Posted by Rich Huddleston and Kim Reeve on July 18th 2013
Now that the 2013 session of the Arkansas General Assembly is over, where do we go from here when it comes to taxes? A recent report from the Center on Budget and Policy Priorities (CBPP), Four Steps to Moving State Sales Taxes into the 21st Century, provides some insights into one possible avenue for future changes to the Arkansas system. According to the CBPP report, now is the time for states to modernize their revenue systems as they look to shore up their investments in strategies such as education and transportation that are important to promoting future economic growth. The report goes on to say that states “won’t be able to make these investments and sustain them over time without modern revenue systems that can raise adequate revenue as today’s economy expands.” A key step in any such effort has to include modernizing state sales tax systems which nationally account for one-third of the tax revenue states collect (35 percent in Arkansas).
Read the CBPP report here.
Most states, including Arkansas, have state sales tax systems that are ill suited to raising adequate revenue because they have not been sufficiently modernized to keep up with the growth of the service sector and e-commerce. States have attempted to compensate for their antiquated sales tax systems by raising sales tax rates repeatedly over the years. According to the CBPP report, the median state sales tax rate among the states is almost twice as high today as it was back in 1970. Arkansas recently enacted a half-cent increase in the state sales tax for at least 10 years to help pay for highways and roads, bringing the current state rate for most items up to 6.5 percent (note: food is taxed at a much lower rate and the state sales tax on food is scheduled to be reduced to just 0.125 percent if the conditions are met under Act 1398). Many localities have their own sales tax levies on top of the state sales tax.
The CBPP report goes on to suggest 4 ways states can modernize their sales taxes:
· Broadening the tax base to include more services. Many states, including Arkansas, have not broadened their sales tax bases sufficiently to reflect consumer spending that has been shifting from goods to services. States lose billions of dollars in tax revenue each from not applying sales tax to the broad array of services. Arkansas currently exempts a range of services, examples of which include veterinary services and advertising. For a relatively comprehensive listing of goods and services currently exempt from the Arkansas sales taxes, see here and here.
· Extending the sales tax to Internet downloads such as software, music, movies, books, and other goods delivered on the internet. Twenty-three states, including Arkansas, don’t tax these downloads even though they are taxed in stores. These items are becoming increasingly popular with consumers and comprise a larger portion of the economy than ever before, a trend that is only expected to grow in the future. The resulting revenue loss nationally is roughly $300 million per year.
· Closing the online hotel tax loophole that allows online travel companies such as Expedia and Orbitz to collect only part of the sales taxes on hotel room bookings. Forty two states, including Arkansas, have failed to collect taxes protected by this loophole. This costs states and localities nationally roughly $275 to $400 million per year in lost revenue.
· Enacting an “Amazon law” to require large online retailers to collect sales taxes on online purchases that are legally due but that online retailers are not currently required to collect. States and localities lose more than $20 billion annually as result. Arkansas is one of the few states that have already adopted an “Amazon law.” Act 1001 (also known as an “Amazon Law”) was signed into law during the 2011 legislative session and requires large on-line retailers who had some sort of physical location in the state to collect sales tax. Even with the adoption of the Amazon law, Arkansas can still do more to collect sales taxes from online retailers. For more information check out AACF’s 2011 report Add to Cart: How Arkansas can support vital services by fully taxing internet purchases.
The need to modernize and shore up Arkansas’s sales tax base is more important than ever. The Arkansas legislature passed a large tax cut package during the 2013 legislative session that targeted high income earners and corporate interests, resulting in cuts that will escalate to $141 million in state general revenue by fiscal year 2016. Not only do these cuts reduce the state’s ability to build and maintain investments in our workforce and infrastructure that are important to the state’s ability to compete for better paying jobs in the future, they also weaken the future revenue base to pay for programs that are critical for at-risk children – including quality pre-k, child welfare, and juvenile justice. These programs have been flat funded or cut during the economic slowdown in recent years. It is essential that Arkansas look for ways to rebuild its fiscal foundation for the future. Modernizing the state’s sales tax base has to be part of any strategy for doing that.
Admittedly, modernizing the Arkansas sales tax is by no means the answer to all of the state’s revenue problems. Short of repealing the high income tax cuts passed during the 2013 session, modernizing the state sales tax base may be one of Arkansas’s best options for shoring up the state’s uncertain fiscal foundation. More importantly, it has to be done if the Arkansas tax system is going to keep pace with, and benefit from, the changing economy and the continuing shift from goods to services and products purchased online and over the Internet.
Arkansas will have to address two important issues after expanding its sales tax base. First, other steps, including shoring up personal and corporate income taxes (or at least not allowing further decline in the ability of those taxes to raise revenue), will have to be taken to build up the state's fiscal foundation. Second, Arkansas will have to address the impact that expanding the sales tax base will have on low-income households. In general, sales taxes are more regressive than income taxes (i.e., they consume a larger portion of the incomes of low-income families than upper-income families) and expanding the sales tax base would hit low-income households harder. Arkansas still needs to pass a state-level earned income credit (EITC) to mitigate the impact of expanding the sales tax base on low-income families. It could do this by directing part of any revenue resulting from expanding the base to paying for a state EITC. Although the Arkansas legislature rejected a bill to do this during the recent 2013 legislative session, this has to be on the state's agenda for future tax changes.