxing streaming services. And while Pasadena, Calif. officials weigh extending the cable TV tax to streaming services, state legislators have proposed a bill that would prohibit such a tax.

On-demand economy

The emergence of the on-demand economy, with platforms like Airbnb and Uber, presents a host of regulatory questions, and taxation is just piece of that. Airbnb seems to have taken a page from the Amazon playbook and began voluntarily collecting and remitting various state and local hotel taxes,though sometimes as a means of encouraging states and localities to forgo meaningful regulation of the company. So far this year the company has agreed to collect and remit taxes in Arizona, Arkansas, and Colorado.

“Nudge” taxes

Using taxes to discourage perceived bad behavior are nothing new. So-called “sin taxes” on alcohol and cigarettes are the most well known. But evidence from the field of behavioral economics has recently led public health and environmental officials to advocate for excise taxes as a way to nudge consumers away from other potentially hazardous buying habits. Excise, or per unit, taxes on sugary drinks and plastic bags have gained traction, despite criticism of their regressive and paternalistic nature. Illinois lawmakers briefly floated a statewide soda tax as part of an effort to reach a “Grand Bargain” on the state’s budget. Montana legislators want to tax newly legalized medical marijuana, which would treat it more like alcohol and tobacco than a prescription drug. And a Maryland bill to legalize recreational marijuana includes an excise tax much like taxes included in other states’ legalization plans. While these taxes have the potential to change some behavior, most law-makers are introducing them as a way to raise revenue rather than improve well-being.

Tennessee Gov. Bill Haslam’s proposal (dubbed the IMPROVE Act) to raise the state’s gas tax while cutting three other taxes would essentially be a tax cut for the state’s wealthiest residents and a tax increase for the lowest-income Tennesseans.

While the gas tax is badly in need of an update to fund maintenance and investment in the state’s roads and bridges, slashing other taxes by an equivalent amount would essentially plug the hole in transportation funding with money devoted to other vital needs like K-12 schools, higher education, and public safety. And because the gas tax increase predominantly impacts lower-income Tennesseans and many of the tax cuts are tilted in favor of the highest-income Tennesseans, the net effect of the proposal would be a shift in responsibility for funding state investments away from high-income individuals and onto low- and middle-income families (Figure 1).

Raising the gas tax in Tennessee is long overdue and gas taxes are widely regarded as an appropriate means for funding transportation infrastructure because they are paid by the people who use that infrastructure the most. Importantly, this includes visitors passing through Tennessee as well as businesses that may not be headquartered in Tennessee but ship goods into, out of, or within the state.

However, increasing the gas tax has a bigger effect on low- and middle-income family budgets than it does on those with higher incomes. While it is desirable to seek ways to offset the gas tax increase for those families least able to afford the tax, lawmakers should seek to do so without sacrificing revenues needed to fund other public services. The IMPROVE Act fails mightily in this regard, slashing other taxes to such an extent that the state will end up with no more revenue than it has today, and focusing many of those tax cuts on wealthy individuals and corporations.

As shown in Figure 2, only the token grocery tax reduction (from the current 5 percent rate to 4.5 percent) is targeted to the Tennessee families most affected by the gas tax increase. On the other hand, the Hall Tax cut for investors (from the current 5 percent rate to 2 percent over two years) and corporate tax cut (allowing businesses to choose “single sales factor” apportionment) predominantly benefit the state’s wealthiest residents. The Hall Tax is slated for full elimination in 2022.