Decline in District Tax Rates Belies Increases Across Other Jurisdictions

Vertex’s annual End-of-Year Sales Tax Rates and Rules report showed the overall decline was skewed by a decline in only one category—new district taxes. After a five-year stretch during which an average of 180 new district-level taxes were created each year, that number dropped to 115 this year.  

The data gets even more interesting as you get more granular. Even though fewer district taxes were created in 2022, the increases to existing district tax rates outnumbered decreases by a ratio of three to one.  

Beyond that, rate changes at other levels of government including city, state and local remained at record highs similar to the last few years. In fact, the county level posted a three-year high in 2022, while city rate changes remained at near all-time highs. 

Beyond the broad numbers, the 2022 report revealed several other interesting trends including declining income and property tax revenue, a shrinking sales tax base and the possibility of nationwide sales tax parameters.  

• Tax policy, economic conditions and fiscal conditions remain intertwined. 
  Although inflation is trending downward, it remains high and is unlikely to return to pre-2022 levels any time soon. Beyond that, there is a high probability of at least a moderate recession in the United States occurring this year. As it continues to be too expensive to borrow, state and local jurisdictions will need to pull other levers to bolster amid higher prices and labor costs.  

• Income tax and property tax revenue declines also drive sales tax changes. 
  Through legislation and ballot measures in 2022, state governments showed a growing desire to limit income tax rate increases, sometimes even lowering income tax rates and reducing property taxes in the same breath. With home values leveling off and commercial office space values declining due to hybrid working environments, governments will see lower property tax receipts in 2023 and beyond. And since property taxes, income taxes and transaction taxes represent the top three funding sources for state and local governments, more sales tax rate changes are likely on the horizon.  
• The shrinking sales tax base may spark new legislative approaches. 
  The sales tax base has shrunk significantly in the past two decades. State sales tax bases “are narrowing,” according to the Tax Foundation, “forcing states to either raise rates or shift to other sources of tax revenue in response to this continuous erosion.” This means state and local governments will look to create new sales tax bases including a growing number of digital taxes. That could also soon extend to professional services, such as accounting and other business-to-business offerings. 
• Post-Wayfair sales taxes are attracting federal attention. 

The Government Accountability Office (GAO) recently released a report addressing nationwide sales tax standards. The report encouraged Congress to work with states “to establish nationwide parameters for state taxation of remote sales.” This would help assuage compliance challenges, including the headaches remote sellers experience while trying to comply with “a complex patchwork of requirements … governing the taxation of remote sales.” Beyond that, last June the U.S. Senate Finance committee hosted a committee hearing to examine the impact of the Wayfair decision on small business and remote sellers.  

Given all this information, the big takeaway for businesses and consumers is that sales tax rates will continue to increase. It’s likely state and local governments will be looking even more closely to transaction taxes, especially on digital goods, services and advertising. 

Furthermore, as federal COVID funding dries up and borrowing becomes more expensive and inflation puts pressure on local economies, state and local governments will need to fill their budget shortfalls. State and local governments will undoubtedly look to sales tax because it is generally more efficient to implement and administer than other funding sources—making it a resilient and reliable revenue driver. Tax teams need to keep their eye on myriad changes again in 2023 or risk noncompliance. 

Michael Bernard is VP of Tax Content and Chief Tax Officer at Vertex.