State Budgets + Lagging Economic Forces = Sales Tax Changes

As their data-driven organizations embrace instantaneous forecasts and analyses, tax leaders should continually monitor a major wild risk card that rarely operates in real-time, often lags and has gaps – the economy. I’m referring to the “real” economy, which is adjusted for inflation, and comprises the total aggregate and dynamic “real” factors of an economy, excluding the financial components, although also essential. The real economy, encompassing goods production, purchase, consumption and the flow of goods and services, significantly impacts fiscal policies and consumption taxes like sales and value added tax. 

This is certainly the case in the U.S. where many state and local budgets (and rainy-day funds) appear flush – at least for the moment. These optimistic fiscal conditions are at risk of swift deterioration due to interrelated economic factors.  While states have been reducing taxes, both income and sales, a recent Stateline Weekly article discusses how Blue and Red states are slashing taxes despite warnings of hard times ahead. 

Even though the timing and magnitude of the impact of these economic forces remain uncertain, rest assured that the state and local government revenue declines these forces cause will increase the need for tax jurisdictions to: 

1. Increase existing sales tax rates; and/or 
2. Expand the breadth of the sales and use tax base by reducing sales tax exemptions and/or enacting new types of taxes, including digital services taxes and taxes on business services.  

As tax leaders prepare year-end strategic planning activities, they should consider the following economic variables to assess their organization’s future tax liabilities: 

• The COVID effect is just about finished: The federal government’s COVID stimulus programs conclude next year. While this recovery relief and stimulus funding provided crucial fiscal support during a difficult time, it also increased liquidity and artificially amplified spending and budgets, obscuring a more realistic picture of state and local fiscal conditions. 
• Student loan repayments are resuming: Tens of millions of Americans who have student loans through the federal government have benefitted from a payment hiatus (and interest) for more than three years. Now, most of those loan repayments will resume (borrowers who currently earn less than $32,800 annually will continue to be exempt from repayment). Citing 2017 Federal Reserve research, The Economist recently estimated that average payments of student debt range from $250 to $393 per month. As consumers with student loans restart their monthly payments, they will spend less on other goods and services, which will result in lower sales tax revenues at state and local levels. 
• Inflation remains stubbornly high: While the U.S. Federal Reserve chose not to raise interest rates in September, inflation pressure remains elevated.  The consensus at the most recent National Association of Business Economists (NABE) meeting that I attended was that getting the benchmark funds rate back to 2.0% any time soon is unrealistic. That helps explain why Federal Chair Jerome Powell has emphasized that higher rate increases remain an option. If that occurs, borrowing costs – for all borrowers, including state and local governments – are likely to remain elevated and could even increase later this year.  

These factors increase the odds that even more sales tax rate changes are on the way. Vertex’s Mid-Year Sales Tax Rates and Rules report indicates that the number of changes in jurisdiction rates across the U.S. have increased by more than 40% through June 30 compared to the same period last year. Those changes are not likely to subside – nor are states’ growing interest in enacting new types of digital taxes. 

These possibilities make it important for tax leaders to keep their eye on the looming impacts of current economic forces.  According to NABE, although the U.S. economy has been resilient, a recession may still be possible (50% chance or less), hence, the risk and uncertainty persist.