Introduction
Tricia Schafer-Petrecz: Welcome to Tax Matters, a Vertex podcast! I’m Tricia Schafer-Petrecz, Public Relations and Social Media Lead at Vertex.
In this episode, Vertex Chief Tax Officer Michael Bernard talks to business writer Eric Krell about the Vertex Mid-Year Rates and Rules Report.
Mike explains why local tax jurisdictions that have been negatively affected by COVID remain hungry for revenue… and how those cities and districts continue to leverage sales tax rate changes to adapt. After highlighting key findings from our mid-year report, Mike talks about related trends of interest to indirect tax groups. These topics include attempts by some states to eliminate corporate income taxes, the tax profession’s important role in ESG matters, and the fact that auditing activity has quietly returned to pre-COVID levels.
Now, I’ll turn it over to Eric and Mike.
Eric Krell: Mike, Vertex recently published its mid-year Sales Tax Rules and Rate Change Report. A lot of changes continue to take place at all levels. What’s your biggest takeaway from the mid-report?
Michael Bernard: Well, Eric, think one of the biggest things is that the states and locals received dramatic federal support in March of 2021. When President Biden signed the COVID Relief Act, states received almost 350 billion dollars of direct relief, which they’ll access over the next couple of years, from 2021 to 2024. Even though they received all that, there were still a lot of locals – not states, but a lot of locals – that felt they needed to increase their tax rate. Or they felt they actually had to create a new district with a new taxing jurisdiction. Despite all of that relief, there are still a lot of sub-state geographies looking for revenue. And that occurred in places that were disproportionately affected by COVID, based upon the industries in those areas. That was probably the biggest takeaway from the mid-year report.
Eric Krell: What are some other notable findings in the report that tax leaders should keep in mind going forward?
Michael Bernard: …Given what happened with COVID, there was a dramatic decrease in revenues and then it looked like revenues bounced back pretty strongly. But as I mentioned, I think state and locals are still looking to make sure that they have enough revenue on hand to produce the services they need in their jurisdictions. So, I think there will be more rate increases and new taxing jurisdictions – that’s just going to happen. Here at Vertex, we continue to update those jurisdictions and put them in our monthly data update for our customers so that they remain up-to-date with all rules and rate changes.
Eric Krell: I'm sure tax groups are making adjustments right now. In your work and conversations with tax leaders, what are you seeing in terms of how tax teams are responding to these challenges, or at least planning to do so?
Michael Bernard: Well, one thing they’ve obviously learned to do is to work remotely. One of the biggest recent changes is in the area of technology. A lot of tax groups have created a digital office. Before the pandemic, maybe 30% or 40% of our customers actually had a digital office – meaning that all of their data, reporting and filing abilities were all done centrally off of a server. During COVID and immediately post-COVID, we’ve seen a dramatic increase in tax groups centralizing their operations, in part, to ensure that all of their business applications can be shared over a distributed network so that people can actually work from home. That was the biggest thing that we saw in terms of operations. Second, tax groups know that there’s going to be continual changes in all areas. Whether those changes occur to gross receipts taxes, transaction taxes, income taxes or property taxes, they know that they have to respond to those changes when they’re reporting, remitting and defending their positions. That’s just a matter of taking care of the core business of their tax departments.
Eric Krell: Are there any other trends underway inside indirect tax groups that may not be evident from looking at the mid-year rules and rate change figures?
Michael Bernard: There really are, Eric. Over the last several years, states have started to think about corporate income tax vs. sales and use tax. I think what they’re starting to see is that … sales taxes represent a smoother way to generate revenues given the fluctuation of economic cycles. I think they also view sales tax as less complicated compared to corporate income tax. It’s also much easier to administer. I think you’re going to start seeing some states actually maybe doing away with a corporate income tax, while moving to an entirely transaction-based system…We’ve seen some attempts to do just that, in Mississippi, West Virginia, Nebraska and Wyoming. None of those bills passed during the last couple of years, but those efforts are definitely out there. Tax departments are going to have to be aware that there could be substantive change in some states, driven by the fact that sales tax is a stable source of revenue for them.
Eric Krell: When you talk about that, my mind immediately goes to the idea that this could stimulate competition to attract companies to relocate to different states without a corporate income tax. Are you monitoring whether states are considering doing that as a lever to attract businesses?
Michael Bernard: That’s going to be in play. It was attempted several times and although it didn’t get off the ground there are a bunch of states in the Northeast that have tried to create a regional response to what you just described. So, rather than Maine and Connecticut trying to compete with New York, New Jersey or Vermont (on corporate income tax rates), those governments tried to come up with a single regional package to attract new companies to do business in that region. The purpose of the effort was to avoid having states compete against each other by coming up with a similar and shared tax proposal. That didn’t really get off the ground. I bring it up because I think what we’re going to see is politicians and policy makers try to attract high-paying jobs and good companies to their states. And competition is going to continue to be quite intense. And states will compete based on a combination of enticements, including the strength of the local labor pool, education, transportation, recreational opportunities and more. It will not only be about taxes, but rather a larger package of offerings that companies will be attracted to. I want to add one more thing. Tesla moved one of its huge manufacturing plans from California to Texas. HP did something similar. The reason they moved was not just because of taxes, but also because of the affordability of housing. So it’s not just one thing, but several things that will be factors in where companies locate their headquarters and facilities.
Eric Krell: How are tax groups responding to these competitive enticements?
Michael Bernard: They’re often going to be front and center in evaluating these options. Tax will have an important input on the decision, but it will not have the only input. So, when companies are thinking about moving, tax teams have to make sure that they’re on the team making the decision. That way, they can offer a financial perspective of what the taxes look like in different areas and scenarios.
Eric Krell: As Vertex continues to monitor state legislatures, what do you see as some important variables to watch?
Michael Bernard: First of all, watch the pace of change related to the creation of new tax districts. And there’s another important legislative topic that is gaining momentum on the legislative and regulatory front – ESG, which stands for environmental, social and governance. The governance piece of that is familiar to tax departments. Governance relates to using proper accounting practices, identifying proper disclosures in the financial statements and reconciling your accounts every month. That’s not a new thing. The new kids on the block are environmental and social. At some point soon we’ll see more rules at the intersection of environmental and social. We’ve already seen it on the environmental side in some geographies. For example, if a company produces packaging that is non-compostable, there may be a tax on that packaging. This is already common in Canada…. You’re going to see more and more of that kind of taxing on products and activities that strain natural resources.
Regarding the social aspect, companies are taking a closer look at their supply chains. What companies are concerned about is whether the workers who produce products that they use … are being paid a fair wage, whether there’s proper lighting in the facility, proper break rooms, proper tools and management in place and so on. To the extent that those conditions aren’t present, there’s probably going to be taxes on the import of those certain goods. This is actually a way to change behavior in the supply chain, generally, as we see it… At some point, if the goals of ESG are not met, there’s going to be generally what will be viewed as a transactional tax. While this is not present in the U.S. yet, you’re certainly going to see other places where it will be more prevalent – and that will concern more than carbon emissions in the supply chain. These topics are being talked about extensively on the federal level – not so much on the state level yet, but that’s coming.
Finally, we’re always looking at where there are sufficient revenues for the states and locals. Are they pretty close to what they budgeted? Are they within a range of what they’re looking for?” If those revenues project to be in line with what they forecasted, there will probably be minimal changes to transaction taxes. But if they’re not in line, then I think we’ll go back to what happened when COVID hit: there will be an expansion of districts and taxes, sales tax rates will increase and there will be cuts to services and even jobs. On the back end of all of that, there also will be more auditing of corporate tax departments.
… One thing I will say, particularly over the last six to eight months, is that the amount of audit activity that companies have experienced is back to normal. Pre-COVID, you kind of had a “normal” level of audit activity. During COVID, the states and the locals really weren’t out that much, and now, they’re back to a normal level. One of the things that our polling and discussions with customers shows is that a lot of auditing work is in a backlog right now. The authorities are working to address that and move through their audits.
Eric Krell: Mike, thanks so much for catching up and shedding light on so many different topics. I look forward to touching base with you again soon.
Michael Bernard: Thank you, Eric.
Tricia Schafer-Petrecz: Thank you for listening to Tax Matters, a Vertex podcast. Check back here for more episodes soon.
