Deep-Diving the Texas Comptroller's Single Local Tax Proposal
For a basic explanation of the proposed single local tax rule, see this post.
As economist Thomas Sowell once said, “There are no solutions, there are only trade-offs.” The single local tax rule for remote sellers recently proposed by the Texas Comptroller certainly hits on one of its stated goals: it definitely “eas[es] the burden” on remote sellers.
But are the trade-offs worth the marginal gains in ease for out-of-state businesses?
Argument for: Making it easier on sellers
The assumption that complying with local sales tax laws is particularly onerous is one that needs to be challenged. It was certainly true 26 years ago when the Quill case was decided, but advances in technology have rendered the argument relatively moot.
Hordes of services now exist to help alleviate the pain of managing sales tax collections for small businesses. TaxJar, for example, provides sales tax automation tools that integrate into many of the most popular merchant platforms, including Ebay, Etsy, and Shopify.
Other payment gateways, such as Stripe and PayPal, also integrate with these services to provide on-the-fly sales tax calculations. Heck, even the Comptroller provides a search tool to determine the tax rate at a given address.
No doubt, using a flat rate is easier than determining the actual rate, even if one were to use one of the many tools at one’s disposal. But the challenge of identifying the exact tax rate for a given location is a solved problem.
Argument for: Ease of reporting will encourage more people to collect local sales tax
The marginal gains in ease of reporting will most likely not be a major contributor when one decides whether to collect local sales tax. If I could file my income taxes on the back of a postcard, it would be easier to file them; but it’s the enforcement that provides the biggest motivation, not the ease of use.
Even more to the point, it’s extremely difficult to make this a selling point when the Comptroller has also issued a proposal to set the threshold for remote sales tax collections at $500,000 in taxable sales. Is there a business with half a million or more in annual sales outside of the state in which it is located that can’t afford $17/month for a TaxJar account?
We address the proposed $500,00 threshold rule in more detail here (coming soon).
Even at $100,000 - which is the threshold in South Dakota (where the Wayfair case originated) and which many states are using as a guideline - it’s hard to argue that accuracy isn’t worth less than 0.2% of the Texas sales it would cost to use one of these automation services.
Trade-off #1: Accuracy vs Ease
Even if one were to agree with the arguments presented above, one still has to grapple with the trade-off of ease over accuracy. As presented, this plan will benefit jurisdictions with higher per-capita sales tax at the expense of those with lower per-capita sales tax.
Let’s take an extreme example to prove the point: Sunset Valley, Texas, is a lovely town of about 700 people nestled in close proximity to some of the wealthiest parts of Austin. Over the past 12 months, the annual per capita sales tax collections total nearly $9,000, roughly 28 times the statewide per capita total for local tax collections.
With an above-average median household income, it is likely that the 700 residents of Sunset Valley spend more than the average bear; but it’s impossible to deny that the bulk of those sales tax dollars are imported from residents of neighboring jurisdictions. Sunset Valley stands to reap an outsized benefit from the single local tax rule. Rather than collecting only on the remote sales that occur within its 1.4 square mile borders, they’ll get credit for all the non-residents who come to town, spend a lot of money, and then leave.
Obviously, this is an extreme example, but if the local jurisdictions with above average per-capita sales tax collections stand to benefit from this rule, the rest stand to lose from it.
Trade-off #2: Easier on remote sellers, harder on Texas consumers
By making it easier for non-resident business owners, we’re making it more difficult and costly for Texas consumers. The many Texans who live in unincorporated areas with less than the full 2% local rate (in some cases, with no local tax rate) will be forced to pay the single local tax rate on remote transactions. They will be able to annually file for a refund on excess taxes, but the rules for how to prove excess payments are not yet defined and are likely to be taxing, if you’ll pardon the pun.
It strains credulity to suggest that it’s too difficult for a business to keep track of sales tax collections (when they use systems with the express purpose of keeping track of such things), but it’s not too onerous to expect an individual to monitor every remote transaction, check if the seller charged the single local tax rate or some other rate, and then calculate the amount of overpayment in order to receive a refund (when they have no such tools at their disposal).
Downward pressure on the single local tax rate calculation
Although perhaps a minor problem, it’s worth noting that the way the single local tax rate is calculated will result in downward pressure on the rate in future years as more and more single local filers remit their taxes.
The state will still collect its full 6.25% on single local tax payments, but localities will only receive their estimated percentage (rounded to the nearest quarter percent). For the most recent fiscal year, the estimated average local tax rate is about 1.84%, which gets rounded down to 1.75%.
This means that the state’s portion of these collections get counted in full for subsequent years, but localities only get 95% credit for them, driving down the ratio of local taxes vs state taxes and pushing the estimated tax rate down toward a limit of most likely 1.75%.
Population growth in areas with a full 2% local tax may mitigate this over time, but it’s unlikely that the single local tax rate would ever be rounded up to the full 2%.
At the very least, setting the single local tax rate at the actual estimated rate (rather than rounding to the nearest 0.25%) would prevent the formula from being skewed in future years. Although the rounding is a carry-over from the current fee-in-lieu-of-taxes, it is a bigger concern now that we should expect much higher amounts of single local tax collections than fees-in-lieu-of-taxes.
Impact on Confidential Reports
It’s also worth noting that the bill does not address how these tax payments will be recorded in the confidential information reports provided to local governments. Will these businesses be identified as single local taxpayers? Will cities have to guess as to which rate a business is using? We don’t know the answers to those questions, but will be following closely since it impacts how our clients analyze their sales tax data.
While the proposed single local tax rate has some attractive qualities, especially if you’re a business not located in Texas, it doesn’t come without trade-offs. And those trade-offs negatively impact local governments and Texas consumers alike. We believe the trade-offs aren't worth benefitting high per-capita tax jurisdictions at the expense of others, and of benefitting out-of-state businesses at the expense of Texas consumers.
You can read the full draft bill here.