Use Tax Revenues: How Much Are States Not Collecting?

Many taxpayers opt not to pay use tax. View reported totals and estimated amounts uncollected for each state.
by | May 1, 2012

States are now tallying an influx of income tax returns after the federal filing deadline passed a few weeks ago. But some are also eyeing another largely untapped source of potential revenue: use tax collections.

Updated figures compiled in a Minnesota state House report show just how rarely taxes on Internet transactions and other untaxed goods is collected. A mere 1.6 percent of taxpayers in surveyed states reported use tax on their 2009 income returns, amounting to totals that would hardly register on state budgets. Only California and New York reported use tax revenues exceeding $5 million.

A much larger portion goes uncollected as online retailers expand their reach and more taxpayers make out-of-state purchases. Consumers aware of the often-ignored tax must save all untaxed receipts to report accurate totals. This expectation, along with a lack of enforcement, leaves states with little recourse.

“It’s just a widespread structural crack in the foundation of the sales tax,” said Verenda Smith, deputy director of the Federation of Tax Administrators.

When consumers do not pay sales tax on Internet transactions or purchases made in other jurisdictions, they are liable for use taxes at the state sales tax rate plus any applicable local taxes. Internet retailers are not required to collect tax unless they maintain a physical presence in a state, though, and taxpayers seldom report it on their returns.

A prominent University of Tennessee study estimates state and local governments nationwide will lose at least $11.4 billion in potential use tax revenues from e-commerce sales for tax year 2012. When factoring in catalog, phone and all other untaxed transactions made across state lines, the total uncollected balloons to more than $23 billion, according to the Streamlined Sales Tax Governing Board. (See state estimates below)

States rarely pursue those who skirt use tax obligations. Instead, they’re harnessing efforts in attempts to pass federal legislation mandating online and other remote sellers collect sales tax.

Much of the lost revenue, Smith said, stems from taxpayers being oblivious to use tax requirements.

To make it easier to report, 25 states include a use tax line item on individual income tax returns. Louisiana, Massachusetts and Michigan all reported jumps in collections after recently adding the line item, according to the Minnesota report.

But even with increases in some states, total collections remain minimal. Information on income tax returns mostly serves to educate taxpayers and fulfill legal obligations, Smith said.

Moreover, awareness isn’t the only factor impeding states’ collections efforts.

“Even if you educate people and they fully understand it, they aren’t necessarily going to fully comply with it,” Smith said.

Low participation rates

States have grown accustomed to expecting paltry participation rates. In California, for example, only 0.3 percent of 2009 income tax returns reported use tax, with an average of $202 per return. The state stands to lose an estimated $4.2 billion in uncollected revenue for tax year 2012.

Maine recorded the nation’s highest participation rate for tax year 2009 (according to the Minnesota report), taking in use tax from 9.8 percent of income returns. The study did not include data for 13 states imposing use tax that do not list a reporting line on income returns.

For most of the 1990s, Maine automatically assessed use tax for taxpayers that left the line item on their returns blank. Mike Allen, associate commissioner for tax policy for Maine Revenue Services, said this could explain the state’s higher participation rates, with more taxpayers aware of the tax. He also suggested many Mainers know New Hampshire does not assess a sales tax when they make purchases across the border, so they’re more mindful of the issue.

The state later launched a use tax amnesty program in 2006 with an advertising campaign aimed at encouraging citizens to report use tax for previous years without incurring penalties or interest. The campaign netted more than $5 million in additional revenues, costing the state less than $200,000.

More recent state figures indicate Maine’s rate dipped slightly to 9.6 percent of returns for tax year 2010.

Neighboring Vermont reported the second highest 2009 participation rate at 7.9 percent.

Vermont, Maine and seven other states provide taxpayers with a lookup table to estimate how much use tax they owe based on income. The Minnesota study found participation rates in these states are typically higher.

When Vermont doubled suggested rates in 2010, the total collected climbed slightly, but participation rates dropped to 6.7 percent.

Susan Mesner, economist for the Vermont Department of Taxes, said the state benefits from a strong “buy local” culture. Still, many evade paying the tax.

“I think use tax, despite the education that we try to do, is still a foreign concept to a lot of people,” Mesner said.

Streamlined Sales Tax and University of Tennessee figures estimate Vermont and its localities will miss nearly $45 million in use tax revenue for 2012.

Calls grow for national solution

Twenty-four states adopted measures to modernize sales and use tax administration as part of the Streamlined Sales and Use Tax Agreement. The effort’s governing board has supported federal legislation requiring remote retailers to collect tax.

Most states have historically not done a good enough job informing taxpayers about use tax, said Scott Peterson, the board’s executive director. Those making an effort to educate citizens tend to enjoy higher participation rates, he said.

Targeting use tax cheats is largely impractical. States would need to audit a taxpayer’s personal finances, and any use tax applied would likely generate meager revenues.

“I don’t hear states talking about aggressive use tax collection initiatives,” Peterson said. “For the most part, they’re hoping and waiting for Congress to do something.”

But many states have put Amazon.com, the world’s largest online retailer, in the crosshairs.

Tennessee Gov. Bill Haslam signed a law earlier this year requiring the retail giant to collect sales tax for residents in 2014. The company recently began sending notices to Tennessee customers informing them of the use tax.

Nevada also reached a similar agreement with Amazon last week. Gov. Brian Sandoval’s administration estimates the deal would add $16 million to state coffers annually once the retailer starts collecting sales tax in 2014.

Amazon currently does not charge sales tax for Nevada and Tennessee residents, despite owning facilities in both states.

Yet taxes on only Amazon purchases pale in comparison to overall use taxes not collected for many untaxed business-to-business deals, phone orders and other transactions. Nevada, for instance, is slated to lose a total estimated $345 million for tax year 2012.

The Alabama Department of Revenue took a unique approach to the problem in 2010, sending letters to approximately 20,000 taxpayers who left use tax line items blank on their returns.

Taxpayer responses to the notices varied. State revenue officials told Governing the letters served primarily as an educational tool, and could not provide figures on additional use taxes collected.

The pilot program subsequently ended in early 2011.

Alabama Revenue Commissioner Julie Magee said the best solution can be found at the federal level. She and officials in other states argue the current system is unfair to many brick-and-mortar merchants, with the absence of a sales tax boosting online retailers' profit margins.

“Everyone thinks it's too big of a problem to be solved by any state,” Magee said.

Likewise, Alabama Gov. Robert Bentley recently pledged support for the Marketplace Fairness Act, one of multiple proposed bills in Congress giving states the authority to require out-of-state merchants to collect sales tax from residents.

The likelihood of Congress passing any legislation is unknown, though, and lawmakers could be less inclined to push through bills in an election year. Until then, revenues from many online and other untaxed transactions will continue to remain off limits.

Use Tax Collection Data

Click a state in the map to display estimated collected and uncollected use tax revenues, if available. Information was obtained from the following sources:

-- Uncollected use tax estimates for electronic sales and non-electronic business-to-consumer sales: University of Tennessee report (methodology begins on page 15)

-- Uncollected estimates for non-electronic business-to-business transactions: Streamlined Sales Tax Governing Board

-- Use tax collections from 2009 income returns: Minnesota state House report

 

Use tax for tax year 2009

 
Have use tax; list income return line item
 
Have use tax; no reporting line
 
Have use tax; no income tax
 
No sales tax
 
Data unavailable

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