Outdated sales taxes are keeping states from fully competing in a 21st century economy. As they emerge from the recession, many states are recognizing the urgent need to invest in highly competitive education systems, modern transportation networks, and a range of other innovative public initiatives that will form a strong foundation for future economic growth. But states won’t be able to make these investments without modern revenue systems.
A key step in the right direction is to modernize their sales taxes, which account for nearly a third of the tax revenue states collect. Currently, most state sales taxes are stuck in an era before the Internet and before services became so important to the economy. As we explain in our new paper, states can modernize their sales taxes by:
Broadening the tax base to include more services. Household spending has been shifting from goods to services for decades (see graph), yet most states haven’t updated their sales taxes to reflect this fact. This failure costs states tens of billions of dollars each year. Every state with a sales tax except Hawaii, New Mexico, and South Dakota ¾ states where the sales tax already is very broad ¾ could extend the tax to include more services.
Enacting an “Amazon law” to require large online retailers to collect sales taxes. States and localities lose more than $20 billion a year in uncollected sales taxes that are legally due on online purchases but that retailers aren’t required to collect. Thirty-four states could enact a law requiring large online retailers such as Amazon and Overstock to collect taxes on sales in the state.
Extending the sales tax to Internet downloads. Twenty-three states don’t tax the sale of computer software, music, movies, and various other goods delivered on the Internet — even though they tax the same items when sold in physical stores. The resulting revenue loss is roughly $300 million a year.
Closing the online hotel tax loophole. Forty-two states have failed to close a loophole that allows online travel companies like Expedia, Orbitz, and Priceline to collect taxes on only part of the sales taxes due on hotel room bookings. This costs states and localities roughly $275 million to $400 million each year.