The Fighting Over Online Sales Taxes Isn’t Finished

You're reading Route Fifty's Public Finance Update. To get the latest on state and local budgets, taxes and other financial matters, you can subscribe here to get this update in your inbox twice each month. You can find a full archive of these newsletters here.

Public Finance Update - Sept. 20, 2022

Welcome back to Route Fifty’s Public Finance Update! I’m Liz Farmer and this week I’m writing about sales taxes. More than four years after the U.S. Supreme Court issued its landmark decision clearing the way for states to collect taxes from online sales, there are still issues to work out. In this newsletter, I’ll explain one of them, which involves longstanding sales tax incentives, rule changes for remote sales and, in Texas and elsewhere, has pit cities against states.

Located in Central Texas just outside of Austin, the suburb of Round Rock is in the heart of one of the country’s fastest-growing regions. It’s home to major employers, like Amazon and UPS. Dell Technologies has been headquartered there since the mid-1990s. The sales taxes collected from those companies and others help pay for servicing the city’s rapid growth.

But two years ago, a sales tax rule change by Texas Comptroller Glenn Hegar threatened to devastate that revenue structure. The change amended administrative rule 3.334 and moved the point of taxation from where the business operates to where the buyer lives. It’s the way most other states already apply remote sales taxes and Hegar has said it’s more fair because online purchases are taking up a more significant portion of retail sales.

“This loophole doesn’t represent truth in taxation,” Hegar said at the time. “Instead, it’s the worst possible combination for taxpayers: You’re still paying the tax, but you’re getting no benefit,” he added. “And your roads will still have potholes that need to be fixed.”

But for Round Rock, it would have resulted in as much as $30 million in lost annual revenue, according to city figures. What’s more, in the case of Round Rock and a few other Texas cities, the rule change complicates existing tax rebate agreements with major employers.

Last year, Round Rock sued, as did the city of Coppell. Those lawsuits have been combined and four other cities have joined the fight. Round Rock and others argue that the rule change not only harms their ability to pay for services for a growing population, but that it also potentially jeopardizes existing economic development deals.

"Because of Round Rock’s willingness to enter into this agreement (in August 1993) it is understood that Dell chose to locate in Round Rock rather than move its headquarters to Tennessee," the city’s original complaint against Hegar says. 

During the city's most recent fiscal year, about $9.6 million was rebated to Dell, according to the Austin American-Statesman. Round Rock collected about $30.7 million in gross sales and use taxes from the deal.

Sales Tax Breaks Elsewhere

The transition to remote sales tax collection has come into conflict with sales tax-sharing agreements elsewhere that sought to attract warehouses and distribution centers in order to boost local sales tax revenue. In California, a Bloomberg Tax investigation found dozens of agreements with small California cities that rebate tens of millions of dollars a year from their local sales tax to companies. The deals often span decades and are in exchange for locating in a certain jurisdiction or designating a city as a point of sale for all California transactions.

In several cases, the lawyer who arranged the deals received a cut of the sales tax revenue. The Bloomberg investigation found he and two affiliated companies earned $1.9 million so far from one city where he landed a deal with a retailer, and that they stand to earn at least $18 million for their share of sales tax revenue gains from two others.

In Morrow County, Oregon, a community with just 12,000 residents, civic officials lured Amazon with tax breaks worth nearly $50 million a year. “The company’s presence in Morrow County illustrates how unusual Oregon tax breaks from the 1980s now primarily benefit large tech companies, who openly play small communities off one another to maximize their tax savings,” wrote OregonLive investigative reporter Mike Rogoway.

Before the Supreme Court’s 2018 ruling in Wayfair v. South Dakota, attracting distribution centers was a lucrative way for a locality to capture revenue from e-commerce. Sure, the customers weren’t located in city limits, but it was the option available to local leaders at the time. Now that the way has been cleared for remote sales tax collection, critics say such agreements pit one city against another. And on top of that, the rebates associated with these deals give money back to companies that cities need.

“This is an example of how when you put the power of controlling money over a large number of years in the hands of a few people...it’s a recipe for corruption,” Greg LeRoy, executive director of the tax break transparency organization Good Jobs First, told Route Fifty. “You could be diverting huge amounts of money for a very long time from one government away to others.”

In Sacramento, state lawmakers passed a law requiring more transparency about expected tax revenue, jobs, and other state and federal subsidies the companies are getting. But Gov. Gavin Newsom vetoed a separate bill that would have banned the tax-revenue-sharing practice in future deals. And in Oregon, lawmakers and candidates for governor now say they want to evaluate whether the incentive programs have adequate guardrails.

Planning For the Worst

Back in Texas, localities have had to make adjustments to plan for the potential revenue losses as the issue remains unresolved in court.

“The city of Coppell must plan for the worst case scenario,” City Manager Michael Land told the state legislature in 2020, adding that Coppell could see a 20% drop in general fund revenue if the comptroller’s rule change went into effect.

As the case has lingered, Coppell has instituted a hiring freeze, reduced expenditures and cut capital spending. To cover the remaining expected revenue losses, the city plans to use rainy day savings and, if necessary, transfers from a water/sewer fund and other fund balances. Meanwhile, city staff are conducting a budget analysis to determine where Coppell needs to make more long-term adjustments, such as revenue increases, service cuts and stretching out payments for projects.

For its part, Round Rock already has a Concentration Risk Fund that was established to provide a buffer against its reliance on its highest sales tax remitters. In 2019, the city instituted a policy in which any Dell sales tax in excess of 20% of budgeted General Fund sales tax revenues would be sent to a different fund used for one-time capital expenditures.

Last month, the Texas cities got a small victory in their legal case—but it’s only temporary.

Judge Karin Crump issued a letter ruling, saying that Hegar “failed to substantially comply with one or more of the procedural requirements” necessary for rulemaking. State law requires at least 30 days’ notice of an impending rule before adopting it, and then a 20-day waiting period before the rule becomes effective. 

Importantly, Crump didn’t comment on the actual merits of the case and instead remanded the case back to the comptroller’s office for “revision or re-adoption through established procedures within a reasonable time." His office has not yet indicated when he will do so, but LeRoy says it’s only a matter of time and advises localities to get their financial houses in order.

“In a global economy, tax breaks like these only distort local finances while providing unnecessary rewards to companies,” he said.