Vertex EOY Rules and Rates Report: Why Governments Embrace Transaction Taxes as a Consistent Source of Revenue

According to KPMG’s 3rd Annual Chief Tax Officer (CTO) 2022 Survey, 78% of tax leaders believe regulatory risk is the greatest threat to their organizations over the next three years with talent risk next at 52%.

This means corporate tax needs to expect continued transaction tax volatility. Transaction taxes figure as an increasingly effective and convenient revenue lever for state and local tax jurisdictions throughout the U.S., according to Vertex’s Year-End 2021 Sales Tax Rules and Rates Report. 

While income tax and property tax increases tend to encounter major resistance from citizens and voters due to the size of those dollar-amount increases and the direct impact to individual wallets, new sales taxes and sales tax rate increases typically encounter minimal friction: What’s another few cents here and there? 

On the other hand, transaction tax changes represent a more practical and precise arrow in the revenue-generation quivers of state and local municipalities. Sales tax rate increases can be enacted quickly. Plus, since these taxes are paid on a monthly basis, taxing jurisdictions can access that revenue faster compared to other revenue sources, such as property taxes.

New sales taxes also can be activated relatively quickly, as taxing districts so vividly demonstrated in 2021. The fact that volume of new district taxes reached the second highest level in the past decade features as one of the most noteworthy aspects of our 2021 Year-End Report: 

• Combined average tax rates continues decade-long climb: The combined average U.S. sales tax rate, which reached 10.2% in 2021, continued to increase, extending a trend that has sustained for the past decade. While the average state sales tax rate held steady at 5.6%, the average county, city and district rates each increased in 2021. What’s more, the vast majority of sales tax rate changes at the city (85%) and county (72%) levels were increases.
• Jurisdictions continue to broaden the tax base: In 2021, 197 new district taxes were implemented. During the past 10 years, only 2017 (238) saw more district taxes.  Common types of taxing districts include public improvement, transportation, transit, resort area, community improvement and emergency services districts.
• Puerto Rico, Indiana, Winter Park, Colo.., top the high-rate charts: In 2021, Puerto Rico posted the highest state sales tax rate (10.5%). Indiana, Mississippi, Rhode Island and Tennessee finished second with a 7% rate. Kodiak, Ak., Wrangell, Ak., and Winter Park, Colo., took the gold medal for the highest city sales tax rate (7%). And residents within the Sterlington Economic Development District No. 1, which is based in Ouachita Parish, La., paid the highest combined sales tax rate (12.95%) in 2021.
• Labor cost, other inflationary pressures and record borrowing will have impacts: As, I noted in my preview of our 2021 year-end results, state and local governments contend with the same rising labor costs challenging most industries and businesses. This and related inflationary pressures increase the costs of capital projects, routine maintenance and a range of operating expenses. State and local governments also took advantage of low interest rates by issuing record levels of municipal bonds last year. Both of these trends are a safe bet to increase future revenue needs, which makes future sales tax rules changes and rate increases more likely.
• A digital transformation looms: While electronic invoicing, real-time reporting and similar digital tax submission rules have yet to hit the U.S., that could change soon. Tax authorities throughout the European Union and other global regions have embraced digital transformation, and it seems inevitable that U.S. jurisdictions will follow suit.
• Audits are back in business: The pandemic-induced lull in audit is officially over. Transaction tax teams should anticipate more scrutiny, inquiries and visits from auditors.