The Progressive, Creditable Implied Purchases Tax

A MODEST, SELF-HELP PROPOSAL ENABLING INDIVIDUAL STATES TO ADDRESS THE REMOTE SELLER TAX PROBLEM AND MUCH MORE.

As we await any Congressional response to the United States Supreme Court’s 5-4 ruling in the remote seller sales tax enforcement case of South Dakota v. Wayfair, Inc., et al, 585 U.S.___ (2018), this is to describe a simple alternative proposal by which any individual state can not only serve its sales tax revenue interests, but which will also solve both the related compliance concerns of remote sellers and enable pursuit of other major state tax policy objectives of the state and taxpayers alike.

Thus, this proposal is also designed to ameliorate the perceived threat of state border competition which, otherwise, greatly limits the flexibility of states to employ expansion of their consumption tax bases and increases in their rates in addressing not only insufficient revenue capacity, but, more importantly, in pursuing structural reform of their tax systems to the end of greater competitiveness.[1] Likewise, in a profoundly “win-win” manner, the proposal also enables remote and on-line sellers to avoid the administrative nightmare they regularly invoke in opposing imposition on them of sales and use tax collection duties by a vast array of state and local jurisdictions. [2]

First, this simple, but potentially game-changing, proposal is designed as a bulwark against chronic non-compliance with states’ consumption taxes due to their legal or practical inability to require remote, internet vendors to collect such taxes on sales to their residents. Simply described, the proposal is for a state to impose a tax equal to a fixed portion of the annual amount of sales or use tax otherwise due on purchases each of its resident individual income tax filers are presumed/implied to have made, based on their income level and family size. If the concept underlying that measure sounds familiar, that is because it is the one used in the current optional, state-by-state tables provided for claiming itemized deductions of state and local sales taxes for federal income tax purposes.[3]

To implement the proposal, a state would enact legislation which imposes such a tax equal to some fixed percentage of the applicable sales tax table amount. Since the tables are based on taxpayers’ income levels and family sizes, they are inherently progressive, but, to make this implied purchases tax even more so, the law could exempt from its operation all those whose federal taxable income is below any given level the state’s legislature selects.

Under the proposal, each resident of the state, filing a federal income tax return for a given year, would receive an annual notice of implied purchases tax from their state revenue agency. That notice would be generated from copies of those returns which are automatically provided to each state by the Internal Revenue Service. Then, each taxpayer would be given a reasonable time to respond to such notices with a return of the implied purchases tax, showing a credit against the proposed liability for the cumulative amount of the sales or use taxes he or she actually paid during the same annual period to vendors in their home state or in any other US jurisdiction. Any remaining uncredited balance of implied purchases tax due would then be due for remittance to the state.

However, as practical matter, precisely because credits under the proposal would be granted for consumption tax paid to other jurisdictions, both fiscal prudence and administrative convenience militate against actually paying refunds if the amount of a given taxpayer’s claimed credits exceed the amount of the implied purchases tax stated in the notice. A state might, if it is willing to bear a further layer of administrative complexity, actually pay refunds in circumstances where credits for payment of its own consumption tax alone exceed the implied purchases tax for a given period. The importance of such a nuance in the scheme would likely turn on such factors as the number of reporting taxpayers (determined by the level of income exempted) and by the percentage of the sales tax amounts on the federal sales tax tables selected for use in determining that state’s implied purchases tax. Obviously, the higher the level of income exempted from liability for the implied purchases tax, and the lower the percentage of federal table tax used in measuring that tax, the less weight would be given to the argument for making such refunds.

Another important administrative aspect, which would also turn largely on those same factors, would be whether copies of sales receipts, showing payment of consumption taxes, would be required to accompany the implied purchases tax return when claiming credits for such payments. A simpler alternative would be to just require a taxpayer’s retention of those receipts to then be produced in the case of state revenue agency audits of randomly-selected returns. Again, the higher the exempted income levels and the lower percentage of federal table taxes, the fewer the number of taxpayers who would bear the practical burden for keeping paper sales receipts.

Potentially, there would also be a small number of higher income taxpayers who would favor convenience over relatively modest tax savings and simply not go to the trouble of claiming all possible (or any) credits and maintaining the supporting sales tax records.[4] Of course, the availability of actual refunds, when such credits exceed the noticed implied purchases tax, would also influence a given taxpayer’s incentive to consistently keep such records, and the state’s interest in enforcing the requirements for maintaining the same.

Of course, a key to the practical efficacy of the proposal is the continued availability of the optional federal sales tax tables which are annually updated for each state. One might ask whether that crucial data source can be expected to remain available going forward, given the recently enacted Tax Cuts and Jobs Act, which, among other things, limits the itemized deduction for state and local taxes to $10,000.00. However, absent further major changes in that aspect of the governing federal income tax laws, since the highest maximum deductible amount, listed on such tables, is no more than about one-third of the new SALT deduction limit, their practical application and administrative usefulness should remain.

Aside from such practical administrative considerations, skeptics about the viability of this proposal will, no doubt, raise largely philosophical questions about the very concept of tying consumption taxes, traditionally based on actual transactions, to the mere implication of engaging in a taxable transaction based on income level and family size. To that, one might simply observe that, as to the traditional reliance on actual purchases to trigger the tax, “that’s the way we’ve always done it” is not a substantive principle in any state or the federal constitutional provision authorizing exercise of the sovereign’s taxing power.[5]

Moreover, no one seriously questions the constitutional viability of using the federal sales tax tables to determine itemized deductions for federal income tax purposes. Indeed, since the conceptual underpinning of the progressive income tax itself is the economic theory of the diminishing margin utility (i.e. purchasing power), of each additional dollar of income, the conceptual nexus between having income and the implied spending of it is beyond debate.[6]

For that very reason, well-founded characterizations of the regressive tendency of any consumption tax are based on the relative amounts of income different individuals have available to make purchases of life’s necessities. Thus, it is incontrovertible that income levels, and the use of that income to make purchases, are mutually integral. As a result, any tax, which is based on objectively measured and statistically massive samples to coordinate individual income levels with individual spending levels, is conceptually sound.

Importantly, there is nothing in the proposal which presumes to displace the long-standing vendor collection responsibilities of nexus-satisfying sellers. Moreover, by allowing its residents to claim credits against the implied purchases tax for payment of other jurisdiction’s sales and use taxes, the proposal also manifestly honors both the nexus principles of federalism, and the growing use of market-based sourcing of transactions for consumption tax administration purposes.

Thus, this proposal offers a simple and administratively straight-forward way by which states, acting unilaterally, can avoid both the loss of future state consumption tax revenue and the corollary threat to local, bricks and mortar merchants’ competitiveness. At the same time, it will also spare the on-line, remote seller community from the nightmare of administrative burdens their advocates have long lamented should multiple jurisdictions’ sales and use tax collection responsibilities be imposed upon them (as the ruling in South Dakota v. Wayfair now authorizes).

Finally, and perhaps most importantly, the proposal should also significantly mitigate the fear of inter-state border competition which often constrains structural state tax reform efforts. Specifically, for the cohort of a state’s taxpayer population, which would be generally subject to its implied purchases tax, any financial incentive, to travel to an adjoining jurisdiction to purchase items simply because they are either not taxable or are subject to a lower rate of tax there, is inherently eliminated.

Of course, the lower the income level threshold set, and the higher the percentage of sales tax table used, for imposition of a state’s implied purchases tax, the larger the number of in-state consumers who would thus be dissuaded from crossing the border to shop in a lower tax jurisdiction. In addition, due to the inherent and strong correlation between an individual’s income level and the value he or she attributes to personal convenience, the greater will be the sales tax payment credits earned (whether claimed or not) for higher income individuals’ in-state purchases.

Far more important, than the precisely optimum level of those structural details within an implied purchases tax scheme, is its potential to enable such major competitiveness-enhancing reforms as replacement of a state’s income tax with a far more broadly-based (and, perhaps, higher rate) general consumption tax.[7] While, thorough use tax audits of business purchases, combined with market-based sourcing rules, largely limit the “border competition” concern to that involving retail purchases of goods, that is still the very economically massive part of the overall market which the states claim has heretofore been disrupted and unfairly exploited by the no-nexus remote seller phenomenon.

To meet that concern, a progressive creditable implied purchases tax system offers each state the unilateral opportunity to protect both its tax base and its in-state merchants, while more freely reforming its entire tax structure to achieve improved competitiveness. Moreover, as to each such state, members of the on-line remote seller community could, as a part of the proposal’s implementing legislation, also be freed from the potential administrative hassles of vendor collection/remittance responsibilities. As a result, their lobbying efforts, advocating adoption of that version of the proposal, would be prudently directed to every state whose market they seek to exploit.

[1] E.g. “Consumption Tax vs. Income Tax: Why More States Are Opting to Collect Consumption Taxes Only,” by Amanda Grossman, March 16, 2015; www.howmoneywalks.com. (April 3, 2017)

[2] E.g. Transcript of oral argument on April 17, 2018 before the Supreme Court of the United States in South Dakota v. Wayfair, Inc. et al, Id. Heritage Reporting Corporation, Washington, DC.

[3] IRC §164(b)(5)(H)(ii); “Instructions for Schedule A, Form 1040”, Internal Revenue Service.

[4] Given such a possibility, a state, which relies on the random audit approach to assure accuracy of claimed credits, would, to discourage taxpayers from playing “audit roulette,” be prudent to include, in its implementing legislation, a fairly stiff penalty for a credit-claiming taxpayer’s failure to produce sales receipts if audited.

[5] Indeed, to contend otherwise, suggests the same purely academic, but impractical perspective as seen in the contentions that the enforcement of vendor sales and use tax collection responsibilities is technically not authorized under states’ taxing powers. E.g. “Tax Collection Obligation is Not a Taxing Power Issue.” James Edward Maule, http://mauledagain.blogspot.com (Nov. 9, 2012).

[6] See, Alfred Marshall, Principles of Economics, (1890).

[7] The concept, underlying the Progressive Creditable Implied Purchases Tax was first developed to mitigate such “border competition” concerns as described on pages 25-26 of the author’s “Fair 55 Tax Reform Plan for West Virginia,” co-published by the Tuscarora Institute for Enterprise Studies & Advancement, LLC and the Public Policy Foundation of West Virginia, Inc. in 2016. See, www.tiesablog.com and www.ppfwv.org. The basic premise of the Fair 55 Tax Reform Plan is that if West Virginia had a broader-base (but lower rate) consumption tax system, it could, in a fiscally responsible manner, phase-out and repeal all its taxes on income and tangible personal property, and, thus, become one of the most economically competitive states in the USA.