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Monday, November 24, 2008

Vendor Compensation for Collecting Sales Tax

I've suggested before that any state or congressional effort to get more vendors to collect sales tax (whether because they have nexus in the state and must collect it or because they have voluntarily registered in the state) - click here (#8 under Implementation Recommendations).

A Wall Street Journal article of 11/18/08 observed that the 26 states that allowed for vendor compensation for collecting the states were "forgoing" about $1 billion of taxes each year. Illinois paid the largest total amount of vendor compensation - $126 million in 2007.

The Journal article is primarily based on a recent report issued by Good Jobs First. Their report - Skimming the Sales Tax: How Walmart and Other Big Retailers (Legally) Keep a Cut of the Taxes We Pay on Everyday Purchases (11/08). This report also comments on situations where a city or state allows a big-box retailer to get some type of sales tax benefit for locating in the jurisdiction.

The report encourages states to rethink the policies and in particular, to put a cap on the possible amount of vendor compensation possible. The report seems to imply that today's technology for sales tax compliance is less costly than years ago when the cash register was the main technology. The report also encourages jurisdictions to not give any tax subisidies to busiensses unless necessary to ensure that basic necessities are available for sale in an area.

The report is very interesting by providing examples of tax subidies given to particular businesses and estimating based on Walmart public reports how much vendor compensation it likely receives. The report also lays out policy options for reform.

Is vendor compensation a bad idea? No, I don't think so for these reasons:
  1. Unlike income tax compliance, a business is collecting the sales tax directly from the customer for the state. Compliance costs can be high in terms of technology and peoplepower needed. While software systems exist, they are not cheap and need constant updating due to the frequency of state laws. Also, the sales tax laws vary from state to state making compliance challenging for companies that have collection obligations in multiple states. In addition to the software, there is a need for personnel to be sure the reports are correct and timely filed, to deal with notices from the tax agencies and to handle audits.
  2. Congressional proposals to allow states that simplify their sales tax systems to start collecting sales tax from remote vendors also call for states to all for reasonable vendor compensation. See for example, H.R. 3396 (110th Congress).
  3. States do benefit from vendors collecting sales tax as evidenced by high use tax non-compliance among the states (even those that make it easy by having a use tax line on the state income tax form).
  4. Costs of tax compliance are passed along to individuals in some manner - to customers via higher prices, to investors via lower earnings or perhaps even to workers via lower wages. While states could skip vendor compensation and just let normal business practices work, complicated and frequently changing sales tax rules are like an unfunded mandate to businesses if no compensation is provided. Legislators should be considering the costs of their current systems.

Could improvements be made? Certiainly. There would seem to be some economies of scale and a significant portion of the compliance costs are fixed, so a maximum compensation level seems warranted.

States should also look for ways to reduce compliance costs for vendors - simplifying the laws (even beyond what the Streamlined Sales & Use Tax Project has done), limiting the frequency of changes, and using technology to aid collection.

I've also noted in prior posts that for online vendors, a link on the payment page to the customer's state tax agency could enable the sales tax to be collected right then without the need for any vendor or customer filing. I know that privacy is a concern, but a certified third party could collect the sales tax rather than the state and then remit the tax to the state so that the state does not know what the resident purchased or how much they spent.

California does not provide vendor compensation. I think that when the states broadens/modernizes its sales tax to start collecting sales tax on personal services, digital goods and entertainment, it should also start some level of vendor compensation for all vendors. For vendors that newly become subject to sales tax collection, a refundable tax credit should be allowed to help cover their start up costs of getting ready to collect this tax on behalf of the state.

The bottom line for states is that they need to review their sales tax law to see how to make them workable - that the tax is remitted. If vendor compensation representing a very small percentage of the tax collected helps, it is worth it.

States must also work to reduce their sales and use tax gap. While California is considering increasing its already high sales tax rate to help address a budget shortfall, over $1 billion of the existing tax goes uncollected each year due to unremitted use tax!

For more on this topic, please see my reports and articles here.


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