With contributions from Gabriel G. Diederich, CFA, Portfolio Manager; Brandon Pae, Senior Analyst, Municipal Credit Research; and Gilbert L. Southwell III, Senior Analyst, Municipal Credit Research

The U.S. Supreme Court ruled on June 21, 2018, that states may require online retailers to collect sales taxes.

In the case of South Dakota v. Wayfair Inc., the court ruled that so long as the state internet sales tax law is not an undue burden on interstate commerce and the internet retailer has a minimum connection with the state, internet retailers may be required to collect applicable state sales taxes, thereby overturning a previous 1992 ruling that had prohibited states from taxing internet sales.

The revenue benefits from the broadening of the sales tax base likely will be modestly  positive for state and local government coffers because many states already collect sales taxes on the majority of internet transactions. Additionally, a more level playing field for in-state brick-and-mortar retailers could support local economies and local credit quality, and benefit specific sales tax revenue bonds.

State collection of sales taxes on internet retail sales likely will be a positive for the revenue generation of states and local governments, but it won’t be a significant budget relief panacea

A state’s ability to collect sales taxes on internet retail sales will not create a large revenue windfall in the near term for most of the 45 states that currently impose sales taxes nor for local governments that share in those state sales tax collections.

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Reasons the revenue windfall likely will be limited:

  • The Government Accountability Office (GAO) estimated that state and local governments could gain between $8 and $13 billion if states were given authority to require sales tax collection from all online sellers. This amount represents less than 4% of total 2016 sales and local government general sales and gross receipts tax revenues. In addition, because various services are now purchased over the internet, those states that have use taxes will be entitled to capture those use taxes to the extent they have the proper laws and collection/enforcement systems in place. These additional sources of revenue are positive but not large ones.
  • According to the Tax Foundation, 31 states had some form of internet taxation law as of March 2018 and currently collect at least a portion of the online sales taxes they are eligible to receive. The Supreme Court decision, therefore, is likely to have a modest effect on sales tax revenues now that smaller internet retailers will be required to collect such taxes. Those states that do not currently have these online sales tax laws and those states that have no sales tax laws (Alaska, Delaware, Montana, New Hampshire, and Oregon) will not see a revenue bump at this point.
  • States may have smaller internet retailers who may qualify under de minimis exceptions or who actively seek to circumvent required sales tax collection. Additionally, states may not have the staff or funding to effectively police and audit these online retailers (and non-US online sellers).

The effect of internet sales taxes likely will be modest because major internet retailers already comply with existing state sales tax laws

As the 2017 GAO report notes, 35% to 40% of all internet retailers (representing 78% to 86% of the estimated internet sales taxes owed) voluntarily collect state sales taxes where applicable. This data includes giant internet retailers like Amazon and Walmart. Business-to-business internet retailers, which comprise as much as 45% of total internet retailers, also were voluntarily collecting state sales taxes where applicable.

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Local governments that levy their own sales taxes will benefit from a broader tax base

To the extent local governments collect local internet sales tax, there could be a benefit to local governments and specifically to local sales tax revenue bonds. In fact, state and local governments have sold $230 billion of bonds backed by sales tax revenues, according to Bloomberg. Local government reliance on sales taxes varies by region, with the greatest effect on local coffers likely to be in the Southwest and Southeast and more muted effects in New England and the Mideast states, as the table below indicates.

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Local economies may benefit from a more level playing field between physical stores and online stores because the implicit cost advantages for formerly untaxed internet retailers would disappear  

The Supreme Court decision could benefit brick-and-mortar businesses if the imposition of sales taxes on out-of-state internet transactions made these local businesses more competitive—potentially curbing local job losses and improving assessed real estate values over time. Accordingly, we believe local municipalities with significant retail presence could realize modest incremental local sales tax growth. Additionally, revenue increases from new internet sales tax collections (especially as the growth of these transactions have dwarfed those of traditional brick-and-mortar retailers), could help mitigate local budget pressures and/or increase infrastructure investment that could spur additional local economic growth. While positive, we believe such a transformation would occur over multiple years with uneven impacts and is unlikely to upend the trend favoring online shopping.

Lessons for muni investors

The Supreme Court’s decision to allow states to collect internet sales taxes is a long-term credit positive for state and local governments, though the immediate benefits may be muted. The revenue effects for municipalities that levy local sales taxes are modestly positive because those municipalities may realize potential sales taxes from both state and local internet transactions. Lastly, allowing states the right to collect sales taxes on out-of-state internet transactions may allow brick-and-mortar retailers to compete on a more level playing field.

For investors interested in evaluating the effect of the Supreme Court ruling on particular muni bonds, credit expertise will be necessary to determine the credit-specific and municipality-specific impacts of broadening the sales tax base. The impact on any specific credit would require an analysis of the issuer’s revenue mix, budgetary framework, tax collection scheme, local economy, and a number of other factors. As our analysis appears to show, the benefits of the Supreme Court’s internet sales tax ruling will help boost both state and local coffers, but at varying levels between states as well as between local governments.

 

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