Amazon and lots of other online retailers don’t collect sales tax, and a flurry of bills this session have been filed to change that. Technically, consumers are supposed to remit those taxes on their own, but few do. These bills attempt to encourage the collection of such taxes and dictate how any new revenue collected should be spent. Arkansas needs to do everything it can, subject to federal law and court rulings, to promote and/or require out-of-state sellers without a physical presence in the state to collect the state and local sales taxes due on purchases of their goods by Arkansas consumers. Indeed, the legislative activity so far this session has even led the largest online retailer, Amazon, to announce that it would soon begin collection of sales taxes for purchases at Amazon made by Arkansas consumers.
It’s hard to make online retailers collect sales taxes like normal brick-and-mortar stores because of constitutional restrictions. A U.S. Supreme Court decision in 1992 limited the ability of state governments to force out-of-state sellers such as Amazon to collect sales taxes. States can only force a company to collect the sales taxes owed by consumers on online purchases if the company has a “nexus,” or physical presence in the state. Physical presence can mean a brick-and-mortar store, a distribution center, or even an “affiliate” seller in Arkansas—think cyber salesmen—an Arkansas company that links to an internet retailer from their site and receives a commission when consumers click and make a purchase from the retailer’s online store.
Companies with a physical presence in Arkansas, such as Wal-Mart or local mom-and-pop businesses that also sell via the internet, must collect sales taxes on the purchases its customers make online, while other companies such as Amazon can avoid collection (although many out-of-state retailers do voluntarily collect these taxes and remit the money to Arkansas).
This doesn’t absolve Arkansas taxpayers of their responsibility to pay the taxes owed in such cases. Under a law passed in 1949, Arkansas consumers are required to pay sales taxes on items purchased from out-of-state or remote sellers (technically such taxes are “use” taxes). The Arkansas Department of Finance and Administration (DFA) even has a form for taxpayers to remit sales tax payment owed on such purchases. But without an enforcement mechanism, most consumers fail to pay. Since DFA doesn’t have any information about the purchases consumers make online, they can’t go to consumers directly and collect the sales taxes owed.
With more purchases being made online, this limitation erodes the Arkansas sales tax base and reduces the state tax revenue that would otherwise be owed, and collected, by the State of Arkansas. Legislative sponsors have reported that Arkansas could be losing over $100 million annually in uncollected sales taxes (DFA has not released any official estimates). In turn, this reduces the revenue available for the state budget and funding for critical programs serving children and families.
It also impacts Arkansas businesses. Out-of-state sellers, in effect, have a competitive advantage over Arkansas-based companies forced to collect these taxes. All other factors being equal, the prices charged by out-of-state sellers for their goods could be as much as 6.5 percent cheaper (the cost of paying state sales taxes, excluding any local option sales taxes) and will be more attractive to consumers looking to pay the lowest price.
With this background, let’s turn to the bills that have been introduced this legislative session. One is House Bill 1388 by Representative Douglas. This bill makes avoiding collecting sales taxes much more cumbersome for online retailers. Online retailers who don’t collect sales tax would have to report all of the purchases that Arkansas consumers make. More specifically, it would require retailers that do not have a physical presence in Arkansas and that do not collect Arkansas sales taxes to do the following: (1) at the time of every purchase, notify the Arkansas customer that a sales tax is due on the purchase and that the State of Arkansas requires the customer to file a sales tax return; (2) by January 31 of each year, send a notice to their Arkansas customers showing the total amount the customer paid on purchases by the seller in the previous year; and (3) to submit an annual report to DFA by March 31 that includes the name of each of their Arkansas customers, the total amount paid by the customer during the previous year, and the customer’s shipping or delivery address. Out-of-state sellers that fail to make these notifications or file the necessary reports would be subject to financial penalties ranging from $5 to $10 for each instance of noncompliance.
The goal of HB1388 is to “encourage” out-of-state sellers to voluntarily collect the sales taxes owed by Arkansas consumers, rather than send notices to their Arkansas consumers or file reports with the State of Arkansas. In the absence of that, DFA would have the information to improve the collection of sales taxes owed by Arkansas consumers. The bill has passed the House and is now in the Senate awaiting consideration.
Another bill designed to improve collection of the sales taxes on purchases from out-of-state retailers by Arkansas consumers is Senate Bill 140 by Senator Files.1 Out-of-state companies without a physical presence in Arkansas would have to either file annual reports to DFA on the online purchases made by each of their Arkansas customers—similar to HB1388—or collect the sales taxes owed on purchases made by their Arkansas customers. It would also require the new Tax Reform and Relief Legislative Task Force to identify the amount of any new revenue collected under SB140 and recommend how to spend the new revenue, such as for more tax cuts or funding programs. (Note: At press time, there were hints that more amendments to SB140 might be forthcoming).
Other legislative action this session has focused on how to spend any revenues resulting from changes in state policy and collection of online sales taxes. Under existing state law, if federal law changes to allow Arkansas to require all out-of-state sellers without a physical presence in the state to collect sales taxes on purchases, a trigger kicks in to cut personal income taxes. Revenue gains exceeding $70 million from these taxes would be directed to reducing the state’s personal income tax rates. It would reduce the 4.5 percent tax rate equally for all taxpayers subject to that rate (Note: Such a tax cut would leave out many low-income taxpayers who would not qualify for a tax cut under that provision). The amount of the rate cut would depend on the amount of new revenue generated.
Under House Bill 1512 by Representative Davis, a federal law change would NOT be required before tax cuts kick in with the new revenue generated by the taxes paid by out-of-state sellers. HB1512 also changes the focus of the tax cuts to high income taxpayers. Under existing law, taxpayers subject to the 4.5% personal income tax rate would have their rates cut. HB1512 provides a personal income tax cut for taxpayers subject to the current top rate of 6.9% (taxpayers with net taxable incomes over $75,000). The amount of the cut in the current 6.9% top rate would depend on the amount of revenue generated by new out-of-state sellers—those registering on or after January 1, 2017—for the time period from July 1, 2017 through Jun 30, 2018. HB1512 also removes the requirement under existing law that the tax cut would only kick in when new sales tax revenue generated by out-of-state sellers exceeds $70 million. The tax cut under HB1512 would be effective for tax years after January 1, 2019. The bill also eliminates existing state law that would have cut state sales taxes on food to a 0% rate if certain conditions were met.
Another bill, House Bill 1535 by Representative Hendren, would also change how the new revenue would be spent if federal law gave Arkansas greater authority. The first $85 million in new revenue generated would be deposited into the State Apportionment Fund. Any new revenue in excess of that amount would be split evenly between (1) reducing the 4.5 percent rate in the personal income tax cut, as would already be required under existing state law; and (2) reducing the state sales and use tax by an amount equal to any new remaining revenue. To date, neither HB1512 or HB1535 has been presented in committee.
What does all of this mean for Arkansas? It’s clear that the future of the Arkansas sales tax and its ability to help fund critical investments in the state budget for children and families depends on it making sure all online retailers collect sales taxes. HB1388 and SB140 would both be positive steps in that direction.
What is problematic, however, is dedicating new revenue from the collection of sales taxes on online purchases to tax cuts, especially tax cuts that do little to help the poor. After $242 million in tax cuts enacted in 2013 and 2014, and $65 million in tax cuts already enacted this session, Arkansas can’t afford to adopt other tax cuts that would further undermine the ability of the state budget to make critical investments in our children and families. Perhaps more importantly, using the new revenues generated by sales tax collection on online purchases to pay for income tax cuts that would mostly leave out the poor would make our already regressive tax system even more so (low-income taxpayers pay about 12 cents on every dollar in state and local taxes, compared to just 6 cents for upper-income taxpayers).
Finally, tying new revenue from greater collection of online taxes to income tax cuts would undermine the ability of the future legislature to make decisions about how to use the revenue. It takes a three-fourths super-majority vote to raise income taxes, so bills such as HB1512 and HB1535 would make it impossible to spend the revenue a different way in the future.