In an informative session on the first day of the 75th Anniversary Celebration and Annual Conference in October, experts addressed the topic “SALT Tax Policy: As Deficits Turn, Will the Tide Change?” The panel included Mo Bell-Jacobs, senior manager in the Washington, D.C., office of RSM, who specializes in state and local taxes (SALT) and chairs AICPA’s state and local tax technical resource panel; Nikki Dobay, a shareholder with Greenberg Traurig, who advises her clients on multistate tax issues with a focus on SALT policy issues, planning, and controversy; and Jeff Vesely, a partner with Pillsbury Winthrop Shaw Pittman, who focuses on SALT matters, including income, franchise, sales and use, and gross receipts taxes. Natalie Friedman of Charter Communications and chair of TEI’s SALT Committee moderated the discussion.
Bell-Jacobs started off with economic issues that have impacted SALT in recent years. “More people had more money in their pockets, thanks to COVID relief to individuals,” he said. “Tax receipts increased dramatically, with the beginning of inflation raising both corporate profits and sales tax revenues. Wage growth spiked as well in ’21 and ’22. It’s now back closer to that pre-pandemic trend, though. And the 2021 markets were excellent—double-digit increases in all the major indices. So we’re looking at all that together, the capital gains taxes and corresponding individual income tax collections, and it wasn’t just a bounce-back from pandemic lows. The states were as flush [as] or flusher than they’ve ever been in history during this FY21–FY22 period.”
Dobay said she thought almost every state had adopted marketplace and economic nexus provisions by 2021. “We had a few stragglers in 2022,” she noted. “But again, there was just so much money going into state coffers, and a lot of it was coming in through the individual income tax.” Referring to corporate income taxes, Dobay added, “I think those also spiked during that period, but probably not to the same extent.”
An Interesting Statistic
Bell-Jacobs agreed, then noted, “Here’s an interesting statistic: individual income taxes, out of the state tax pie nationwide, [made up] thirty-six to thirty-nine percent. Nationally speaking, states run on individual income taxes. The things that happen in the economy that impact individual income taxes directly impact state budgets. Then, when state budgets are impacted, we get concerned as tax professionals, as tax policy people. The last seven quarters we have data on, through Q2 of 2023, we have three quarters of declining growth, a flat quarter, then three quarters of negative growth. FY23 brought in less money than FY22 in the states. That doesn’t happen very often. FY24, our current fiscal year, also looks probably to be flat or negative. So, now we’re going to start thinking about what the states might do in response.”
Referring to his own state, Vesely said, “I look at these numbers dropping like that in California. You may have read about the exodus of people out of the state. Well, that’s not false. That’s very true. A big part of our practice is advising them how to do it right and how not to get stuck with California taxes. But I think the reduction is very interesting, because California’s budget goes up and down because of personal income tax, which gets to Mo’s point right there. Very interesting.”
Decline Likely to Continue
The downward trend will probably persist, Bell-Jacobs pointed out. “What have the states been doing? We’re talking three quarters of negative growth in individual income taxes, but what have the states been doing at the same time? They’ve been cutting individual income taxes, right? So, some states have cut individual income taxes three years in a row.”
Friedman asserted that “some of us on the business side are concerned that they’re cutting the personal income tax at the expense of potentially raising business taxes.” Bell-Jacobs responded, “Yeah, as an overall piece of the pie. The states did that because they were really flush, right? FY21, FY22. They continued to do it this summer. Some states did it twice in one year. So, states are still looking at those individual income tax cuts. We’re going to worry about that a little bit, because the states collectively may not be as flush when they come to budget season next spring.”
“Mo, the term ‘state tax cuts’ or ‘tax cuts’ is not in California’s vocabulary,” Vesely interjected. “There is no way. Rebates—we’ve had rebates, but no—state income tax rates, sales tax rates, any rates, you name it, they’re all going up or staying the same.”
Some trends were visible in those rate fluctuations, Dobay said. “Yes, the rebates and other things where I think to some extent, too, this may be reflective of what was going on with the pass-through entity [PTE] taxes,” she posited. “Because we actually haven’t talked about that piece of this and how that has potentially impacted state budgets. There, I think even though we’re seeing declines in the personal income tax, the PTEs have led to some of that shift, too, because we have taxes that would normally come in through the personal income tax [now] sometimes being shifted into the business tax bucket. They’re being categorized more as corporate taxes when they’re coming in through the PTEs. We’ll see what happens there, because, you know, when the state and local tax cap was put in place back in 2017, it was a ten-year period. They said, ‘Oh, there’s no way that it won’t get extended.’ And now I think we’re seeing that that’s being used as a political lever. So, maybe the SALT cap goes away? And who knows what happens with the PTEs. I think that’s going to be a big question mark in all of this, too.”
Bell-Jacobs agreed. “I actually did try to find data on the PTE elections, because ultimately they’re revenue-neutral for the state,” he said. “But the bucket recategorization, that isn’t in the available data. The states have those insights, but we don’t. The other thing we’re looking at—market performance 2022—that was a terrible year for the market. So we saw that direct correlation, capital gains and people taking profits. This year as well, things are more mixed. The NASDAQ is up, I think, twenty-five percent. The Dow is flat. But, look, people might still take profits, so it’s not the year-end yet, but we will look at that. Again, none of this information is a secret. The states have it, too. Policymakers are going to be thinking about this at the end of the day, because they’ve been cutting taxes. What are they going to do if they need revenue?”
Sales Taxes
Bell-Jacobs then transitioned to state sales taxes. “We said personal income taxes are thirty-six to thirty-nine percent of all state taxes. Sales taxes, thirty-three percent, thirty-four percent, among forty-six states. That’s a massive amount of revenue as well. . . . Policymakers love sales taxes—they’re very predictable. It’s politically easier to expand the sales tax base as well, compared with having to increase individual income tax rates. We had forty quarters of sales tax growth between the Great Recession and our COVID quarter. That’s between about three percent and five percent overall. That’s pretty healthy; it’s pretty on trend. Then we have this huge, explosive growth after COVID for all those reasons we talked about: more money in the pocket, student loans were paused for three years. People were spending, and people still are spending.
“One factor we think about with sales taxes is that it’s bolstered quite a bit by those who make more money,” Bell-Jacobs added. “For those not impacted by inflation, who maybe don’t make an inflation-based decision when they’re at the electronics store, it’s not really impacted. However, there’s basically no growth in Q2. So, that’s something that could be concerning as well on the sales tax side. Nikki, you mentioned Wayfair implementation—fully implemented in forty-six states and also many Alaskan localities. Consumer expenditures continue to be strong. So, that still exists. The labor market’s tight. Those are all good things. [There are] some headwinds to consider—generally speaking, most federal student loans started again this month, housing costs, gas prices of course. This is an interesting stat from the Federal Reserve, that the personal savings rate is dropping, so are people still spending? Maybe. And then, of course, we always have this question of recession.”
Moore at the Supreme Court
Dobay next discussed the potential impact of Moore v. United States, which is currently before the Supreme Court. “The oral arguments are set for December 5,” she said. “If you’re not aware, this case involves [Internal Revenue Code Section] 965. The deemed repatriation that was part of the [Tax Cuts and Jobs Act] is being challenged as being unconstitutional under the Sixteenth Amendment. The Ninth Circuit upheld that as being constitutional, but if the Supreme Court were to reverse that decision and determine that 965 is unconstitutional, it would have a massive ripple effect. First, there would be many provisions of the Internal Revenue Code that would essentially be unconstitutional because they also involve deemed income or unrealized income. So, the Internal Revenue Code as we know it would kind of be blown apart. Why do we care as state tax professionals? Again, states that have corporate income taxes and personal income taxes all conform to the federal code in some way, shape, or form. So, this could lead to massive revenue reduction at the state level if that case were to come out for the taxpayer at the Supreme Court. Will that happen? It’s hard for me to imagine that the Supreme Court is going to blow up the Internal Revenue Code.”
Vesely said any changes would be minimal at best. “You’re right about this,” he began. “It would have a tremendous impact on the states, but for folks who are not state tax practitioners, one of the problems with conformity is that all the states don’t automatically conform to the Internal Revenue Code. My beloved state of California does what’s called ‘selective conformity.’ We have conformed to the IRC as of 2015. We have selectively conformed to other things. We do have certain provisions regarding Subpart F in our law that are very interesting, but it is, again, not the Subpart F that you know from the federal law. It’s really an adjusted way of using Subpart F. How Moore will impact state taxes, boy, that makes our job very much more complicated, because you have got to go through each state to determine what the impact would be. But Nikki’s right. I think this is something that could be tremendously impactful. I don’t see the Supreme Court going that far.”
Dobay agreed: “It’s hard for me to imagine, but wherever they land, we’ll probably have to be reading those conformity provisions very carefully. If they are to make some big change that limits the federal government’s ability to impose tax, I think it also just makes it harder for the states to piggyback on those provisions, even if they still exist and the states do not have the constitutional issues, because the states lose the administrative benefits that come from being conformed with the federal code. Now California doesn’t get any of those, so maybe we’ll just have to start doing whatever California does.”
Bell-Jacobs provided some key takeaways. “In 2017, I gave a TEI speech in northern New Jersey at Meadow Wood Manor, if anybody’s in that TEI,” he said. “We went up there and said there are forty-five states with shortfalls. And this was 2017, pre-TCJA—the sky was falling, the sky was falling. We didn’t know what states were going to do. Then, TCJA passed, expanded the tax base for the states, and a booming economy followed. I want to compare 2017 with now, in the context of ‘Are the states prepared or not?’ So in 2017, we didn’t have Wayfair, and now every state with sales taxes has Wayfair. We didn’t really have marijuana revenue, either, and I think that is an interesting revenue source. It’s not a lot of money, it’s a couple billion dollars. But it’s a revenue source that didn’t exist before, and now we have twenty-four states taxing marijuana. Gambling revenues is another one. At least $5 billion nationwide. That’s also getting wider adoption. Didn’t have gambling revenues in 2017, either. Vaping taxes have expanded quite a bit. And then, during the pandemic, thanks to all those [American Rescue Plan Act] funds and everything else, states expanded their rainy-day funds quite a bit. Here I have $155 billion, that’s an estimate in FY23, from $68 billion in FY17. The states are maybe overall in a better financial position to weather a short-term recession and to weather some of these revenue losses that could result. But if there is a recession, if people do lose jobs, those individual income tax reductions are going to accelerate. People are going to further decrease discretionary spending as much and as often. Those are the things we’re going to want to watch closely.”
Rainy-Day Funds
Dobay said, “The rainy-day funds, while we hear a lot about them, and there’s talk that the states are in pretty good shape, those are very short-lived if there’s a major downturn. I think the other piece of this is the states have also really amped up their spending, and then they also have certain things in effect, like employee pensions, that are really these systemic expenses that the states have a very difficult time getting out from under. This was shocking to me. I was at a conference with tax administrators a couple weeks ago. Alaska actually has abolished its pension system for public employees. That is earth-shattering—for a state to go there really does say something about spending and how much can the states really take on. Maybe we see some structural changes at the state level, but it’s hard for me to believe, [in] any other state, that their public employees would allow them to give up their pension.”
Friedman noted that on the business side of things, when states start to go into the red, and with the switch in California happening so quickly after it had such a big surplus, annual state budgets do not seem to be going down at all, nor is spending. “They’re going to have to make up for this revenue at some point,” Friedman said, “and I feel like they’re getting more creative with the way that they’re implementing and proposing new taxes. So, is there any chance at all of states cutting any spending, or are they just going to come after ‘big bad business’ to make up the difference?”
A few states will cut spending, Dobay noted. “There’s a couple that are very fiscally conservative, but not the ‘normal troublemakers,’” she said. “The states, when you look at them and go to them and talk about spending cuts, they look at you like you have two heads. On the business side, we know when revenues go down there are cuts. There are people afraid of losing jobs. There’s no pensions anymore, by and large, on the corporate side. There’s a significant disconnect with policymakers on that. . . . But the states are definitely getting more creative. And then, before we just leave the topic of state-of-the-state fiscal impact, I would love thoughts on the locals. By and large the [local jurisdictions’] budgets are based on property tax or some piece of sales tax. And property values are pretty volatile as well. We’ve seen huge shifts in commercial properties versus residential, and so we’ve seen a lot of state policy questions about local property taxes. If we think the states are creative, the locals get even more creative when it comes to how they are going to fill revenue shortages. Jeff, anything going on in California with the locals?”
“There is a shrine to the city of San Francisco in my living room because of all the work that they are creating for us these days,” Vesely said. “They have a gross receipts tax, and if you haven’t seen it before, you really want to stay away from it. Our best advice is, Don’t come to San Francisco. They actually have, interestingly enough, so much litigation pending that they aren’t spending the money they’ve collected. It’s a pay-to-play fight. And it’s even pay-to-play in the administrative process before you get to court. The city has a bunch of money that’s sitting in some escrow funds there. They’re complaining about they don’t have enough funds, but we’re talking about millions of dollars in the escrow account. I have a client—public company, very well known—its San Francisco gross receipts tax liability is the biggest tax liability they have, state or local, in the country. Think about that for a second. This is San Francisco. It’s very aggressive, and they’re now going to go through a new program where they’re asking for advice from practitioners, companies, whatever: How can we fix this tax? Because, oh by the way, there’s a lot of people not coming to San Francisco right now, too. I don’t buy this is what they’re going to do, because they came up with a gross receipts tax the last time they did this same thing, which was not exactly the greatest thing ever. And so be careful of the locals, really the whole thing. San Francisco is a classic example.”
On California’s ACA 13
To shepherd the session to its conclusion, moderator Friedman turned the discussion to the currently proposed Assembly Constitutional Amendment 13 (ACA 13) in California, which aims to thwart the main intent of another proposal, the business-backed Taxpayer Protection and Government Accountability Act. The Taxpayer Protection Act proposes that all new local special tax increases must be passed by a two-thirds supermajority of voters, rather than by the current fifty-five percent voter approval threshold. “What is the thought,” Friedman began, “about this particular tactic being used in the future to try and scuttle future taxpayer-friendly proposals or to even lower the threshold . . . from, say, fifty-five percent down to fifty-one percent?”
Responded Dobay, “I think that it is directly targeted at that. This is also kind of coming from Ohio’s playbook. There was a similar ballot initiative. It had nothing to do with taxes; they were really focused on the voter thresholds and changing those, and what impact that could have on the way that ballot initiatives in general would be passed. I think this could have huge impact. ACA 13 is drafted in a way that it applies to any other ballot initiative in 2024, so it would apply to the Taxpayer Protection Act [itself]. If that were not successful, anytime the proponents bring something to try to ensure that voter-approval limits are [increased], they would have to meet that higher requirement if 13 was approved.”
“Right now the Taxpayer Protection Act would only need a simple majority or fifty-five percent,” Friedman said.
“I believe it only needs a simple majority,” Dobay replied. Friedman and Dobay went on to agree that if ACA 13 passes, then the Taxpayer Protection Act would need to pass by a supermajority as well.
As the session wrapped up, Vesely commented on several state tax policy trends expected in 2024. Specifically, he said, “There’s a variety of things that we’re going to just touch on. We’re going to see a targeted expansion of the sales tax base; we’re seeing it with the digital side—digital taxes on goods and services and other items like that. And, an oldie but a goody, Public Law 86-272, which was passed in 1959 by the federal government yet the states think that they can amend it and modify it on their own without the federal government doing anything. Income tax . . . while the corporate side doesn’t generate as much revenue for the states, we spend a heck of a lot of time on corporate income tax issues throughout the country. What we’re seeing more and more are sales factor sourcing issues and where should you source your income or gross receipts and other apportionment issues as well. And how do you deal with alternative apportionment? We’ve already talked a bit about the local tax expansion. I mentioned San Francisco—it is certainly not the only one.”
Dobay’s closing comments addressed administrative issues related to sales taxes, which she has focused on extensively for the past few years. In particular, she noted that “as we discussed earlier, the sales tax tends to be very steady. It’s a good revenue source for the states. There’s a lot of focus on the sales tax, because many states do believe that the sales tax base is declining. Why is the sales tax base declining? By and large the sales tax was put into place in most states between the 1930s and 1960s. It was based on the sale of tangible personal property. Let’s fast-forward, and the economy has shifted and the states are really looking at that change and how to rejigger things. But what the states also need to understand is that the businesses that collect and remit sales tax also need some assistance, because things have gotten a lot more complex. From my perspective, rethinking sales tax audits is a win-win for the states as well as the collecting businesses. This isn’t even their tax, and all they want to do is get it right. It’s time the states partner with them to do just that.”
