By: Ned A. Lenhart, MBA CPA


As reported by the U.S. Census Bureau, total state revenues for 2016 were close to $1 trillion ($927,991,215,000). This total is nearly double the 1996 state tax collections of $418 billion. In 20 years state tax collections have doubled but there still seems to be no end in sight for the ‘need’ for additional state revenue to fund education, roads, public safety, and healthcare. As more federal programs get pushed to the state level, the states must decide whether to shift existing spending to cover the new programs or to increase revenue. As the overall U.S. economy has expanded and contracted during the past 20 years, the source of revenue collected by the states has shifted.

In 1996, individual income taxes accounted for 32.4% of state revenues nationwide. In 2016, individual income taxes were 37.2% of state revenues nationwide. The reasons for this growth are varied, but include the general growth in nationwide employment and the expansion of the federal individual tax revenue base which is used by most states as the starting point for state income tax calculations.

In 1996, corporate income tax accounted for about 7.0% of state revenues nationwide. In 2016, corporate income taxes were slightly more than 5.0% of state revenues nationwide. In terms of tax dollars collected, this is a relative decrease in over $18 billion of state revenue during the past 20 years by states related to corporate income tax. This decline is not surprising given the significant efforts many companies made to structure their businesses to take advantage of differing state corporate tax rules and filing methods and the expansion of state tax credits use to offset income tax. Even though corporate income tax collections were almost $47 billion in 2016, many states are viewing the corporate income tax as a relic and may eliminate it or narrow the application to just a certain range of companies.

This takes us to sales tax. During 1996, sales tax collections were $139 billion and made up 33.31% of total state revenues. During 2016, sales tax collections were $290.5 billion and made up 31.31% of total state revenue. The highest percent of sales tax collections occurred in 2001 when over 46% of total state revenue was collected from sales tax.

State Revenue Loss

Given the numbers reported above, it’s hard to imagine the states are having much of a revenue problem. We constantly hear the whining of state revenue administrators and state legislators about the shortage of revenue and the need for tax reform or special studies to review ‘tax expenditures’ to see what revenue is being lost. You would think that $1 trillion in state revenue would be enough to fund the programs. A deeper review, though, may support some of the points these administrators are making.

When comparing the percent of sales tax collections in 1996 to the percent of tax collections from sales tax in 2016, there has actually been a 6 percent decrease in the relative amount of sales taxes collected. The total dollar amount of sales tax collected has more than doubled from 1996 to 2016, but the sales tax collected as percent of total state revenue has declined. If the percent of sales tax collected in 2016 was the same as the percent collected in 1996 (33.31%), states would have collected an additional $18.5 billion of sales taxes in 2016.

When you combine the relative decrease in corporate income tax collections for the past 20 years ($18 billion) with the relative decrease in sales tax collections for the past 20 years ($18.5 billion), there is a combined decrease in state revenue of almost $37 billion when compared to percentages of tax collected in the 1996 base year.

Over the years, the states have bridged this revenue gap by imposing other special taxes and fees. In 1996, about $114 billion was collected in special state fees and taxes. In 2016, over $245 billion was collected in special fees and taxes. This is a 214% increase in revenue from special taxes and fees. Plus, individual income tax collections have remained solid and have grown.

The Shift in Sales Tax

The decline in the relative collection of sales tax over the past 20 years is not surprising given the seismic shift in the sales tax base and in sales tax compliance during the past 20 years. The impacts differ by state based on the sales tax laws they have. The sales tax laws of 1996 (most of which are still on the books) were focused on the application of sales tax to the sale of tangible personal property. If you bought a book, you went to the store and paid tax on the cost of the book at the checkout counter. In 2016, you’re hard pressed to find a bookstore. Books (and lots of other products) have now become digital and are downloaded. Few states have been able to capture the taxation of these electronic transactions.

From a business purchase perspective, software sales in 1996 were made by delivering the software on tangible media. This was taxable in every state. A few years later, electronic transmission of software was common, and today Software as a Service (SaaS) and other remote access methods is the standard. Only a few states are taxing SaaS or downloaded software. The advancement in communications has made the sales tax rules developed for landline telephone communications obsolete, but they are still on the books. As the population has become older, our need for ‘things’ has decreased and our consumption of ‘services’ has increased; very few states broadly tax services. The more you look at how we live our lives in 2016, the easier it is to identify reasons why the sales tax base has changed.

In addition to the shift in tax base, comes the decrease in revenue due to compliance issues. In 1996, the concept of e-commerce was in its infancy. In 2016, over 10% of all retail sales are made through some form of remote commerce. For retailers that do not have nexus in the state where their customer is located, there is no obligation to collect sales tax. However, the consumer has the obligation to pay use tax in the state where they take possession of the property. Many large companies have use tax payment procedures in place to pay the tax due on out-of-state purchases, but for individual consumers, there is close to zero percent rate of compliance. As such, the sales tax that was once collected by the retailer when the customer would come to their store is now not being collected by the remote seller or paid in the form of use tax by the purchaser. Over the past 10 years, more businesses have started to collect sales tax on remote sales, but there is still a meaningful amount of sales tax revenue that is not being collected by the states on transactions that they believe are taxable.

Future Reliance on Sales Tax

The statistics I’ve mentioned above are well known to the state revenue and budget offices. They are concerned about collecting the revenue needed to fund state programs. There is unlikely to be any increase in individual income tax rates and the corporate tax is becoming a smaller piece of state revenue and may even be eliminated. With federal income tax reform on the horizon there may be a decrease in state individual income tax because the federal tax base may shift. That leaves sales tax as the primary revenue source for states to use to bridge the anticipated revenue gap.

From my reading, the states are beginning to shift the sales tax base to include more services and to remove some sales tax exemptions where the need for those exemptions has changed. More states are taxing downloaded software and SaaS, more states are taxing digital products and some personal and professional services. Florida taxes commercial property rents and Texas taxes a variety of real property services. The state of North Carolina recently implemented a tax on personal and real property repair services. I expect changes to be subtle at first, but as time goes on and the revenue decline continues, the changes could become rather dramatic.

In addition to substantive law changes, the states are actively trying to collect more revenue by getting remote sellers to begin collecting tax on their sales. The states are attempting to implement ‘economic nexus’ rules but these rules are currently illegal. The goal is to take this fight to the Supreme Court with the hope that the Quill case will be overturned. There is no assurance that the court will take these cases or will overturn Quill even if it does take the case. There may even be some federal law changes that could impact remote sales tax collection.

States are also increasing efforts to identify sellers that have nexus in their state because of a physical presence in their state. Once identified, the states are sending deficiency notices for the back tax, interest, and penalties to these retailers. The states have given up trying to collect use tax from the individual purchaser, and now view getting retailers to collect tax as their primary focus. States are opening out-of-state audit offices to find these sellers and to put their auditors closer to the seller’s location.



As outlined above, sales tax as a percentage of total state revenue is significant but it has been declining. As the states look ahead, their plan is to use sales tax as the primary driver of state tax revenue as they expect the individual and corporate tax bases to decline. The focus on sales tax will affect us as consumers and as businesses. As consumers, we may start paying sales tax on the haircuts we get or the dry cleaning we have done. As businesses, we may have to begin charging our customers tax on the accounting services or consulting services we provide. For remote sellers, the states have you on their radar and believe that getting you to collect sales tax on your sales to customers in their state will bridge this revenue gap. The states plan on increasing state sales tax revenues through a combination of substantive tax reform and increased compliance. There is no single short-term solution to this problem. I fully expect that in another 20 years (2036) sales tax (or whatever it may be called at that time) will be the dominant source of state tax revenue.