Early signs as to what’s ahead
To no one’s surprise, 2022 was a busy year in the world of sales tax. Along with the usual barrage of rate, rule and form changes, many of which will become effective on January 1, 2023, we began to witness what is likely the beginning of a shift in tax philosophy. This new philosophy suggests an expanded role for sales tax in government funding in comparison to corporate and personal income taxes. In adopting this new approach, states appear to be recognizing that the regressive nature of sales tax, especially in an inflationary economy, supports targeted exemptions for basic human necessities. These two forces serve to make sales tax compliance both more important and more complex, and from the way it looks right now, more of the same is on tap for 2023.
The new philosophy
In August 2022, the Tax Foundation published data showing that for FY 2020, individual income taxes represented the largest source of state tax revenue. However, at 32.2%, sales tax was also a significant revenue source across the country. In the intervening years, the landscape has been changing. With the South Dakota v. Wayfair decision in 2018, states now possess expanded authority to apply their compliance requirements to remote sellers, and according to a recently issued GAO report, sales tax revenue collected across the country from remote sales approached $30 billion for CY 2021.
Perhaps with a sense of confidence that sales tax revenue will continue to grow, many states have been reducing their reliance on corporate and individual income taxes. As reported by the Tax Foundation, during the 2022 legislative session, 10 states enacted individual income tax rate reductions while six states reduced the corporate income tax rate. Perhaps no change was better emblematic of this shift than Kentucky HB 8 which, effective January 1, provides for a gradual reduction in the personal income tax, along with a marked increase in the types of personal and professional services subject to sales tax.
Combatting regressivity and inflation
Since sales tax applies at the point of consumption and disproportionately impacts those who spend more than save, most economists would describe it as a regressive tax. Across the country, legislators and regulators seek to alleviate the regressive nature of sales tax by enacting a variety of product-specific exemptions, exclusions or reduced rates. These exemptions often apply to items deemed to be basic human necessities such as groceries, drugs and clothing. The momentum around necessity-based exemptions also seems to tick up in times of increased inflationary pressures, with politicians keen to position themselves as providing their constituents with relief that can be felt at the cash register.
With these factors in mind, its no surprise that in 2022, we saw a decided uptick in states either enacting or expanding such exemptions and/or reductions, particularly as it relates to groceries (IL – temporary, KS, VA), diapers and baby feeding (CO, FL – temporary, IA, IL, LA, MD, PA, RI, VA) and feminine hygiene products (CO, IA, LA, MI, NE, NM, VA). There were also no fewer than eight new temporary tax holidays this year, with five in the state of Florida alone.
What’s on tap for 2023?
As new governors are sworn in and bills for the upcoming legislative session are pre-filed, we see continued interest across the country in further reducing income taxes. What’s not clear just yet however, is if those same states will seek sales tax increases to fund these proposed rate reductions. If sales tax base expansion is in the offing, likely targets include professional services and/or digital products which remain untaxed in many states.
Likewise, the effort to decrease the regressivity of sales tax seems set to continue, particularly as it relates to grocery food. While only a small handful of states continue to apply their full sales tax to grocery staples (AL, HI, ID, MS, SD) its possibly the number will shrink even further in 2023. Fresh from re-election, South Dakota Governor Kristi Noem declared the elimination of the state sales tax on groceries as her top priority for the 2023 legislative session.
Eliminating the sales tax on groceries is the best way to help families that are feeling the pressures of inflation at the grocery store. Since January 2021, the cost of a gallon of milk has risen 21%, a pound of ground beef costs 28% more, and the price of a dozen eggs has risen a staggering 133%.
This same sentiment is echoed by incoming Hawaii Governor Josh Green, who is seeking to author a proposal to eliminate the general excise tax on both food and medicine during his first 100 days in office.
It will carry a cost with it. We do have a surplus. It’s something that is the right thing to do. It’s been discussed for a long time. Those are very regressive taxes.
…and all this before we have officially turned the calendar to 2023. Without a doubt, it’s going to be an exciting year.
If you thought we had a lot of change and excitement in 2022, just wait until 2023. Because just like the phrase made famous by Bachman–Turner Overdrive, you ain’t seen nothing yet.
Hear more about sales tax trends and changes in this year’s annual edition of RegTalk.