september 6–9, 2018

Federal Tax Reform —
Impact on the States

Kim S. Rueben, PhD

Senior Fellow
Tax Policy Center
Urban Institute & Brookings Institution

An expert on the implications of tax reform for the States, Dr. Reuben interpreted the new Federal Tax Reform law and explored what States can do to take advantage of new opportunities it offers.

Dr. Reuben pointed out that taxes are essential to pay for services to make our communities better; however, she advised Forum members to reconsider what the business of governing is, and to assess new strategies to provide the services needed to build the States’ futures. The impacts of the major changes to the Federal tax code from the Tax Cuts and Jobs Act (TCJA) will differ across the states, depending on each state’s economic, fiscal, and demographic characteristics, she observed.

The new tax law makes substantial changes to the rates and bases of both the individual and corporate income taxes, cutting the corporate income tax rate to 21% from 35%, redesigning international tax rules, and simplifying reporting for those who do not itemize deductions, but adding complexity for pass-through businesses. The most meaningful individual tax changes include an increased standard deduction, a $0 personal exemption, a larger child tax credit, and capping the State and Local Tax (SALT) deduction. The law is not revenue neutral but is estimated to cost $1.5 trillion over the next 10 years.

TCJA Enacted by Congress in December 2017

SOURCE: Urban-Brookings Tax Policy Center Microsimulation Model (version 0217-1).

Overall Impact

About two-thirds of taxpayers will receive a tax cut with the largest changes for higher income taxpayers, while taxes will increase for 6% of taxpayers, largely concentrated in the top 3 quintiles. The individual income tax cuts will be largest for high-income households, particularly those in the 95th to 99th percentile of the income distribution.

In general taxes will fall, but different effects will be based on individual characteristics, including state and local taxes, family structure, composition of income, and occupation/employment characteristics. In most States, changes in individuals’ after-tax income in 2018 is close to the national average of 1.8%. However, the tax cut will exceed 2.1% of after-tax income in seven states (Alaska, Louisiana, North Dakota, South Dakota, Texas, Washington, and Wyoming) and fall below 1.5% of after-tax income in three states (California, New York, and Oregon)

Impacts on the States

States link their State income taxes to federal rules, therefore they must decide whether to let the TCJA changes flow through to their State income tax systems or decouple and establish new rules. These choices will have big effects on both State tax revenues, Dr. Reuben observed.

Percentage Change in After-Tax Income (2018)

SOURCE: Urban-Brookings Tax Policy Center Microsimulation Model (version 0217-1).

Percentage of Tax Units with Tax Increase (2018)

SOURCE: Urban-Brookings Tax Policy Center Microsimulation Model (version 0217-1).

The reaction from the States has been less active than expected, Dr. Reuben reported.  Nearly all States estimated that revenues would be increased due to TCJA, with estimates for FY2019 ranging from $65 million in Massachusetts to over $1 billion in Michigan. Much of the new revenue comes from the TCJA’s corporate income tax changes, as well as from revenue increases on the individual side, particularly due to the elimination of personal exemptions.

While some States chose to maintain new tax increases, others responded to increased revenue projections with big tax cuts including Georgia, Iowa, Idaho, Kentucky, and Missouri. Some States decoupled the personal exemption from State taxes, while 17 States will still offer exemptions.

Some States where the cap on SALT had significant impacts on tax payers, including New York, New Jersey and Connecticut, allowed individuals to make charitable contributions to government-sponsored funds and deduct the value from state income tax payments. However, the US Treasury responded by proposing rules to limit the ability of taxpayers to claim charitable contributions if they received a state tax credit. This rule requires taxpayers to reduce federal charitable deductions by the amount of any tax credit received if the tax credit is more than 15%, including existing tax credits for other charitable contributions.

Online Sales Tax Collections – Aftermath of the Wayfair Decision:
What will new state policies look like?

Joe Crosby

CEO & Principal
Multistate Associates

The Supreme Court’s June 2018 Wayfair decision, which suggested that South Dakota’s Internet sales tax law would pass constitutional muster, can have significant effects on State sales tax revenues. Mr. Crosby examined the opportunities and challenges that arise from the ruling. A major question is what legislation is required to begin Internet sales tax collections and which States can begin enforcing collection requirements administratively.

The debate over non-resident businesses collecting State sales taxes began in 1992, with the Supreme Court’s ruling in Quill Corp. v. North Dakota. The Court ruled that only those companies with a physical presence inside a state can be required to collect sales tax.

This decision prohibited States from requiring out-of-state merchants to collect and remit sales taxes on sales to consumers within the State unless the out-of-state merchant had a physical presence or nexus within the State.  Since then, the debate over e-Fairness has raged, with States seeking to level the competitive playing field by requiring e-commerce-based businesses to collect and pay State sales taxes like their bricks-and-mortar counterparts.

In June 2018, the Court reversed itself in its decision in the South Dakota v. Wayfair, Inc. case.

The factors favoring South Dakota included their participation in the Streamlined Sales and Use Tax Agreement, allowing simplification and uniformity in their tax laws. In addition, South Dakota provided free access to certified software providers to help with sales tax collections and provided liability protection for smaller businesses.

The Court’s opinion stated: “States and local governments lost an estimated $26 billion in 2015 from uncollected sales and use taxes from out-of-state sellers. The effect of these decisions in today’s digital economy, where online sales are a mere click away, is devastating for States and local governments, who depend on these revenues.” Since the Wayfair decision, many states have been analyzing the implications of the case and positioning existing statutes, or proposing new legislation, to capitalize on the elimination of the physical presence nexus standard.

A key undecided factor is the “economic nexus,” or sales volume threshold, at which online sellers will be required to collect State sales taxes, Mr. Crosby said, anticipating that this threshold will soon be decided by the States.

Economic Nexis (Sales Volume Threshold)

A plurality (41%) of voters support the 2017 GOP tax bill, while one third (34%) oppose it.

SOURCE: Morning Consult, Tax Polling (presentation); September 8, 2018.

A second area of debate is about “marketplaces,” such as eBay or Amazon, who act as a conduit for other vendors to sell their goods. “Most of the larger entities are agreeable to collecting the State sales taxes and have already started,” Mr. Crosby reported. “It makes sense to have the larger entities with more sophisticated technology do the tax collection for the smaller sellers.”  But many States have not yet captured tax revenues from marketplaces. “Collecting State sales taxes from marketplaces will be a big issue for States next year, and those States who have sales taxes will likely take advantage of this windfall,” Mr. Crosby predicted.

Adopted Markplace Collection

Voters are split over whether states should require online online retailers to collect state sales taxes on purchases.

SOURCE: Morning Consult, Tax Polling (presentation); September 8, 2018.

Who will decide the rules for remote sales tax collection? Mr. Crosby pointed out that 9 to 0, the Supreme Court said physical presence was not the correct criterion.  In Congress, Democrats sought to define the criteria for “substantial nexus,” while Senate Republicans split on whether to draft a definition. Therefore, Congress is not likely to change the rules. “We are still defining a 21st century tax system, that will be uniform and will simplify sales tax collections,” he concluded, and this gives the States a significant opportunity.

Discussion

Sen. John Cullerton (IL): What stakeholders would oppose marketplace collections?

Mr. Crosby: Consumption taxes are generally better than other taxes for stimulating economic growth. However, some stakeholders such as Americans for Prosperity, NetChoice and some think tanks oppose it, arguing that if one seller has to collect, all should be required to collect State sales taxes.

Dr. Reuben: Some marketplaces, for example, Etsy, argue that their sellers are artists and craftspeople whose smaller sales volume would not justify the complications of collecting State sales taxes.

Mr. Crosby: The average Web-based seller collects taxes for 17 States if their sales are over the threshold set by the State. These thresholds can be as low as $50,000 (New Hampshire). The marketplace entities will take over the burden.

Dr. Reuben: There are numerous third parties offering to manage online State sales tax collections, but this is also an opportunity for fraud.

Sen. Martin Looney (CT): Most States have had a Sales and Use Tax for many years. Consumers who purchased items out of state were required to pay a “Use tax,” but compliance with this has been poor. Now online sellers like Amazon are starting to open physical stores so they will have a State sales tax liability.

Mr. Crosby: Companies are audited for their collection of use taxes. For consumers, Wayfair paves the way for online purchases to be taxed.

Tom Finneran (Moderator): Why did the Court declare that the Quill decision was wrong, rather than just letting Congress make the decision?

Dr. Reuben: The Wayfair decision made it clear that change was needed but Congress did not take responsibility for defining the necessary changes.

Mr. Crosby: There is an interesting separation of authority between the Court and Congress. The Court can rule on a Due Process law, while the Congress can make changes to Commerce laws.

Sen. Robert Stivers (KY): What is an accurate estimate for the potential State sales taxes from Web-based sales?

Mr. Crosby: It is difficult to get an accurate number, especially as marketplace sales are not predictable. However, the Government Accountability Office (GAO) conducted a study in 2017 to examine potential sales tax collections. They estimated that state and local governments could gain from about $8 billion to about $13 billion in 2017 if states were given authority to require sales tax collection from all remote sellers. This is about 2% to 4% of total 2016 state and local government general sales and gross receipts tax revenues.

Sen. Wayne Niederhauser (UT): The States who participate in the Streamlined Sales Tax Agreement already had agreements with 4,000 businesses to collect State sales taxes, and voluntary compliance by large-scale sellers like Amazon added to this revenue. So the Wayfair decision will not have a big effect on those States.

Speaker Biography

Kim S. Rueben, PhD

Kim Rueben, a senior fellow in the Urban-Brookings Tax Policy Center at the Urban Institute, is an expert on state and local public finance and the economics of education. Her research examines state and local tax policy, fiscal institutions, state and local budgets, issues of education finance, and public-sector labor markets. Rueben directs the State and Local Finance Initiative. Her current projects include work on state budget shortfalls, financing options for California, the fiscal health of cities, and examining higher education tax credits and grants. She serves on a Council of Economic Advisors for the Controller of the State of California and a National Academy of Sciences panel on the economic and fiscal consequences of immigration, and she was on the DC Tax Revision Commission in 2013. In addition to her position at Urban, Rueben is an adjunct fellow at the Public Policy Institute of California (PPIC).

Before joining Urban, Rueben was a research fellow at the PPIC. She has served as an adjunct professor at the Georgetown University Public Policy Institute and the Goldman School of Public Policy at the University of California, Berkeley; as a visiting scholar at the San Francisco Federal Reserve Bank; and as a member of the executive board of the American Education Finance Association.

Rueben received a BS in applied math-economics from Brown University, an MS in economics from the London School of Economics, and a PhD in economics from the Massachusetts Institute of Technology.

Joseph R. Crosby

Joseph R. Crosby is a principal with MultiState Associates, the nation's leading state and local government relations consultants. Joe is involved in all aspects of the firm’s efforts to help clients resolve the challenges they face in the state and local government arena, with a concentration on providing strategic counsel, identifying and deploying political assets, and advancing tax policy objectives.

Prior to joining MultiState in 2011, Joseph spent 11 years with the Council On State Taxation (COST), an association representing 600 of the nation's largest companies on state and local business tax issues. Joseph served COST as chief operating officer & senior director, policy. In addition to his operational responsibilities, Joseph managed all aspects of COST's advocacy program and regularly testified before state legislatures and other state and national policy-making bodies.

Joseph is a nationally recognized expert on state and local business tax policy. In 2011, he was identified by State Tax Notes as the “single most influential person in state taxation” and named as the publication’s inaugural Person of the Year.

Prior to his work with COST, Joseph was national director of state legislative services for Ernst & Young LLP, where he provided legislative monitoring, advocacy management, and coalition development services. Earlier in his career, Joseph spent four years as a senior executive with a state legislative tracking firm. Joseph is past president of the State Government Affairs Council, the premier national association for multistate government affairs executives, and served on the board of directors of the Washington Area State Relations Group, another association of government relations professionals. He earned his bachelor's degree in history from Loyola Marymount University in Los Angeles and completed graduate course work in economic policy at American University in Washington.

The law is not revenue neutral but is estimated to cost $1.5 trillion over the next 10 years.

States link their State income taxes to federal rules, therefore they must decide whether to let the TCJA changes flow through to their State income tax systems or decouple and establish new rules.

The US Treasury responded by proposing rules to limit the ability of taxpayers to claim charitable contributions if they received a state tax credit.

States and local governments lost an estimated $26 billion in 2015 from uncollected sales and use taxes from out-of-state sellers.

A key undecided factor is the “economic nexus,” or sales volume threshold, at which online sellers will be required to collect State sales taxes.

Collecting State sales taxes from marketplaces will be a big issue for States next year, and those States who have sales taxes will likely take advantage of this windfall.

Who will decide the rules for remote sales tax collection?

Sen. John Cullerton (IL)

Sen. Martin Looney (CT)

Tom Finneran (Moderator)

Sen. Robert Stivers (KY)

Sen. Wayne Niederhauser (UT)

Kim S. Rueben,
PhD

Joseph R. Crosby

CONTACT

Senate Presidents’ Forum

579 Broadway

Hastings-on-Hudson, NY 10706

 

Tel: 914-693-1818

Copyright © 2018 Senate Presidents' Forum. All rights reserved.

september 6–9, 2018

Federal Tax Reform —
Impact on the States

Kim S. Rueben, PhD

Senior Fellow
Tax Policy Center
Urban Institute & Brookings Institution

An expert on the implications of tax reform for the States, Dr. Reuben interpreted the new Federal Tax Reform law and explored what States can do to take advantage of new opportunities it offers.

Dr. Reuben pointed out that taxes are essential to pay for services to make our communities better; however, she advised Forum members to reconsider what the business of governing is, and to assess new strategies to provide the services needed to build the States’ futures. The impacts of the major changes to the Federal tax code from the Tax Cuts and Jobs Act (TCJA) will differ across the states, depending on each state’s economic, fiscal, and demographic characteristics, she observed.

The new tax law makes substantial changes to the rates and bases of both the individual and corporate income taxes, cutting the corporate income tax rate to 21% from 35%, redesigning international tax rules, and simplifying reporting for those who do not itemize deductions, but adding complexity for pass-through businesses. The most meaningful individual tax changes include an increased standard deduction, a $0 personal exemption, a larger child tax credit, and capping the State and Local Tax (SALT) deduction. The law is not revenue neutral but is estimated to cost $1.5 trillion over the next 10 years.

The law is not revenue neutral but is estimated to cost $1.5 trillion over the next 10 years.

TCJA Enacted by Congress in December 2017

SOURCE: Urban-Brookings Tax Policy Center Microsimulation Model (version 0217-1).

Overall Impact

About two-thirds of taxpayers will receive a tax cut with the largest changes for higher income taxpayers, while taxes will increase for 6% of taxpayers, largely concentrated in the top 3 quintiles. The individual income tax cuts will be largest for high-income households, particularly those in the 95th to 99th percentile of the income distribution.

In general taxes will fall, but different effects will be based on individual characteristics, including state and local taxes, family structure, composition of income, and occupation/employment characteristics. In most States, changes in individuals’ after-tax income in 2018 is close to the national average of 1.8%. However, the tax cut will exceed 2.1% of after-tax income in seven states (Alaska, Louisiana, North Dakota, South Dakota, Texas, Washington, and Wyoming) and fall below 1.5% of after-tax income in three states (California, New York, and Oregon)

Impacts on the States

States link their State income taxes to federal rules, therefore they must decide whether to let the TCJA changes flow through to their State income tax systems or decouple and establish new rules. These choices will have big effects on both State tax revenues, Dr. Reuben observed.

States link their State income taxes to federal rules, therefore they must decide whether to let the TCJA changes flow through to their State income tax systems or decouple and establish new rules.

Percentage Change in After-Tax Income (2018)

SOURCE: Urban-Brookings Tax Policy Center Microsimulation Model (version 0217-1).

Percentage of Tax Units with Tax Increase (2018)

SOURCE: Urban-Brookings Tax Policy Center Microsimulation Model (version 0217-1).

The reaction from the States has been less active than expected, Dr. Reuben reported.  Nearly all States estimated that revenues would be increased due to TCJA, with estimates for FY2019 ranging from $65 million in Massachusetts to over $1 billion in Michigan. Much of the new revenue comes from the TCJA’s corporate income tax changes, as well as from revenue increases on the individual side, particularly due to the elimination of personal exemptions.

While some States chose to maintain new tax increases, others responded to increased revenue projections with big tax cuts including Georgia, Iowa, Idaho, Kentucky, and Missouri. Some States decoupled the personal exemption from State taxes, while 17 States will still offer exemptions.

Some States where the cap on SALT had significant impacts on tax payers, including New York, New Jersey and Connecticut, allowed individuals to make charitable contributions to government-sponsored funds and deduct the value from state income tax payments. However, the US Treasury responded by proposing rules to limit the ability of taxpayers to claim charitable contributions if they received a state tax credit. This rule requires taxpayers to reduce federal charitable deductions by the amount of any tax credit received if the tax credit is more than 15%, including existing tax credits for other charitable contributions.

The US Treasury responded by proposing rules to limit the ability of taxpayers to claim charitable contributions if they received a state tax credit.

Online Sales Tax Collections – Aftermath of the Wayfair Decision:
What will new state policies look like?

Joe Crosby

CEO & Principal
Multistate Associates

The Supreme Court’s June 2018 Wayfair decision, which suggested that South Dakota’s Internet sales tax law would pass constitutional muster, can have significant effects on State sales tax revenues. Mr. Crosby examined the opportunities and challenges that arise from the ruling. A major question is what legislation is required to begin Internet sales tax collections and which States can begin enforcing collection requirements administratively.

The debate over non-resident businesses collecting State sales taxes began in 1992, with the Supreme Court’s ruling in Quill Corp. v. North Dakota. The Court ruled that only those companies with a physical presence inside a state can be required to collect sales tax.

This decision prohibited States from requiring out-of-state merchants to collect and remit sales taxes on sales to consumers within the State unless the out-of-state merchant had a physical presence or nexus within the State.  Since then, the debate over e-Fairness has raged, with States seeking to level the competitive playing field by requiring e-commerce-based businesses to collect and pay State sales taxes like their bricks-and-mortar counterparts.

In June 2018, the Court reversed itself in its decision in the South Dakota v. Wayfair, Inc. case.

The factors favoring South Dakota included their participation in the Streamlined Sales and Use Tax Agreement, allowing simplification and uniformity in their tax laws. In addition, South Dakota provided free access to certified software providers to help with sales tax collections and provided liability protection for smaller businesses.

The Court’s opinion stated: “States and local governments lost an estimated $26 billion in 2015 from uncollected sales and use taxes from out-of-state sellers. The effect of these decisions in today’s digital economy, where online sales are a mere click away, is devastating for States and local governments, who depend on these revenues.” Since the Wayfair decision, many states have been analyzing the implications of the case and positioning existing statutes, or proposing new legislation, to capitalize on the elimination of the physical presence nexus standard.

States and local governments lost an estimated $26 billion in 2015 from uncollected sales and use taxes from out-of-state sellers.

A key undecided factor is the “economic nexus,” or sales volume threshold, at which online sellers will be required to collect State sales taxes, Mr. Crosby said, anticipating that this threshold will soon be decided by the States.

A key undecided factor is the “economic nexus,” or sales volume threshold, at which online sellers will be required to collect State sales taxes.

Economic Nexis (Sales Volume Threshold)

A plurality (41%) of voters support the 2017 GOP tax bill, while one third (34%) oppose it.

SOURCE: Morning Consult, Tax Polling (presentation); September 8, 2018.

A second area of debate is about “marketplaces,” such as eBay or Amazon, who act as a conduit for other vendors to sell their goods. “Most of the larger entities are agreeable to collecting the State sales taxes and have already started,” Mr. Crosby reported. “It makes sense to have the larger entities with more sophisticated technology do the tax collection for the smaller sellers.”  But many States have not yet captured tax revenues from marketplaces. “Collecting State sales taxes from marketplaces will be a big issue for States next year, and those States who have sales taxes will likely take advantage of this windfall,” Mr. Crosby predicted.

Collecting State sales taxes from marketplaces will be a big issue for States next year, and those States who have sales taxes will likely take advantage of this windfall.

Adopted Markplace Collection

Voters are split over whether states should require online online retailers to collect state sales taxes on purchases.

SOURCE: Morning Consult, Tax Polling (presentation); September 8, 2018.

Who will decide the rules for remote sales tax collection? Mr. Crosby pointed out that 9 to 0, the Supreme Court said physical presence was not the correct criterion.  In Congress, Democrats sought to define the criteria for “substantial nexus,” while Senate Republicans split on whether to draft a definition. Therefore, Congress is not likely to change the rules. “We are still defining a 21st century tax system, that will be uniform and will simplify sales tax collections,” he concluded, and this gives the States a significant opportunity.

Who will decide the rules for remote sales tax collection?

Discussion

Sen. John Cullerton (IL): What stakeholders would oppose marketplace collections?

Mr. Crosby: Consumption taxes are generally better than other taxes for stimulating economic growth. However, some stakeholders such as Americans for Prosperity, NetChoice and some think tanks oppose it, arguing that if one seller has to collect, all should be required to collect State sales taxes.

Dr. Reuben: Some marketplaces, for example, Etsy, argue that their sellers are artists and craftspeople whose smaller sales volume would not justify the complications of collecting State sales taxes.

Mr. Crosby: The average Web-based seller collects taxes for 17 States if their sales are over the threshold set by the State. These thresholds can be as low as $50,000 (New Hampshire). The marketplace entities will take over the burden.

Dr. Reuben: There are numerous third parties offering to manage online State sales tax collections, but this is also an opportunity for fraud.

Sen. Martin Looney (CT): Most States have had a Sales and Use Tax for many years. Consumers who purchased items out of state were required to pay a “Use tax,” but compliance with this has been poor. Now online sellers like Amazon are starting to open physical stores so they will have a State sales tax liability.

Mr. Crosby: Companies are audited for their collection of use taxes. For consumers, Wayfair paves the way for online purchases to be taxed.

Tom Finneran (Moderator): Why did the Court declare that the Quill decision was wrong, rather than just letting Congress make the decision?

Dr. Reuben: The Wayfair decision made it clear that change was needed but Congress did not take responsibility for defining the necessary changes.

Mr. Crosby: There is an interesting separation of authority between the Court and Congress. The Court can rule on a Due Process law, while the Congress can make changes to Commerce laws.

Sen. Robert Stivers (KY): What is an accurate estimate for the potential State sales taxes from Web-based sales?

Mr. Crosby: It is difficult to get an accurate number, especially as marketplace sales are not predictable. However, the Government Accountability Office (GAO) conducted a study in 2017 to examine potential sales tax collections. They estimated that state and local governments could gain from about $8 billion to about $13 billion in 2017 if states were given authority to require sales tax collection from all remote sellers. This is about 2% to 4% of total 2016 state and local government general sales and gross receipts tax revenues.

Sen. Wayne Niederhauser (UT): The States who participate in the Streamlined Sales Tax Agreement already had agreements with 4,000 businesses to collect State sales taxes, and voluntary compliance by large-scale sellers like Amazon added to this revenue. So the Wayfair decision will not have a big effect on those States.

Speaker Biography

Kim S. Rueben, PhD

Kim Rueben, a senior fellow in the Urban-Brookings Tax Policy Center at the Urban Institute, is an expert on state and local public finance and the economics of education. Her research examines state and local tax policy, fiscal institutions, state and local budgets, issues of education finance, and public-sector labor markets. Rueben directs the State and Local Finance Initiative. Her current projects include work on state budget shortfalls, financing options for California, the fiscal health of cities, and examining higher education tax credits and grants. She serves on a Council of Economic Advisors for the Controller of the State of California and a National Academy of Sciences panel on the economic and fiscal consequences of immigration, and she was on the DC Tax Revision Commission in 2013. In addition to her position at Urban, Rueben is an adjunct fellow at the Public Policy Institute of California (PPIC).

Before joining Urban, Rueben was a research fellow at the PPIC. She has served as an adjunct professor at the Georgetown University Public Policy Institute and the Goldman School of Public Policy at the University of California, Berkeley; as a visiting scholar at the San Francisco Federal Reserve Bank; and as a member of the executive board of the American Education Finance Association.

Rueben received a BS in applied math-economics from Brown University, an MS in economics from the London School of Economics, and a PhD in economics from the Massachusetts Institute of Technology.

Joseph R. Crosby

Joseph R. Crosby is a principal with MultiState Associates, the nation's leading state and local government relations consultants. Joe is involved in all aspects of the firm’s efforts to help clients resolve the challenges they face in the state and local government arena, with a concentration on providing strategic counsel, identifying and deploying political assets, and advancing tax policy objectives.

Prior to joining MultiState in 2011, Joseph spent 11 years with the Council On State Taxation (COST), an association representing 600 of the nation's largest companies on state and local business tax issues. Joseph served COST as chief operating officer & senior director, policy. In addition to his operational responsibilities, Joseph managed all aspects of COST's advocacy program and regularly testified before state legislatures and other state and national policy-making bodies.

Joseph is a nationally recognized expert on state and local business tax policy. In 2011, he was identified by State Tax Notes as the “single most influential person in state taxation” and named as the publication’s inaugural Person of the Year.

Prior to his work with COST, Joseph was national director of state legislative services for Ernst & Young LLP, where he provided legislative monitoring, advocacy management, and coalition development services. Earlier in his career, Joseph spent four years as a senior executive with a state legislative tracking firm. Joseph is past president of the State Government Affairs Council, the premier national association for multistate government affairs executives, and served on the board of directors of the Washington Area State Relations Group, another association of government relations professionals. He earned his bachelor's degree in history from Loyola Marymount University in Los Angeles and completed graduate course work in economic policy at American University in Washington.

september 6–9, 2018

Federal Tax Reform —
Impact on the States

Kim S. Rueben, PhD

Senior Fellow
Tax Policy Center
Urban Institute & Brookings Institution

An expert on the implications of tax reform for the States, Dr. Reuben interpreted the new Federal Tax Reform law and explored what States can do to take advantage of new opportunities it offers.

Dr. Reuben pointed out that taxes are essential to pay for services to make our communities better; however, she advised Forum members to reconsider what the business of governing is, and to assess new strategies to provide the services needed to build the States’ futures. The impacts of the major changes to the Federal tax code from the Tax Cuts and Jobs Act (TCJA) will differ across the states, depending on each state’s economic, fiscal, and demographic characteristics, she observed.

The new tax law makes substantial changes to the rates and bases of both the individual and corporate income taxes, cutting the corporate income tax rate to 21% from 35%, redesigning international tax rules, and simplifying reporting for those who do not itemize deductions, but adding complexity for pass-through businesses. The most meaningful individual tax changes include an increased standard deduction, a $0 personal exemption, a larger child tax credit, and capping the State and Local Tax (SALT) deduction. The law is not revenue neutral but is estimated to cost $1.5 trillion over the next 10 years.

The law is not revenue neutral but is estimated to cost $1.5 trillion over the next 10 years.

TCJA Enacted by Congress in December 2017

SOURCE: Urban-Brookings Tax Policy Center Microsimulation Model (version 0217-1).

Overall Impact

About two-thirds of taxpayers will receive a tax cut with the largest changes for higher income taxpayers, while taxes will increase for 6% of taxpayers, largely concentrated in the top 3 quintiles. The individual income tax cuts will be largest for high-income households, particularly those in the 95th to 99th percentile of the income distribution.

In general taxes will fall, but different effects will be based on individual characteristics, including state and local taxes, family structure, composition of income, and occupation/employment characteristics. In most States, changes in individuals’ after-tax income in 2018 is close to the national average of 1.8%. However, the tax cut will exceed 2.1% of after-tax income in seven states (Alaska, Louisiana, North Dakota, South Dakota, Texas, Washington, and Wyoming) and fall below 1.5% of after-tax income in three states (California, New York, and Oregon)

Impacts on the States

States link their State income taxes to federal rules, therefore they must decide whether to let the TCJA changes flow through to their State income tax systems or decouple and establish new rules. These choices will have big effects on both State tax revenues, Dr. Reuben observed.

States link their State income taxes to federal rules, therefore they must decide whether to let the TCJA changes flow through to their State income tax systems or decouple and establish new rules.

Percentage Change in After-Tax Income (2018)

SOURCE: Urban-Brookings Tax Policy Center Microsimulation Model (version 0217-1).

Percentage of Tax Units with Tax Increase (2018)

SOURCE: Urban-Brookings Tax Policy Center Microsimulation Model (version 0217-1).

The reaction from the States has been less active than expected, Dr. Reuben reported.  Nearly all States estimated that revenues would be increased due to TCJA, with estimates for FY2019 ranging from $65 million in Massachusetts to over $1 billion in Michigan. Much of the new revenue comes from the TCJA’s corporate income tax changes, as well as from revenue increases on the individual side, particularly due to the elimination of personal exemptions.

While some States chose to maintain new tax increases, others responded to increased revenue projections with big tax cuts including Georgia, Iowa, Idaho, Kentucky, and Missouri. Some States decoupled the personal exemption from State taxes, while 17 States will still offer exemptions.

Some States where the cap on SALT had significant impacts on tax payers, including New York, New Jersey and Connecticut, allowed individuals to make charitable contributions to government-sponsored funds and deduct the value from state income tax payments. However, the US Treasury responded by proposing rules to limit the ability of taxpayers to claim charitable contributions if they received a state tax credit. This rule requires taxpayers to reduce federal charitable deductions by the amount of any tax credit received if the tax credit is more than 15%, including existing tax credits for other charitable contributions.

The US Treasury responded by proposing rules to limit the ability of taxpayers to claim charitable contributions if they received a state tax credit.

Online Sales Tax Collections – Aftermath of the Wayfair Decision:
What will new state policies look like?

Joe Crosby

CEO & Principal
Multistate Associates

The Supreme Court’s June 2018 Wayfair decision, which suggested that South Dakota’s Internet sales tax law would pass constitutional muster, can have significant effects on State sales tax revenues. Mr. Crosby examined the opportunities and challenges that arise from the ruling. A major question is what legislation is required to begin Internet sales tax collections and which States can begin enforcing collection requirements administratively.

The debate over non-resident businesses collecting State sales taxes began in 1992, with the Supreme Court’s ruling in Quill Corp. v. North Dakota. The Court ruled that only those companies with a physical presence inside a state can be required to collect sales tax.

This decision prohibited States from requiring out-of-state merchants to collect and remit sales taxes on sales to consumers within the State unless the out-of-state merchant had a physical presence or nexus within the State.  Since then, the debate over e-Fairness has raged, with States seeking to level the competitive playing field by requiring e-commerce-based businesses to collect and pay State sales taxes like their bricks-and-mortar counterparts.

In June 2018, the Court reversed itself in its decision in the South Dakota v. Wayfair, Inc. case.

The factors favoring South Dakota included their participation in the Streamlined Sales and Use Tax Agreement, allowing simplification and uniformity in their tax laws. In addition, South Dakota provided free access to certified software providers to help with sales tax collections and provided liability protection for smaller businesses.

The Court’s opinion stated: “States and local governments lost an estimated $26 billion in 2015 from uncollected sales and use taxes from out-of-state sellers. The effect of these decisions in today’s digital economy, where online sales are a mere click away, is devastating for States and local governments, who depend on these revenues.” Since the Wayfair decision, many states have been analyzing the implications of the case and positioning existing statutes, or proposing new legislation, to capitalize on the elimination of the physical presence nexus standard.

States and local governments lost an estimated $26 billion in 2015 from uncollected sales and use taxes from out-of-state sellers.

A key undecided factor is the “economic nexus,” or sales volume threshold, at which online sellers will be required to collect State sales taxes, Mr. Crosby said, anticipating that this threshold will soon be decided by the States.

A key undecided factor is the “economic nexus,” or sales volume threshold, at which online sellers will be required to collect State sales taxes.

Economic Nexis (Sales Volume Threshold)

A plurality (41%) of voters support the 2017 GOP tax bill, while one third (34%) oppose it.

SOURCE: Morning Consult, Tax Polling (presentation); September 8, 2018.

A second area of debate is about “marketplaces,” such as eBay or Amazon, who act as a conduit for other vendors to sell their goods. “Most of the larger entities are agreeable to collecting the State sales taxes and have already started,” Mr. Crosby reported. “It makes sense to have the larger entities with more sophisticated technology do the tax collection for the smaller sellers.”  But many States have not yet captured tax revenues from marketplaces. “Collecting State sales taxes from marketplaces will be a big issue for States next year, and those States who have sales taxes will likely take advantage of this windfall,” Mr. Crosby predicted.

Collecting State sales taxes from marketplaces will be a big issue for States next year, and those States who have sales taxes will likely take advantage of this windfall.

Adopted Markplace Collection

Voters are split over whether states should require online online retailers to collect state sales taxes on purchases.

SOURCE: Morning Consult, Tax Polling (presentation); September 8, 2018.

Who will decide the rules for remote sales tax collection? Mr. Crosby pointed out that 9 to 0, the Supreme Court said physical presence was not the correct criterion.  In Congress, Democrats sought to define the criteria for “substantial nexus,” while Senate Republicans split on whether to draft a definition. Therefore, Congress is not likely to change the rules. “We are still defining a 21st century tax system, that will be uniform and will simplify sales tax collections,” he concluded, and this gives the States a significant opportunity.

Who will decide the rules for remote sales tax collection?

Discussion

Sen. John Cullerton (IL): What stakeholders would oppose marketplace collections?

Mr. Crosby: Consumption taxes are generally better than other taxes for stimulating economic growth. However, some stakeholders such as Americans for Prosperity, NetChoice and some think tanks oppose it, arguing that if one seller has to collect, all should be required to collect State sales taxes.

Dr. Reuben: Some marketplaces, for example, Etsy, argue that their sellers are artists and craftspeople whose smaller sales volume would not justify the complications of collecting State sales taxes.

Mr. Crosby: The average Web-based seller collects taxes for 17 States if their sales are over the threshold set by the State. These thresholds can be as low as $50,000 (New Hampshire). The marketplace entities will take over the burden.

Dr. Reuben: There are numerous third parties offering to manage online State sales tax collections, but this is also an opportunity for fraud.

Sen. Martin Looney (CT): Most States have had a Sales and Use Tax for many years. Consumers who purchased items out of state were required to pay a “Use tax,” but compliance with this has been poor. Now online sellers like Amazon are starting to open physical stores so they will have a State sales tax liability.

Mr. Crosby: Companies are audited for their collection of use taxes. For consumers, Wayfair paves the way for online purchases to be taxed.

Tom Finneran (Moderator): Why did the Court declare that the Quill decision was wrong, rather than just letting Congress make the decision?

Dr. Reuben: The Wayfair decision made it clear that change was needed but Congress did not take responsibility for defining the necessary changes.

Mr. Crosby: There is an interesting separation of authority between the Court and Congress. The Court can rule on a Due Process law, while the Congress can make changes to Commerce laws.

Sen. Robert Stivers (KY): What is an accurate estimate for the potential State sales taxes from Web-based sales?

Mr. Crosby: It is difficult to get an accurate number, especially as marketplace sales are not predictable. However, the Government Accountability Office (GAO) conducted a study in 2017 to examine potential sales tax collections. They estimated that state and local governments could gain from about $8 billion to about $13 billion in 2017 if states were given authority to require sales tax collection from all remote sellers. This is about 2% to 4% of total 2016 state and local government general sales and gross receipts tax revenues.

Sen. Wayne Niederhauser (UT): The States who participate in the Streamlined Sales Tax Agreement already had agreements with 4,000 businesses to collect State sales taxes, and voluntary compliance by large-scale sellers like Amazon added to this revenue. So the Wayfair decision will not have a big effect on those States.

Speaker Biography

Kim S. Rueben, PhD

Kim Rueben, a senior fellow in the Urban-Brookings Tax Policy Center at the Urban Institute, is an expert on state and local public finance and the economics of education. Her research examines state and local tax policy, fiscal institutions, state and local budgets, issues of education finance, and public-sector labor markets. Rueben directs the State and Local Finance Initiative. Her current projects include work on state budget shortfalls, financing options for California, the fiscal health of cities, and examining higher education tax credits and grants. She serves on a Council of Economic Advisors for the Controller of the State of California and a National Academy of Sciences panel on the economic and fiscal consequences of immigration, and she was on the DC Tax Revision Commission in 2013. In addition to her position at Urban, Rueben is an adjunct fellow at the Public Policy Institute of California (PPIC).

Before joining Urban, Rueben was a research fellow at the PPIC. She has served as an adjunct professor at the Georgetown University Public Policy Institute and the Goldman School of Public Policy at the University of California, Berkeley; as a visiting scholar at the San Francisco Federal Reserve Bank; and as a member of the executive board of the American Education Finance Association.

Rueben received a BS in applied math-economics from Brown University, an MS in economics from the London School of Economics, and a PhD in economics from the Massachusetts Institute of Technology.

Joseph R. Crosby

Joseph R. Crosby is a principal with MultiState Associates, the nation's leading state and local government relations consultants. Joe is involved in all aspects of the firm’s efforts to help clients resolve the challenges they face in the state and local government arena, with a concentration on providing strategic counsel, identifying and deploying political assets, and advancing tax policy objectives.

Prior to joining MultiState in 2011, Joseph spent 11 years with the Council On State Taxation (COST), an association representing 600 of the nation's largest companies on state and local business tax issues. Joseph served COST as chief operating officer & senior director, policy. In addition to his operational responsibilities, Joseph managed all aspects of COST's advocacy program and regularly testified before state legislatures and other state and national policy-making bodies.

Joseph is a nationally recognized expert on state and local business tax policy. In 2011, he was identified by State Tax Notes as the “single most influential person in state taxation” and named as the publication’s inaugural Person of the Year.

Prior to his work with COST, Joseph was national director of state legislative services for Ernst & Young LLP, where he provided legislative monitoring, advocacy management, and coalition development services. Earlier in his career, Joseph spent four years as a senior executive with a state legislative tracking firm. Joseph is past president of the State Government Affairs Council, the premier national association for multistate government affairs executives, and served on the board of directors of the Washington Area State Relations Group, another association of government relations professionals. He earned his bachelor's degree in history from Loyola Marymount University in Los Angeles and completed graduate course work in economic policy at American University in Washington.