TaxProf Blog

Editor: Paul L. Caron, Dean
Pepperdine University School of Law

Monday, December 22, 2008

Skimming the Sales Tax: How Big Retailers (Legally) Keep a Cut

Tax Analysts Philip Mattera & Leight McIlvaine (both of Good Jobs First) have published Skimming the Sales Tax:  How Big Retailers (Legally) Keep a Cut, 50 State Tax Notes 713 (Dec. 15, 2008).  Here is the Executive Summary:

No shopper enjoys seeing sales tax added to the bill at the checkout. We tolerate the expense because the funds pay for vital public services. Yet many of us don't realize that in most states with a sales tax, a portion of the money actually goes into the pocket of the retailer under programs set up by state and local governments.

In this first-ever comprehensive national analysis of the subject, Good Jobs First finds that the public sector is losing more than $1 billion a year through these sales tax diversions. A large share of revenue gets redirected to giant retailers such as Walmart, which we estimate pockets more than $70 million a year in sales tax revenue.

The main way sales tax collections are "skimmed" from public coffers is through policies that allow all retailers to keep a portion of what they collect on behalf of state and local governments. The practice, known by terms such as "vendor discount" and "dealer collection allowance," is essentially a service fee meant to compensate store owners for the time and trouble of recording sales tax collections and remitting them to revenue agencies. States first adopted retailer compensation policies when shop owners kept records by hand, but the policies remained in place even after the advent of electronic cash registers and computers.

Today about half the states provide that compensation, which is typically calculated as a percentage of the sales tax collected and is limited to retailers that make their tax payments in a timely fashion. Of the 26 states that provide compensation, put a ceiling on the amount any individual store or chain can receive. Those ceilings range from less than $1,000 a year to more than $10,000 a year; Michigan, with a maximum of $240,000, is by far the highest.

The 13 states without a ceiling end up giving away substantial amounts of sales tax revenue in retailer compensation. Illinois leads the list with an annual revenue loss of $126 million. Texas is second at $89 million, followed by Pennsylvania at $72 million and Colorado at $68 million. Looking at those with and without ceilings, we estimate that the 26 states providing retailer compensation lose a total of just over $1 billion a year.

The compensation issue became more complicated and more contentious with the rise of mail order and online retailing, in which the buyer and seller are usually located in different jurisdictions with different sales tax policies. After a period in which many remote transactions went untaxed, costing states more lost revenue each year, there has been movement toward a new system under which interstate retailers collect taxes on all their shipments based on more streamlined and consistent policies across the states. In exchange, the retailers expect compensation from all the states involved. Hence the issue of what constitutes fair vendor compensation will be a major policy issue for the states, with decisions about those interstate rules likely to affect state revenue for decades.

Retailer compensation is not the only cause of leakage in government sales tax collections. Local governments, as allowed by some states' laws, also use sales tax revenue to finance economic development projects involving big-box stores and malls. That occurs in two main forms. Some localities sign deals that allow big retailers to keep a substantial portion of the local share of the sales tax generated by a new store. In some cases, the locality advances money to the company before the store even opens. Those subsidies are known as sales tax rebates or refunds.

In other cases, localities divert a portion of the sales tax generated by a new retail project to finance tax-free, low-interest bonds that directly subsidize the retailer or pay for infrastructure improvements at the site of the new store or shopping center. This is known as sales tax increment financing (STIF).

There are no national figures on the amount of sales tax revenue diverted through rebates or STIFs. Instead, we take a look at the available information on those practices, as well as retailer compensation, for the country's largest retailer, Walmart.

We estimate that Walmart collects about $60 million a year in retailer compensation in the 26 states that provide those payments. The highest amounts are in Missouri ($10 million), Colorado ($9 million), Illinois ($8.5 million), and Texas ($7.5 million). In a few states, Walmart accounts for more than 10 percent of the total amount paid out in retailer compensation. In Missouri Walmart's estimated share is 25 percent.

Although there is no comprehensive data source on Walmart's use of economic development subsidies, Good Jobs First has done extensive research on the subject. Here we isolate those subsidy deals that involve a sales tax rebate or STIF. We find that over the past decade Walmart projects have been given about $130 million in those subsidies, or an average of about $13 million a year. Combining retailer compensation and subsidies, we find that Walmart accounts for the diversion of about $73 million in state or local sales tax revenue each year.

Our findings impel several policy recommendations. We urge states with retailer compensation to modernize those practices in light of technological advances. In particular, we urge those states with no ceilings on the compensation to consider placing caps on what is now a windfall for giant retailers such as Walmart. Even if some amount of compensation is deemed appropriate, the economies of scale enabled by computerization remove much of the justification for limitless payments.

States will also need to review their practices if they decide to join the streamlined system for interstate transactions. Legislation before Congress would require those states -- including those that do not have vendor compensation programs -- to provide "reasonable compensation" not only for interstate sales but for all transactions. Because the legislation would leave it up to the states to decide what is reasonable, state policymakers would have to confront the issue directly. We urge them to be prudent in the compensation policies they adopt and to ensure that the amount available to any given retailer is not open-ended.

As for economic development subsidies, we have long argued that it is not good public policy to subsidize any retail projects, except in those limited instances in which they help bring necessities such as food, clothing, and prescription drugs to communities that are demonstrably underserved. Elsewhere, sales tax rebates and STIFs have played a detrimental role by encouraging retail overbuilding in much of the nation, and should probably be discontinued.

Sales taxes are an integral part of most states' and cities' "three-legged stool" of revenue, along with property and income taxes. Allowing a significant portion of that income stream to be skimmed serves only to enrich private interests at the expense of essential public services.

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This explains why retailers often demand the sales tax when its not required. For example, take-out food in California is not taxable but many restaurants collect the sales tax. Its policy set at corp HQ (I've asked).

Posted by: guy in the veal calf office | Dec 26, 2008 12:17:39 PM