The Center's work on 'State Budget and Tax' Issues

The Center’s State Fiscal Project works with state officials and state-based nonprofits to develop responsible budget and tax policies that take the needs of low-income families into account. We provide information and technical assistance on a variety of issues, including strengthening state tax systems, state budget priorities, and making low-income programs more effective. We also help state nonprofits understand how federal budget and tax decisions affect states and their residents.


Congress Shouldn’t Renew Internet Tax Freedom Act Unless It’s Paired With the Marketplace Fairness Act

July 21, 2014 at 2:54 pm

The Internet Tax Freedom Act’s (ITFA) ban on state and local sales taxation of monthly Internet access fees costs state and local governments about $6.5 billion annually in forgone revenue, and the states and localities currently taxing access under ITFA’s “grandfather” provision would lose at least $500 million on top of that each year if the provision expired, as I’ve recently explained.  Despite these costs, the House last week approved making ITFA permanent while letting the grandfather clause expire.  A new bipartisan Senate bill, however, would help state and local governments make up for the lost revenue.

The Senate bill would pair a 10-year ITFA extension with the Marketplace Fairness Act (MFA).  The MFA would enable states and localities to receive a substantial share of the sales tax that is legally due on purchases of goods and services from Internet and catalog merchants like Amazon and L.L. Bean but that they can’t collect from the companies.

Due to 1967 and 1992 Supreme Court decisions, a state can require out-of-state companies to charge its sales tax only if they have a physical presence in the state like a store, warehouse, or sales force.  The tax is still legally due, and consumers are supposed to pay it directly to their state, but few people do.  Those lost revenues could help pay for schools, roads, police, and other critical state and local services, and they keep sales and income tax rates higher than they’d otherwise need to be.

MFA would authorize states to require out-of-state sellers with more than $1 million in nationwide interstate sales to charge the applicable taxes — provided that states simplify their sales taxes and give merchants free software that calculates the correct tax.

This change would allow state and local governments to collect as much as $23 billion in annual revenues that they are owed under current law.  That would help them maintain and possibly reinvest in public services they cut during the recent recession.  It would also help offset states’ and localities’ ITFA-related $7 billion revenue loss — lost dollars that will grow as more people subscribe to Internet service; others trade-up to faster, and therefore more expensive, service; and others cancel their taxable landline telephones and cable TV in favor of Internet-based alternatives like Skype and Netflix.

MFA’s long-overdue enactment would also:

  • Create a more level playing field for local store-based retailers.  Because combined state and local sales tax rates typically range between 5 and 10 percent, Internet retailers that don’t collect sales taxes outside their home states start out with a price advantage over their local competitors.  This makes it harder for Main Street merchants to create local jobs.  It also has a ripple effect on local economies, as depressed sales at the neighborhood book or musical instrument shop lead to fewer purchases by their owners and employees at the farmers’ market and dry cleaner. 
  • End the unfair sales tax treatment of consumers who don’t shop online.  Low-income people who lack the computers, Internet access, or credit cards needed to shop online pay more than their fair share of sales taxes because online shoppers can avoid these taxes. 

These are worthy goals, and Congress should have passed the MFA long ago to achieve them.  But if lawmakers decide to extend ITFA, it’s even more urgent that they also enact MFA.  Congress should not extend the moratorium without also enacting MFA.

Busting Three Myths About the Internet Tax Freedom Act’s “Grandfather Clause”

July 18, 2014 at 4:08 pm

The Senate next week will likely consider its version of a bill to renew the Internet Tax Freedom Act (ITFA), a federal law prohibiting state and local governments from taxing the monthly Internet access subscription fee that households and businesses pay.  The House voted earlier this week to make ITFA, which is due to expire on November 1, permanent.

ITFA was enacted in 1998 with strong bipartisan support, and it has always included a “grandfather clause” that allowed states and localities that were taxing Internet access to keep doing so.  Despite its long history, there’s widespread misunderstanding about the grandfather clause in the current debate about renewing ITFA.  Here are the facts behind three widespread myths about that clause:

Myth:  The House and Senate bills that would make ITFA permanent preserve the grandfather clause.

Fact:  The House-approved bill and its Senate analog both effectively eliminate the grandfather clause.  There has been confusion about this because both bills strike ITFA’s November 1, 2014 expiration date with no mention of the grandfather clause.  But the current law terminates the grandfather clause as of November 1, 2014, meaning that it expires as of that date unless policymakers explicitly extend it.  Neither the House nor Senate bill does so.

Myth:  Eliminating the grandfather clause would affect the revenues of only seven states that directly tax Internet access service. 

Fact: Virtually every state, and thousands of local governments, would be at risk of losing revenue if the grandfather clause expires — dollars they use to pay teachers and police, provide financial aid to state university students, repair roads, and provide many other critical services.  That’s because the clause not only preserves the pre-1998 direct taxes on Internet access service of Hawaii, New Mexico, North Dakota, Ohio, South Dakota, Texas, and Wisconsin, it also preserves all pre-1998 taxes that could be considered indirect taxes on Internet access.  That would include, for example, state and local taxes that Internet access providers pay on the things they buy in order to provide Internet service, such as computer servers, fiber-optic cable, or even gasoline for their vehicles.  Almost all of these taxes existed before 1998, so the grandfather clause protects them from legal challenge.  But if Congress eliminates the clause, Internet access providers could challenge these taxes in court as indirect taxes on Internet access service and therefore voided by ITFA.  (For more on this issue, see pages 8-10 of my recent analysis.)

Myth:  The grandfather clause was intended to give states time to phase out Internet access taxes, which they’ve had ample time to do.

Fact:  The original 1998 committee reports on ITFA don’t back up this claim.  Such a rationale wouldn’t have made sense anyway, because ITFA itself was supposed to be temporary.  As the 1998 Senate Commerce Committee report said, ITFA was intended to be “a temporary moratorium on Internet-specific taxes [that] is necessary to facilitate the development of a fair and uniform taxing scheme.”  Lawmakers included the grandfather clause to protect the interests of states and localities that had already come to rely on Internet access tax revenues to fund services.  If Congress had wanted to push the states taxing Internet access to phase out those taxes, it could have had the grandfather clause expire sooner than the overall moratorium in the original 1998 legislation or in any of the three subsequent renewals, but it didn’t.

The facts make the case:  if Congress extends ITFA, no matter for how long, the law must continue to include the grandfather clause.

A Constitutional Convention Poses Grave Risks

July 16, 2014 at 4:33 pm

The idea of convening a constitutional convention to propose a balanced budget amendment or similar amendments raises grave problems, as we explain in a new paper.  A number of states have passed resolutions calling for such a convention, and proponents of a constitutional convention are targeting more states in an effort to obtain the 34 states needed to call one (see map).

A balanced budget amendment poses serious risks in and of itself.  But, as a number of legal experts across the political spectrum have warned, a convention could open up the Constitution to broader radical and harmful changes.  Such serious concerns are justified, for several reasons:

  • A convention could write its own rules.  No constitutional convention has been called since the 1787 meeting that wrote the Constitution, and the Constitution provides no guidance whatsoever on what a convention’s ground rules would be.  This leaves wide open to political considerations and pressures such fundamental questions as how delegates would be chosen, how many delegates each state would have, and whether a supermajority vote would be required to approve amendments.  To show the importance of these issues, consider that if every state had one vote in a convention and the convention could approve amendments with a simple majority vote, the 26 least populous states, with less than 18 percent of the nation’s people, could approve constitutional amendments for ratification. 
  • A convention could set its own agenda, possibly influenced by powerful interest groups.  The 1787 meeting went far beyond its mandate.  Charged with amending the Articles of Confederation to promote trade among the states, the convention instead wrote an entirely new governing document.  A convention held today could set its own agenda, too.  There is no guarantee that a convention could be limited to a given set of issues, such as balancing the budget.  
  • A convention could choose a new ratification process.  The 1787 convention ignored the ratification process under which it was established and created a new process, reducing the number of states needed to approve the new Constitution and removing Congress from the approval process.  The country then ignored the pre-existing ratification procedures and adopted the Constitution under the new ratification procedures that the convention proposed.  Given these facts, it would be unwise to assume that ratification of the convention’s proposals would require the subsequent approval of 38 states, as the Constitution specifies.  For example, a convention might remove the states from the approval process and propose a national referendum instead, or approval by a simple majority of states. 
  • No other body, including the courts, has clear authority over a convention.  The Constitution provides for no authority above a constitutional convention, so it isn’t clear that the courts, Congress, state legislatures, or a President could intervene if a convention went beyond the language of the state resolutions calling for a convention or the congressional resolution establishing it.  Likewise, there may be no recourse if the convention altered the process for ratifying its own proposed amendments.  The Constitution has virtually no restrictions on the operations of a constitutional convention or the scope of the amendments that it could produce, and the courts would likely regard legal challenges to a convention as “political questions” that the judiciary does not wade into. 

States should avoid these risks and reject resolutions calling for a constitutional convention, and those that have already approved such resolutions should rescind them.

Click here to read the full paper.

Balanced Budget Amendment Likely to Harm the Economy

July 16, 2014 at 4:21 pm

A number of states may soon call for a convention to amend the U.S. Constitution to require that the federal budget be balanced every year.  But a convention would pose serious risks, and a balanced budget requirement would be a highly ill-advised way to address the nation’s long-term fiscal problems.  It would threaten significant economic harm while raising a host of problems for the operation of Social Security and other vital federal functions, as we explain in a new paper.

By requiring a balanced budget every year, no matter the state of the economy, such an amendment would risk tipping weak economies into recession and making recessions longer and deeper, causing very large job losses.  Rather than allowing the “automatic stabilizers” of lower tax collections and higher unemployment and other benefits to cushion a weak economy, as they now do automatically, it would force policymakers to cut spending, raise taxes, or both when the economy turns down — the exact opposite of what sound economic policy would advise.  Such actions would launch a vicious spiral:  budget cuts or tax increases in a recession would cause the economy to contract further, triggering still higher deficits and thereby forcing policymakers to institute additional austerity measures, which in turn, would cause still-greater economic contraction.

For example, in 2011 one of the nation’s preeminent private economic forecasting firms concluded that if a constitutional balanced budget amendment had been ratified and were being enforced for fiscal year 2012, “[t]he effect on the economy would be catastrophic.”  If the 2012 budget were balanced through spending cuts, the firm found, those cuts would throw about 15 million more people out of work, double the unemployment rate from 9 percent to about 18 percent, and cause the economy to shrink by about 17 percent instead of growing by an expected 2 percent.

The fact that states must balance their budgets every year — no matter how the economy is performing — makes it even more imperative that the federal government not also face such a requirement and thus further impair a faltering economy.

Such a constitutional requirement — which would be notably more restrictive than the behavior of the most prudent states or families — would also cause a host of other problems.  Requiring that federal spending in any year be offset by revenues collected in that same year would undercut the design of Social Security, deposit insurance, and all other government guarantees.  And it would raise troubling questions about enforcement, including the risk that the courts or the President might be empowered to make major, unilateral budget decisions, undermining the checks and balances that have been a hallmark of our nation since its founding.  It is not a course that the nation should follow.

Click here to read the full paper.

Mazerov on the Risks of Permanently Banning Sales Taxes on Internet Access Charges

July 14, 2014 at 4:04 pm

Writing today in The Hill, I explain why policymakers should reject an effort to permanently bar states from applying their normal sales taxes to the monthly charges that households and businesses pay for Internet access.  Such a permanent ban, which the House is expected to consider this week, could cost states roughly $7 billion a year in potential revenue.

Here’s an excerpt:

For starters, the bill would strip Hawaii, New Mexico, North Dakota, Ohio, South Dakota, Texas, and Wisconsin of at least $500 million in annual state and local revenue from their existing taxes on these charges.

Beyond costing states the $7 billion a year in potential revenue to support education, healthcare, roads, and other services, the bill would violate an understanding between Congress and the states dating back to the 1998 Internet Tax Freedom Act (ITFA):  that any ban on applying sales taxes to Internet access charges would be temporary and not apply to existing access taxes.

Enacted when Internet commerce was still in its infancy, ITFA sought to balance Congress’ desire to encourage development of the Internet against states’ and localities’ need to finance essential services.  Thus, it imposed only a temporary “moratorium” on new taxes on Internet access and protected existing taxes through a “grandfather” clause.

Congressional extensions of ITFA in 2001, 2004, and 2007 maintained those two key features.  This latest ITFA legislation, though, eliminates both — the first time Congress has seriously considered doing so.

Congress should end, not extend, the ban on state and local taxation of Internet access, as I explained in our recent paper.  As I point out in The Hill:

The Internet is no longer an infant industry needing protection from taxes that apply to other services for which Internet access is a close substitute.  Cable television service is widely taxed, for example, but if someone decides to pay Verizon $50 a month so that they can stream Netflix to their TV, ITFA bans the taxation of the access charge.  This unequal treatment doesn’t makes sense.

Read the full op-ed here.