Rachel Litcofsky: Welcome to Tax Matters, a Vertex podcast! I’m Rachel Litcofsky, Manager, Public Relations, at Vertex.
In this episode, Vertex Chief Tax Officer Michael Bernard digs into Vertex’s 2023 Year-End Sales Tax Rates and Rules report. Mike and business writer Eric Krell talk about U.S. sales tax rate changes that took place in 2023.
Last year was challenging. Sales tax rate changes reached a 10-year high and tax rate increases far outnumbered decreases at the city and county levels.
Mike analyzes this surge and the factors contributing to rising tax compliance complexity. Our podcast concludes with Mike highlighting the sales tax trends that he’s monitoring.
Now, I’ll turn it over to Michael and Eric.
Eric Krell: It’s great to talk to you Mike. Let’s dig into Vertex’s Year-End Sales Tax Rates and Rules report. What findings do you want to highlight?
Michael Bernard: Well, it’s good to visit with you again too, Eric. I’m always glad to talk about the report. So, a couple of quick things. One, we had a record number of changes in the report, in terms of increases, decreases and new taxes coming online in districts, cities, other locales and states. We had a record number of changes this year – a 10-year high. Two, I’d like to point out that at the district level -- now, remember, districts are simply [to fund] police, fire, parks and services like that -- there were almost three times as many changes at the district level compared to 2022, which is pretty amazing… And then at the city and county levels, there was significant amounts of changes as well.
Eric Krell: State rate changes also picked up. Only one state changed its rate in the three years from 2019 through 2021. But in the past 24 months, we’ve seen three state sales tax rate changes. What’s happening there, and how does that compare to what’s taking place in city and county jurisdictions.
Michael Bernard: Yes, good question. One of the things I would like to point out is that both South Dakota and New Mexico had reductions. South Dakota has a very broad tax base. To give some relief to their citizens, [South Dakota] actually dropped its rate. New Mexico actually dropped the rate in 2022 as well, so that state has had two years of decreases.
I also want to point out that there was a significant amount of effort in about 23 states over the last couple of years to reduce personal income taxes. This was due to the how the pandemic affected people’s incomes. That was a [notable] change outside of sales tax rates. … At the county level, the number of changes were almost 2 to 1 in terms of increases vs. decreases. And then at the city level, for every five [sales tax rate] increases, there was only one decrease. That makes sense to me because the cities still do not get a lot of revenue-sharing from the states. They need that money to actually deal with increased costs of labor as well as other costs that they’re incurring.
Eric Krell: What do these rate changes – and new taxing jurisdictions – mean from a compliance perspective?
Michael Bernard: If you look at the past 10 years we’ve had almost 6,000 increases, decreases or new taxes come online. That’s about 600 changes per year…There are just so many changes. It’s hard for our customers who are trying to get a handle on these rates. We have a monthly update that actually puts these [rate changes] out to our customers; yet, the complexity remains very [intense]. Obviously, our customers want to comply with the law and make sure that things are properly taxed. It also means that there is a need for more automation. Our updates are loaded into their pre-production environments so that they can test them, and then produce the proper rates and determinations to get their reporting right. All of those changes and the complexity that’s involved due to all of the jurisdictions in the United States certainly is something that all customers are dealing with.
Eric Krell: Rates and rules changes don’t happen in a vacuum. What compliance -- and “compliance-related” -- issues loomed large in 2023 and will continue to do so this year?
Michael Bernard: I think the best way to state this, Eric, is that just a couple of years ago Vertex supported about 400-500 fees. Those fees consist of green [or environmental] fees as well as what we call neighborhood fees. If you dine or purchase things in certain areas, such as at an airport or in a certain neighborhood, a lot of those places are starting to impose fees. Today, we support over a thousand fees. Fees are becoming more and more prevalent, particularly at the local level. I think you’re going to continue to see that, and it’s something that, our customers need continued support on.
Eric Krell: In addition to fees, sales tax holidays and exemptions are also increasing. What are the short- and long-term impacts of pulling those policy levers?
Michael Bernard: If you think about tax holidays, Eric, traditionally those relate to, for example, when students go back to school and buy backpacks, computers or any kind of ancillary materials that they use in school. I think one of the things that we’ve seen is that [tax holidays] have a political angle – they’re enacted because they obviously have a positive effect on the public in general. But, the long-term effect, which we’ve talked about before, relates to the fact that that the sales tax base today for most states is at a 60-year low. If you look back 60 years, sales tax was normally imposed at a lower rate on a wide base. And the opposite is in effect today: we have a much smaller base, to which very high rates are applied.
The increased rates you see in our sales and use tax report are very much in line with what’s going on. If your base is smaller, then you need to increase the rate in order to get the same amount of money -- or more money out of the sales tax funding portion… Over the long term, these tax holidays result in a smaller base and that’s just going to lead to more sales tax increases. The other thing is that most of the items that are exempt, at least regarding tax holidays, people need to buy anyway. Exempting [those products] actually takes them out of the base, in some ways permanently, which also leads to higher sales tax rates.
Eric Krell: When you talk about the tax base, my mind goes to the fiscal conditions of state and local governments. At a very high level, what kind of shape are those budgets in right now, and how might that change during the next 12 months or so?
Michael Bernard: I think, it’s going to change significantly. What happened during the pandemic – during the years 2021 to 2023 – was that a record amount of federal aid was sent to the states. What the Fed did was give a lot of relief to people who had either lost their jobs during the pandemic or who were otherwise negatively impacted by the pandemic. A lot of money flowed into the states: another infrastructure bill was passed to pay for a lot of road and port improvements, which the states didn’t have to pay for. So, coming into the end of 2023, we saw a record amount of rainy-day funds by most states.
Now, there’s an obviously an election coming up at the end of ’24. And we’re not going to see another record amount of money go into the states in 2024 or 2025. So, during their 2024 legislative sessions, states are going to have to think really hard about the fact that, yes, they do have record rainy day funds, but they also have no more money flowing back in – as was the case in 2021, 2022 and 2023. States are going to have to think about how their funding is going to continue so that they can meet their obligations -- roads and park as well as paying increased costs for personnel and for supplies that they buy. We expect to see strong fiscal challenges for state and locals moving in to 2024 and beyond.
Eric Krell: In the past few years, enacting new taxes on professional services seemed like a viable revenue-generation option. Is that still the case today?
Michael Bernard: You’re right, we’ve talked about that in the past. At this point, there are only about seven or eight states that have a sales tax on sales of professional services. I think we’re starting to think differently about more states imposing sales tax on services. As you’re well aware, about 40% to 50% of our economy is based upon services. But instituting a sales tax on services is quite difficult. You have to write new regulations. You have to hire auditors. You have to be willing to socialize those kinds of changes. And you have to think that the public will accept new taxes on services, which could be quite large. We’re starting to think that it is unlikely that we’ll see broad-based adoption [of sales taxes on services] by states and locals. If you think about one of the biggest services that is not taxed (and probably would be extremely regressive) – that’s healthcare… We just don’t see a lot of states, at this point, wanting to adopt a new tax on professional services.
Eric Krell: Before we sign off, zoom out to a global perspective -- what are some notable indirect tax compliance issues outside the U.S. in 2024?
Michael Bernard: I think there are two things. One, if you look outside the US there’s even a greater emphasis on green fees, or climate fees… You’re going to continue to see that VAT rates probably won’t increase. But I think you will see additional taxes designed to pay for some of [the impacts of] climate change. You’re also going to see more taxes on banks and wealthy individuals … I think those are going to be popular in terms of other countries, but not here.
And the other thing that has a tremendous effect outside of the US is e-invoicing. If you’re a company and you’re selling something to a consumer, normally that invoice has to be passed to a regulatory body and approved before that sale can take place. You’re going to see more and more real-time reporting and/or e-invoicing rules. Now, I don’t see that coming to the U.S. anytime soon because the issues are not the same. Outside the U.S., there tends to be a lot of fraud, including in the VAT system. You don’t see [fraud] as much in our sales and use tax system. Those are some of the big challenges that are going to have to be addressed outside of the US.
Eric Krell: Thanks very much, Mike. I look forward to continuing our conversation throughout the year.
Michael Bernard: Always good to speak with you, Eric.
Rachel Litcofsky: Thank you for listening to Tax Matters, a Vertex podcast. Check back here for more episodes soon.
Note: This transcript has been edited for clarity.
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