State and Local Governments Look to the Sales Tax to Refill Coffers
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COMMENTARY | During past adverse economic cycles, the tax has often proven to be a more consistent and efficient method of funding compared to the income tax.
Given today’s high inflation and rising interest rates, it would seem counterintuitive for elected leaders to impose higher income taxes. But, following a growing trend, state and local governments might be willing to increase or even levy new sales taxes.
The situation exists because states and localities face the same burdens of inflation that consumers do. Higher interest rates means borrowing money becomes a lot more expensive. Between that and the fact that many localities have already reached authorized debt levels, elected officials are increasingly considering using transaction taxes to fund services.
Historical trends reveal a pattern of state and local governments relying on the sales tax. In the past 60 years, in times of adverse economic cycles, the sales tax provides a much more consistent method of funding relative to the income tax. Beyond that, several states are considering reducing, eliminating or replacing the income tax with a broad sales tax, making it an even more significant source of revenue.
Regardless of the reason or deployment method, the sales tax will be a driver of government revenue in the near term. We’ve already seen this trend borne out in the first half of 2022. According to a recent report by my company, Vertex’s Mid-Year Rates and Rules Report, state and local taxes are already at an all-time high. For example:
- City and county sales tax rates have soared. City tax rate increases (126) far outnumber decreases (20) by more than a 6-to-1 ratio, while counties enacted almost twice as many sales tax increases compared to decreases (15).
- The average U.S. sales tax has reached an all-time high. Following a brief Covid-induced lull from 2020 to 2021, the average U.S. sales tax rate (which combines the average state, county, city and district rates) resumed its upward trajectory this year, hitting 10.17%.
- New district sales taxes have begun to level off. Following the first two years of the pandemic, when districts imposed new sales taxes at a record-setting pace, the rate of new taxes seem to be leveling off in 2022. During the first six months of this year, districts only implemented 54 new sales taxes compared to 127 new sales taxes enacted within the same time frame in 2021.
Elected leaders not only need to track these rate changes, but they also need to understand the broader economic, business and policy factors that ultimately cause these numbers to move. Wage inflation, rising interest rates, a long-term narrowing of the sales tax base and less federal assistance indicate that additional sales tax rates will continue to increase.
But at the same time, governments will be challenged to find new lanes for these taxes. Given that the economy—especially in lean times—is driven by spending on nondiscretionary items like housing, health care, food and energy each year, state and local governments will have to think about expanding the tax base as a policy matter rather than simply a revenue matter.
As we track this trend through the end of 2022 and beyond, tax teams will need to be watching all of these factors—economic and otherwise—to get a good read on the government tax landscape ahead.
Michael Bernard is the chief tax officer at Vertex Inc.
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