Sales Tax Skimming Costs States $1 Billion

November 18, 2008


Skimming the Sales Tax

, a

new report

from Good Jobs First, shines a light on a little known aspect of state tax policy: the practice in about half the states of compensating retailers for collecting sales taxes on behalf of state and local governments. This is called by a variety of names such as vendor discounts and collection allowances. We use the term retailer compensation, but we also refer to it as a legal form of skimming.

These programs, often unfamiliar even to tax experts, turn out to cost the states involved more than $1 billion a year. Much of the money is going into the pockets of giant retailers such as Wal-Mart. At a time when nearly all states and cities are experiencing fiscal distress, this diversion of taxpayer revenue should be a matter of public concern.

Twenty-six states provide some form of retailer compensation. Nineteen states and the District of Columbia do not. Five states don’t have a state sales tax.

In all 26 states the compensation is calculated as a percentage of the sales tax collected by a company. Half of the 26 states put a ceiling on the amount a given retailer can receive, though the ceilings vary widely—from less than $1,000 a year in states such as Florida and New York to as much as $10,000 or more. The highest ceiling by far is in Michigan, where it can go up to $240,000 a year.

But perhaps the bigger problem is in the 13 states that put no ceiling on what a retailer can receive. These states can end up giving away quite a bit of money. We found the largest loss in Illinois at $126 million. Second was Texas at $89 million followed by Pennsylvania at $72 million and Colorado at $68 million.

States do not disclose how much is given to individual retailers, but we were able to estimate how much is being received by the country’s largest retailer—Wal-Mart. Using state-by-state figures disclosed by Wal-Mart on its sales tax collections, we estimate that the company is receiving a total of $60 million from the 26 states. In Missouri, for instance, we estimate that Wal-Mart is receiving about $10 million, or about 25 percent of all the retailer compensation paid by the state.

Soon retailer compensation may be an issue even in the states that don’t currently provide it. There’s a movement among states to adopt streamlined sales tax policies as part of an effort to get online and mail-order retailers to collect tax on their sales. Pending federal legislation that would authorize states to collect taxes on interstate transactions would also require them to provide “reasonable” compensation to retailers for all their sales (though there is a small business exception). It would be left up to each state to decide what the compensation should be.

The report also looks at another way local governments give up sales tax revenues. This occurs when they uses sales tax receipts as a form of economic development subsidy, such as when they allow large retailers to keep millions of dollars in taxes generated by a new store. There are no national figures available on this practice, but we document a loss of $130 million over the past decade in projects involving Wal-Mart alone.

Finally, we offer some policy options to state and local officials. As for retailer compensation, we urge those states that allow the payments to review their programs. We especially urge states without ceilings to consider adopting them. As for subsidies, we note that retail incentives encourage sprawl and overbuilding, and we urge officials to avoid those subsidies except in those limited instances where they are the only way to bring essential retail services such as groceries and drugstores to underserved areas.