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State Revenue Did Better Than Expected in Pandemic, Report Says

Posted on July 15, 2021

State tax revenues have exceeded the predictions made by revenue forecasters at the beginning of the pandemic, in part because of more-robust-than-expected online sales and income tax collections.

According to a July 13 report by the Urban-Brookings Tax Policy Center, think tanks predicted at the start of the pandemic that states would lose billions in tax revenue because of the economic downturn. Report authors Lucy Dadayan and Kim Reuben say state tax collections decreased nearly $61 billion, or 49 percent, in April 2020 compared with the previous year, which was partly attributed to states and the federal government pushing back tax deadlines.

But state revenues have mostly rebounded since then for a few reasons, according to the report, which is based on a survey of state budget officials conducted beginning in February. The survey, which elicited responses from 44 states, was funded by the tax compliance software company Avalara. The company also provided input on the survey questions, according to Tommy Morgan, senior manager of public relations for Avalara.

First, the revenue losses were stemmed by stronger-than-expected income tax revenues partly attributed to support from the federal Coronavirus Aid, Relief, and Economic Security Act, which provided approximately $200 billion in aid for state and local governments, the authors note. Also, because high-income workers were mostly unaffected by job layoffs, income tax revenues were less affected, especially in states with progressive income taxes.

Sales tax revenues were also higher than expected, buoyed by an increase in online sales. The report notes that most states with a general sales tax established economic nexus for out-of-state retailers after the U.S. Supreme Court’s 2018 decision in South Dakota v. Wayfair Inc., which paved the way for states to impose a collection obligation on sellers without a physical presence in their state. "Before the pandemic, many critics thought that states had rushed to enact legislation without careful assessment of enforcement mechanisms, thresholds, and retroactivity requirements," the report notes. "But quick enactment of legislation in most states turned out to be extremely fortuitous because many consumers accelerated online purchases with the onset of the pandemic."

Before the pandemic, the growing share of spending on services, which aren't as widely taxed as goods, was a challenge for many states, according to the report. People spent more on goods than services during the pandemic — "in part because many services related to entertainment and travel have been curtailed by government mandates" — so the report cautions that "this is likely a one-time shift rather than a change in trend, and many states will continue facing the erosion of their sales tax base." One of the survey questions asked whether state officials are considering changes to the taxation of goods and services given the change in consumer behavior, but the report notes that "most states either didn't respond or indicated no deliberations were underway." 

One major takeaway from the survey is that because of the way sales taxes are remitted, many states can’t distinguish between in-person and online sales for retailers with a physical presence in their state. The authors explain that states are usually able to track remote sales but have trouble monitoring online sales from companies that also have physical nexus.

“Since e-commerce is increasingly playing an important role in states’ economies, it could be crucial for states to monitor and assess sales tax collections from online purchases to ensure that businesses are compliant with rules and regulations,” the report says.

Scott Peterson, vice president of U.S. tax policy at Avalara, told Tax Notes that states would likely have had to enact steeper budget cuts if it weren't for Wayfair

However, states don't have much data on online sellers and their customers, Peterson said, and because the states aren't tracking online sales tax collections, Avalara doesn't know how much revenue states are losing.

“What we do know is that most states, from studies that we have done, show that we’re not yet to 50 percent compliance with the Wayfair decision, and it varies by the business. Larger businesses are much more likely to be compliant, medium are a little less likely, and small are unlikely to be compliant,” Peterson said. And because there are so many more small businesses than there are large businesses, the amount of revenue that could be generated by small businesses that are out of compliance is about the same as what is generated from large businesses, he said.

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