Online Sales Surge Not Enough to Replace Brick-and-Mortar Revenue
States are seeing higher remote sales tax revenues amid the COVID-19 pandemic, suggesting lockdowns have accelerated a shift to online shopping.
With more people staying home and with many stores temporarily or permanently closing their doors, consumers have turned to online retailers, resulting in a significant uptick in e-commerce transactions, according to experts.
“Even if a state was minimally impacted by COVID-19, many national chains closed all of their stores to protect the health and safety of their employees, meaning many of their customers likely turned to online buying,” Natalie Kotlyar of BDO USA LLP told Tax Notes June 15.
“Many consumers who previously avoided online shopping were forced to at least try it out, especially if they were looking to buy anything outside of essentials, and it’s likely that many of them will continue to leverage e-commerce to some degree,” Kotlyar said.
Experts say state governments will look to the increased online sales tax revenue to ease budget shortfalls.
However, sources said this will not be enough to make up for the drop in brick-and-mortar sales tax revenue, especially in states that don't have remote seller laws.
“For states with no remote sales tax laws, a stark decrease in spending on products that are traditionally purchased in-store will have an ongoing impact on sales tax revenues in those states,” Liz Armbruester, senior vice president of global compliance at Avalara, told Tax Notes.
“It's hard to predict, but I think time definitely will tell us that states with online sales tax provisions will likely see revenue from those sources remain more consistent during COVID-19 than when you compare them to the brick-and-mortar sales tax revenue,” Armbruester said.
Shopping Habits Change
Bonnie Swingle, media manager for the South Carolina Department of Revenue, said remote sellers have generated a significant increase in online sales taxes in 2020 compared with 2019. For example, South Carolina sales taxes reported by remote sellers increased by $2 million in March 2020 compared with March 2019 and by $4.2 million in April 2020 compared with the previous year.
Virginia also saw an uptick in remote sales tax collections, according to Stephanie Benson with the state Department of Taxation. “Remote sales and use tax collections in Virginia were up by 36.6 percent at $40.9 million Virginia in April,” she said.
The increase in online sales that states have been seeing will continue throughout 2020 and beyond, Kotlyar said, pointing to an April poll that found that nearly a quarter of consumers say they will not be comfortable shopping in a mall for at least six more months.
Traditional Sales Tax Revenue Losses
Kelly Cortesi, director of communications for the Tennessee revenue department, said in a June 4 email that the increase in remote sales tax revenue is not enough to make up for decreased sales tax revenue from physical stores.
Cortesi said the DOR collected $16.5 million in state and local sales tax from out-of-state retailers for April in comparison to the $7.1 million that was collected during the same time in 2019, but overall sales tax collections for April were down 6 percent.
“From the limited data we have so far, Tennessee appears to be seeing the same trend as other states: Remote sales tax revenue has increased, but not enough to make up for sales tax decreases we’re seeing elsewhere,” Cortesi said.
Charles Maniace, vice president of regulatory analysis and design at Sovos, said July 2 he's not surprised that increased e-commerce is not enough to offset the loss of brick-and-mortar tax revenue. He said that the substantial unemployment rate has likely contributed to the drop in overall buying, especially for more expensive durable goods like cars, which are often purchased locally and generate significant sales tax revenue.
Mississippi has similarly seen an increase in remote sales while in-state sales tax revenue is down, Jacob Manley, spokesperson for the DOR, told Tax Notes May 29. Remote sellers pay use tax in the state and account for approximately 65 percent of Mississippi's total use tax collections, but the increase in tax revenue from remote sales has not offset the loss of sales tax revenue from in-state businesses, he said.
Options to Boost Tax Revenue
Armbruester said states’ options to offset lost sales tax revenue include increased remote sales tax enforcement, changes to remote seller nexus thresholds, the taxation of previously exempt goods, and alternative revenue streams. “How fast our economy recovers will really be an indicator of how fast states are likely to ramp up the enforcement of remote sales tax,” she added.
More states will likely adjust their remote sales tax thresholds to increase their revenue streams like Tennessee recently did, Armbruester said. Budget bill S.B. 2932, signed June 30 by Gov. Bill Lee (R), reduces the economic nexus threshold for remote sellers from $500,000 to $100,000 as of October 1.
“It’s possible that [other] states that are heavily reliant on sales tax revenue could look to follow suit and lower the thresholds that trigger economic nexus obligations or even remove thresholds completely,” Armbruester said.
However, noting that the Supreme Court's decision in Wayfair suggested South Dakota's $100,000 economic nexus threshold did not constitute an undue burden on interstate commerce, Maniace warned that states "should be cognizant of their obligation to ensure compliance is not unduly burdensome and actively consider simplifications that continually make tax a little easier for sellers to deal with."
“While the Court did not say that same standard would pass constitutional muster in all states, many jurisdictions directly aligned their standard to South Dakota’s as a safe harbor,” Maniace added.
States may also seek to broaden their sales tax bases.
“If a significant tax gap emerges from COVID-19, it’s reasonable to expect tax changes,” Maniace said. “Changes will likely include increased state and local rates and other activities that will expand the tax base to cover additional products and services.”
Given that 2020 is an election year, tax rate increases would likely be on hold until 2021, Maniace added.
States and local entities could also look to taxing digital products through digital services taxes. Both Armbruester and Maniace say that states could consider taxes on digital products and services, such as advertising, to make up for revenue shortfalls.
Several states, including Maryland, Nebraska, New York, and the District of Columbia, have all recently considered legislation that would tax digital advertisements.
According to Eric Fader, managing director of BDO’s state and local tax services practice, legislation like the one proposed in Maryland may likely violate the federal statutory bar against a discriminatory tax on electronic commerce.
Some practitioners have echoed the concern that proposals specifically targeting digital advertisements could face constitutional challenges and likely violate the federal Internet Tax Freedom Act.
Fader said one way states could circumvent this issue would be to include all advertising, not just digital advertising services, but acknowledged that “raising taxes and increasing costs for residents and businesses, particularly given the pandemic, is a hard sell.”