Background
In the late 1990's as states whose revenue streams were heavily reliant upon the sales tax began to see significant reductions in revenues, an association of state commissioners of revenue began to address these reductions. It was determined that a majority of the sales tax erosion could be attributed to remote purchases made by customers residing outside the state in which the vendor was located, principally Internet sales.
In a series of cases, most notably the National Bellas Hess, Inc. v. Illinois Department of Revenue (1967), the courts held that requiring vendors to collect and remit sales tax on purchases made by customers residing in another state violates the commerce clause of the U.S. Constitution. In offering these opinions, the Courts argued it was unreasonable to expect vendors to maintain a working knowledge of the varying rates and definitions employed in each of the nation's 7,500 taxing jurisdictions.
In Quill Corp. v. North Dakota (1992), the court modified its previous decisions somewhat by allowing states to require those vendors that maintain a physical presence (nexus) in the state to collect and remit sales tax on out-of-state purchases. However, the principle tenets of the Courts previous rulings with respect to violations of the commerce clause were preserved. Additionally, the Court noted that only the U.S. Congress had the authority to require vendors to collect and remit sales tax on all out-of-state purchases.
States, heeding the Court's instructions, requested Congress to empower states to require the collection of sales and use taxes on out-of-state purchases. Congress was unwilling to do so, unless states adopted a common, simplified taxing regimen.
Status of Streamline Across the Nation
In 2000, the Streamlined Sales Tax Project (SSTP) was created for the purpose of developing and implementing a simplified taxing system. In 2002, SSTP reached consensus on the Streamlined Sales and Use Tax Agreement that took effect on October 1, 2005. Initially, 34 states, including Tennessee, signed and expressed interest in conforming their state's laws to the requirements stipulated in the Agreement. However, only 13 states had enacted legislation and were fully participating in the Agreement on its effective date.
On January 1, 2007, Rhode Island and Vermont joined the 13 participating states, bringing the total number of states fully participating in the Agreement to 15. After five years of promoting the Agreement and talk of congressional or court action being imminent, neither Congress nor the Court have given any indication that action is forthcoming and less than half of the 34 states that signed the Agreement have taken the steps required to comply with its requirements.
Status of Streamline in Tennessee
In 2003, the General Assembly adopted legislation (Public Chapter 357) bringing the state's tax structure, rates, and definitions into compliance with the requirements of the Agreement. A year later, the General Assembly approved a bill making technical corrections to the 2003 legislation and establishing an effective date of July 1, 2005, for Tennessee's streamline legislation.
In 2005, the General Assembly adopted legislation that delayed implementation of Tennessee's streamline legislation and the state's full participation in the Streamline Sales and Use Tax Agreement until July 1, 2007. Absent any intervening actions by the General Assembly, Tennessee's streamline legislation and the sourcing change will be implemented this year.
Problems
Implementation of the state's streamline legislation will result in a dramatic shift in local sales tax revenues, substantially alter municipalities' incentive for economic development, and introduce a degree of uncertainty into the annual budget process.
For Tennessee to comply with the Streamlined Sales and Use Tax Agreement, the state must change the sourcing of sales tax revenues from the point of sale to the point at which the buyer takes possession of the item (point-of-sale sourcing to destination-sourcing). Dr. Bill Fox, an accomplished and respected economist with the University of Tennessee, projected 193 cities will experience an increase in local option sales tax revenues, 150 cities will experience a decrease in local option revenues, and four cities will experience no measurable impact as a result of the sourcing change required under the streamline legislation. However, the estimated cumulative increase for the 193 "winners" is just $19 million, while the 150 "losers" are estimated to experience a cumulative decrease of $57 million - a difference of $38 million. Or said another way, $19 million in local sales tax revenues will be redistributed among cities while $38 million in local sales tax revenues will shift from municipalities to counties upon implementation of the streamline bill.
In addition, numerous purchases will be exempt from the local option sales tax under Tennessee's streamline legislation. Instead, special privilege taxes will be levied on such purchases. When taxed under the local option sales tax, these transactions are taxed in the jurisdiction in which the purchase is made. If taxed under special privilege taxes, revenue from these transactions will be distributed based on population, shifting substantial amounts of revenue away from economic hubs, which have higher infrastructure and operational costs associated with being a regional economic hub.
Beyond the effects of a shift in local revenues, there is a serious concern Tennessee's streamline bill will fundamentally alter the state's economic development model and serve as a disincentive for local governments to be proactive in creating jobs and economic activity. Cities have busied themselves with developing the infrastructure necessary to support, recruit, and retain businesses and industries that produce state and local tax revenues. These activities have been done in the name of economic expansion and with the expectation that the promise of a secure, stable and long-term revenue stream would offset the short-term costs associated with the initial infrastructure improvements and capital outlays required to fuel this expansion. In the process, many of these cities have incurred debt which they planned to retire using revenues derived from the increased economic activity.
But the streamline legislation - specifically the sourcing change - will short-circuit those calculations and leave many of the economic engines of this state with a far different forecast of future revenues than they anticipated. Consequently, this changing calculus could leave many residents of our most economically robust cities less willing to pay higher local taxes to finance further expansion or to retire debt associated with previous investments.
And, finally, regardless of whether they "win" or "lose," municipalities will face fiscal uncertainty and will find budgeting for the upcoming fiscal year to be exceptionally challenging, if the streamline legislation is implemented.
Proposed Legislation
TML is seeking approval of legislation that delays implementation of the state's streamline legislation until the one hundred eightieth day following the effective date of an act of the U.S. Congress authorizing states to enforce their sales and use taxes against out-of-state vendors without a physical location in the taxing state or the one hundred eightieth day following a ruling by the U.S. Supreme Court that gives states such authority, whichever occurs first.
Anticipated Benefits to Municipalities
While the TML remains supportive of the Streamlined Sales Tax Project, without congressional approval or a U.S. Supreme Court decision authorizing states to collect sales and use taxes from out-of-state vendors, the burdens for municipalities in Tennessee far outweigh the benefits. The legislation is necessary to avoid potentially large and damaging shifts in local revenue, associated budgetary uncertainty, and substantially altering municipalities' incentive for economic development.
