July 23rd, 2020

Sales tax after two months of Covid-19, and how Marketplace Providers saved some cities

As we discussed on the latest episode of ZacCast, local sales tax numbers across the state of Texas have outperformed the expectations of even the most optimistic among us. While many cities have taken substantial losses, the statewide loss in municipal sales taxes totaled just over 1% in July (the period covering May sales).

Why certain cities did better than others is the product of many, many factors, and there is no universal theorem to explain why this is the case. But there are some broad brushes with which we can paint:

Statewide

Statewide municipal sales taxes totaled $483,422,612 in July 2020, which was down about $5.495m or 1.12% from 2019.

Note: Once August sales tax is released, the link above will no longer contain data from July

Top 20 Cities

The top 20 sales tax generating cities (for 2020) pulled in 45% of all municipal sales tax in July. This group accounted for $19.624m in declines, a -8.27% change compared to 2019. The largest declines, from a percent-change standpoint, were in Midland and Odessa with 29% and 36% respectively. The top 5 cities (Houston, San Antonio, Dallas, Austin, and Fort Worth), saw total declines of 9.8%, or $14.1m. Only 6 of the top 20 cities had gains in July, including Arlington, El Paso, Irving, Lubbock, McKinney, and Grand Prairie.

There are many plausible explanations for why the largest sales tax cities saw the steepest declines, the most obvious of which being that these cities represent areas with higher population densities, and were therefore subject to higher case loads and more restricted reopening schedules in May than smaller, more rural areas. However, the declines were less pronounced in suburban areas adjacent to these larger cities, which suggests a complementary explanation: that they rely more on importing sales tax by drawing in residents of neighboring cities for shopping. With many businesses still unable to fully reopen, those neighboring residents opted for other shopping outlets (whether in their own cities or via the Internet) rather than traveling to “the city.” 

The following image shows the gain/loss from cities surrounding Dallas and Tarrant counties compared with cities inside those two counties:

Nos. 20 - 250 

The remainder of the top 250 (which includes cities ranging from San Marcos to Seabrook) accounted for 47% of all municipal sales tax in July, or $226.3m. This group saw an increase of $10.99m, or 5.11% compared to 2019.

Everyone else

The other 915 cities generated $39.49m in July, or 8.1% of total tax collections. This group had gains of $3.1m or 8.6%.

For this month’s interesting but ultimately meaningless coincidence: the losses of the top 5 cities were functionally wiped out by gains in cities 21-1,165 ($14.118m declines compared to $14.128m in gains, respectively), meaning that the net drop in sales tax across the state is fully accounted for among cities 6-20.

Assessing the impact of Marketplace Providers

While the tax importation explanation above does not completely explain why bigger cities saw, on average, larger losses over the past two months, a brief survey of marketplace taxpayers lends some credence to the idea. 

If you aren’t familiar with the terminology, Marketplace Providers are entities that provide an outlet for third-party retailers to sell goods, but which do not act as retailers themselves. Examples include eBay, Etsy, Amazon’s third-party sales, and others. New rules passed in the 2019 legislative session require Marketplace Providers to collect and remit sales taxes on behalf of the third-party vendors that use those services. This is an entirely new revenue stream for Texas local governments in fiscal year 2020. 

full list of registered Marketplace Providers can be found here. We’ve taken this list and extracted the payments made by these vendors to the 130+ cities using ZacTax to evaluate their impact during the period of full closures in April and as those restrictions were eased in May.

While the new Marketplace Provider rules resulted in increased revenue across the board, for some cities this new revenue was a significant source of support during this period. These taxpayers represented an average of 3.55% of total collections in April (June allocations), and 4.03% in May (July allocations).

For some cities, new revenue from Marketplace Providers offset between 30-60% of other losses. And in about 2% of cities, it turned what would have been down months in June or July into net gains.

Zooming back out, the Comptroller has begun publishing marketplace totals for local governments.

Note: Once August sales tax is released, the link above will no longer contain data from July

We combined this report with the publicly available allocation data that we collect and make available at OpenZac to calculate the percent of total collections that Marketplace Provider payments made up for all Texas cities in July. The statewide average was 3.2%, but there was a significant difference in impact between larger and smaller sales tax generating cities. 

Here’s a scatter plot showing marketplace payments as a % of total collections for cities generating between $5,000 and $250,000 in total collections (we’ve tried to remove some major outliers by limiting the collections to at least $5,000):

The negative correlation between total revenue and marketplace percentage remains when comparing all cities, but it is slightly less clear due to the low-end outliers. However, a statistically significant difference in the average percentage of marketplace payments exists when comparing cities generating more than $1m in July (2.99%) with those generating less than $1m (6.5%). 

While certainly not conclusive, it does suggest the tax importation explanation mighthave legs. This will be something we’ll continue to monitor over time. If the tax importation hypothesis has empirical support, we’d expect to see the difference between large and small cities shrink as we eventually get “back to normal.” We’ll also attempt to retrieve this data back to November 2019 to see what the world looked like pre-Covid.

Where does that leave us?

The Covid-19 restrictions put in place across Texas during April and May no doubt had a significant impact on the sales tax collections for cities across the state. While it’s safe to say that the collections we’ve seen have outperformed, on average, what most people expected when the closures were implemented, many cities are still facing significant challenges. 

Most of the net losses across Texas occurred in the larger cities. How much of this decline can be explained by the closures themselves, by the spikes in unemployment during those months, by sales tax importation issues, or by the general uncertainty felt by people across the state, is difficult to tease out using only the publicly available data. 

The benefit of tools like ZacTax is that you have much more granular access to your sales tax data. By aggregating this information, we’ve seen how important the new Marketplace Provider rule was to local governments during this time. In our sample of ~10% of Texas cities, these new taxpayers accounted for 3.5-4% of all revenue collected during June and July. In some cases, cities that saw net gains in June and July would have experienced declines without this new revenue source.

We’re not out of the woods yet. As case counts continue to rise, and concerns about having to drop back down to Phase 1 restrictions grow with each day, we might indeed be looking at several more months of sales tax impacts. If you have any questions, or need some help evaluating your sales tax performance, please don’t hesitate to reach out to us.

Editor's Note: This article first appeared as the inaugural issue of the ZacTax Roundup, our new monthly newsletter. Sign up for free so you don't miss our next issue!