Lawmakers Increasingly Looking at Taxing Services
As states focus attention on federal tax conformity and Wayfair implementation legislation, another tax issue is percolating at the state level: proposals to expand sales and use taxes to services, according to MultiState Associates. This idea was highlighted during a U.S. House Judiciary Committee hearing this past July, on Wayfair’s impact on states, when a majority witness noted that “accountants, lawyers, doctors, architects and others who provide services over the phone or internet” could be targets for tax base expansion.
“States may seek to impose new sales taxes or professional services taxes on the sale of digital goods and provision of services of all types to customers in the state, and impose accompanying collection obligations on sellers or service providers that have no physical presence in the state,” said Andrew Pincus, a partner at the law firm Mayer Brown LLP.
The push to expand state tax bases has been building for a long time, and states have increasingly considered taxing services in recent years. These proposals are usually met with widespread opposition, but they are more likely to be successful when states are facing budget pressure or when lawmakers want to offset the cost of personal income tax reductions. Hawaii, New Mexico and South Dakota remain the only states to broadly tax services (because they’ve always done so, not as a result of an expansion campaign). Although there have been plenty of these bills introduced in recent years, nearly all have failed to gain traction.
Taxing services is also one of the few issues without a clear partisan valence: Republican and Democratic lawmakers alike have pursued sales tax base expansion legislation. Texas Comptroller Glenn Hegar recently released a report that proposed eliminating $60 million worth of tax expenditures – including certain services – in order to close the funding gap for the state’s school system. Because Texas has no personal income tax and lawmakers often talk about replacing the property taxes with more consumption-based taxes, a tax on services is not out of the realm of the possibility. For example, Utah Governor Gary Herbert has called for expanding the sales tax to services in his official budget proposal. Additionally, the Wyoming Joint Revenue Interim Committee approved legislation for House introduction that would extend the sales tax to agricultural, engineering, accounting and other related business services.
In addition, California Senator Bob Hertzberg attempted to introduce a tax on services in 2018. Despite the bill failing to make it out of committee, Governor-Elect Gavin Newsom has indicated that he wants to restructure the state’s tax code to shift reliance away from income and capital gains. Hertzberg’s bill may provide the vehicle.
However, despite the rising tide of interest, opponents of taxing services did get a boost on election night when two-thirds of Arizona voters approved Proposition 126, a ballot measure prohibiting state and local governments from levying any new taxes or raising existing ones on services. This marked the second ballot measure to ban service taxes since 2016, when Missouri voters approved a similar measure.
New Laws to Focus on Data Breach Notification and Privacy
A number of high-profile security breaches in 2018 are sure to prompt state lawmakers to seek greater protection of consumer information in 2019. Many of the newer laws have focused on notice given to consumers and state agencies in the wake of a breach, but there are now calls for “data minimization,” which would require companies to purge themselves of consumer information they no longer need.
The European Union General Data Protection Regulation went into effect in 2018, which has inspired more proposed laws in America requiring consent on how consumer information is used. California led the way when it passed the landmark California Consumer Privacy Act of 2018, which will require companies to disclose what information they are collecting from consumers and allow them to opt out of having their data sold. The California law, which was partly a response to a proposed ballot measure that would have included even more sweeping provisions, is set to go into effect in 2020. However, heavy lobbying from interest groups to amend the law before the 2020 effective date is expected. Although all eyes will be on California this year, expect other states to take California’s law as a model to begin their own debate on privacy laws in 2019.
The California bill also requires manufacturers of connected devices to develop comprehensive security plans. With more household devices connected to the internet, there will be greater scrutiny over the security of the “Internet of Things.” The New York Times recently highlighted privacy concerns over location tracking, which could prompt legislation requiring more notice be given to consumers being tracked.
Employer Mandates to be Key Issues in 2019
States will take action on a wide variety of employer mandates in 2019, in many instances continuing legislative work begun in 2018 that was vetoed by Republican governors who have been replaced by Democrats, or that otherwise stalled in the legislature. In 2019, expect state lawmakers across the country to debate and likely enact bills to increase the minimum wage to $15 per hour, mandate paid family leave and bar employers from inquiring into an employee’s salary history.
In New Jersey, Governor Phil Murphy has vowed to work with the legislature to fulfill one of his campaign promises to increase the minimum wage to $15 per hour. Murphy is currently negotiating with the legislature over the current proposal to phase in the increase to $15 per hour by 2024. Murphy is hoping to shorten the timeframe for the increase and would like the legislature to act before the end of the year on the issue. Minimum wage increases were vetoed in 2018 in Vermont and 2017 in Illinois, where Governor Bruce Rauner will be replaced by J.B. Pritzker, who has promised to raise the wage to $15 per hour. This issue will remain active at the state level until Congress enacts a nationwide minimum wage increase.
In 2018, lawmakers in 21 states introduced paid family leave legislation, which was enacted in Massachusetts. In Hawaii, lawmakers passed a study bill to conduct an analysis of the impacts of paid family leave and the best framework for establishing the legislation by September 2019. Governors in Maine and Vermont vetoed paid leave bills, while bills in Colorado and New Hampshire passed their chambers of origin but failed to pass the full legislature. In Minnesota, Governor-Elect Tim Walz and incoming Minnesota House Speaker Melissa Hortman have stated that paid leave will be a priority in 2019. Expect this issue to be debated seriously in a small number of states next year.
Lawmakers will continue to introduce equal pay legislation around the country in 2019. This year, salary history inquiry bans were signed into law in Connecticut, Hawaii and Vermont, and equal pay bills passed their chambers of origin in seven states but otherwise stalled. Additionally, Republican governors in Illinois and Maine who vetoed salary history inquiry ban legislation in 2017 will be replaced in 2019 by Democratic governors who should be more receptive to these proposals.
Finally, expect state lawmakers to continue debates on legislation to regulate employee schedules and ban the use of arbitration to resolve employment disputes next year.
State Lawmakers Targeting Healthcare
This year, voters in three “deep red” states approved ballot measures to expand their state’s Medicaid program under the Affordable Care Act. Measures in Idaho, Nebraska and Utah all received comfortable margins of approval, while voters in Montana rejected a proposal to fund the state’s expanded Medicaid program with new revenue from taxing tobacco products. In March, Virginia expanded its program after years of resistance from the Republican-controlled General Assembly.
In 2019, Maine’s Governor-Elect Janet Mills has vowed to implement Medicaid expansion as soon as she takes office in January after Governor Paul LePage’s administration delayed implementation following a voter-approved ballot initiative in 2017. Kansas Governor-Elect Laura Kelly also included Medicaid expansion as a top priority of her new administration. Last year, the Republican-controlled legislature passed legislation to expand Kansas’ Medicaid program, but then-Governor Sam Brownback vetoed the bill. Despite voters’ rejection of Montana’s ballot measure, the Republican-controlled legislature agrees with Democrats on prioritizing the funding of the state’s Medicaid expansion, though lawmakers have not indicated how they would resolve the funding issue.
In addition to coverage expansion, state governments will continue to wrestle with health insurance market reform, particularly after a Texas judge recently struck down the entire ACA on the grounds that the individual mandate is unconstitutional and ACA’s remaining provisions cannot stand without it. Although this ruling does not have an immediate effect and is expected to be appealed, it leaves state legislators to debate protections for individuals with pre-existing medical conditions, the increase in child coverage to age 26, and employer mandates, among other market issues.
Drug pricing legislation is also expected to be a hot issue in the states in 2019, following President Trump’s “Blueprint to Lower Prices and Reduce Out-of-Pocket Costs,” which his administration released in May, as well as several major state initiatives that passed this year in Oregon, Connecticut and Illinois.
States React to Federal Tax Activity
Over the last 12 months, the federal government has been busy changing many of the parameters of taxation, first with President Trump’s signature enacting the Tax Cuts and Jobs Act last December and then with the U.S. Supreme Court ruling in June that states can collect sales taxes on internet purchases. States have already begun adjusting their own laws to reflect these new fiscal realities, and those efforts will extend into 2019.
Because every state uses the Internal Revenue Code as the baseline for its own tax systems, the TCJA’s passage has significant downstream effects for states. Whether it is expanding the corporate income tax base to include global intangible low-taxed income or creating new interest expense limitations, states have had to decide whether they want to conform their own tax codes with all of the new provisions. While some states made progress, only 21 states to date have enacted conformity legislation. Leaving these conformity issues unresolved can cause headaches for personal and business tax filers, so some states (like Arizona and Virginia) are already discussing the actions they need to take early in 2019.
As with federal tax conformity, most states have set up remote sales tax collection systems in line with Justice Anthony Kennedy’s June decision in South Dakota v. Wayfair, but more work will be necessary next year. Lured by billions in potential revenue, states lawmakers and revenue departments have been eager to pass laws and regulatory rules that put them on the right side of the Court’s decision. For some states, however, questions remain. California recently announced that it would use the same sales thresholds originally designed for South Dakota, despite being more than 40 times larger. Colorado and Louisiana could also run into trouble, as their notoriously complicated local tax systems could delay their efforts to collect the new sales tax revenue.
States Eye Transportation Funding
Election years are generally a bad time for state lawmakers to raise revenues for transportation infrastructure projects, especially if that revenue raiser is a gas tax increase. However, once lawmakers get through an election cycle, they typically take vital, if unpopular, issues like transportation funding more seriously.
Despite frequent but unreliable promises from federal officials for a much-needed injection of infrastructure investment, states have taken a leadership position on the issue. Twenty-four states have raised their own fuel taxes since 2012. Next year, policymakers in Colorado and Missouri will need to find transportation revenue solutions after voters rejected ballot measures to raise gas taxes in November. Senate leadership in Alabama says lawmakers are considering raising and indexing the state’s gas tax in 2019. Governor Rick Snyder in Michigan has proposed using a portion of new sales tax revenue applied to online purchases, thanks to the South Dakota v. Wayfair decision, to help fund roads. Governor Matt Bevin of Kentucky is calling on his state’s legislature to raise gas taxes and fees to fund roads, and might call a special session to get it done.
In 2017 – the most recent non-election year – seven states passed major gas tax increases. Additionally, a popular trend to monitor is for lawmakers to add fees aimed at hybrid or electric vehicles, which are currently a minor part of the overall vehicle fleet on state roads, but growing in popularity.
Four States Likely to Go Big on Taxes in 2019
On Election Day, Democrats took a bite into the state legislative dominance that Republicans have enjoyed for much of the last decade. After being relegated to minority party status and hamstrung by supermajority fiscal policy requirements, liberal lawmakers in certain states now have the ability to chart a new fiscal policy course.
According to Ryan Maness of MultiState Associates, the Coin Laundry Association’s legislative analyst, the four states most likely to go big on taxes next year are California, Illinois, New York and Oregon.
California: In California, progressive members of the legislature have been agitating for years for a more aggressive policy agenda, only to be stymied by Governor Jerry Brown’s relative moderation and their intermittent lack of a supermajority of votes necessary to pass tax increases. Whether it’s tapping into the rainy day fund to boost funding for social services, broadening the sales tax to professional services in response to federal tax reform, or the enactment of a single payer healthcare system, segments of the Democratic caucus have seen their political priorities hindered by procedural and political roadblocks.
But when the next legislative session starts up, many of those barriers will be gone. The biggest change will be Gavin Newsom succeeding Brown as the state’s chief executive. Brown has been a fixture of California governance for more than 50 years, and he has proven himself to be a canny and effective politician. Despite California’s reputation as a high-tax state, he has been able to exert a level of relative fiscal moderation, particularly in the last few years as he has pushed the state to conserve funds in anticipation of another economic downturn. Lt. Gov. Newsom made a name for himself as a progressive champion during his tenure as mayor of San Francisco, but he found himself in political exile after a series of missteps. He has since made his way back into the limelight, but his previous foibles suggests that he will have difficulty holding the reins of a legislature that is champing at the bit to take big moves in opposition to President Trump.
While not as high-profile, the other vital change come January will be the fact that Democrats will again have supermajorities in both legislative chambers. In January 2018, state Senator Josh Newman was recalled from office, targeted in a vulnerable district after he supported a gas tax increase, depriving Democrats in that chamber of the two-thirds majority needed to pass tax legislation. That changed on November 6 when voters sent more than enough new Democrats to the Senate to restore their lock on power.
Illinois: The election of JB Pritzker promises to end an era of partisan gridlock that has defined Governor Bruce Rauner’s tenure in office. Since Rauner ascended to the top job in 2015, he has been at loggerheads with the political power centers in Springfield, most notably Speaker Mike Madigan. As the two leaders fought and sniped, the state’s budget deteriorated: lawmakers went for two years without passing a budget and credit ratings agencies have threatened to relegate their bonds to junk status. This year they were able to pass a budget on time only to admit later that it was $1.2 billion out of balance.
The personnel changes in the governor’s mansion will reshuffle the political environment, but the state will still need to make serious course corrections to right the financial ship of state. On the campaign trail, Pritzker said that one his prescriptions for these fiscal woes is to replace the Illinois’ flat income tax rate with a progressive series of brackets. Since this would necessitate amending the state constitution, it wouldn’t be a quick fix and other revenue patches would be needed in the meantime.
Currently, lawmakers are looking at expanded gaming and recreational marijuana to get them through, but if those revenues alone can’t balance the books then other steps could be necessary. Given the seriousness of the problem, some lawmakers may push drastic correctives without any legislative checks or moderating forces. It’s hard to predict what could shake out of such a scenario, indeed there is the distinct impression that anything could be possible.
New York: While New York has been nominally under Democratic control for most of the last decade, in 2011 a group of lawmakers defected from their party to form the Independent Democratic Conference to caucus with the Republicans. Despite his protestations to the contrary, it is widely believed that Governor Andrew Cuomo had encouraged the splinter group in order to maintain his credentials as a moderate. Without unified control of the legislature, the left flank of the New York Democratic caucus has not been able to make any headway on its legislative agenda, despite living in a blue state.
That status quo evaporated earlier this year, when the IDC’s membership reached an agreement to rejoin their party. The party moved even further left on Election Day, when many of its former members lost their races to more liberal, insurgent challengers.
Democrats will head into 2019 with solid majorities in both legislative chambers and years of policy backlog to work through. When asked about their priorities for the coming session, the most common answers are social issues like codifying Roe v. Wade, marijuana legalization, immigration protection and voting rights. It’s possible that these issues will crowd out any significant tax reform efforts, but if they do choose to focus on fiscal policy (either in an effort to repair New York City’s transit system or to counteract the effects of federal tax reform), then the Democrats could have wide authority to embrace a more progressive vision for the state’s finances.
Oregon: Like California, Oregon lawmakers have been pushing for a more progressive fiscal agenda for some time, with a particular focus on boosting funding for the state’s chronically underfunded school system. There have been several efforts to address this, but so far none have made it over the finish line.
For example, in 2016, education activists and union leaders sponsored a ballot question (Measure 97) that would have levied a 2.5 percent tax on gross receipts tax on revenues in excess of $25 million. The measure was soundly defeated, losing at the ballot box by a 59 to 41 percent margin. The state legislature tried again in 2017 by introducing legislation that also would have levied a revenue-based tax on top revenue earners. That measure failed in committee when the sponsors were unable to pick up the Republicans necessary to overcome the three-fifths supermajority vote requirement to pass tax legislation. When the proposal failed, however, Governor Kate Brown said that she fully intended to reintroduce it in 2019.
Since then, the political landscape has only become more favorable to Oregon tax proponents. On Election Day, voters sent enough Democratic lawmakers to the legislature to meet the supermajority threshold necessary to pass tax legislation. Portland voters also approved the “Portland Clean Energy Community Benefits Initiative,” which levies a 1 percent gross receipts tax on businesses with total annual revenue over $1 billion and Portland annual revenue of over $500,000.
“It’s important to note that these are not the only states with progressive verve where Democratic hold power, but they are the states with the widest political latitude to change fiscal policy,” Maness noted. “Colorado, for instance, will also be controlled by Democrats, but the Taxpayer Bill of Rights requires that any tax increases be approved by a vote of the people, and that has historically been too high a bar for most policies to clear. The election of Michelle Lujan Grisham in New Mexico means that this state also will have unified governance, but efforts at big revenue changes there are unlikely given the state’s culture of fiscal moderation.”
Legislation to Protect Small Businesses from Predatory Lenders
Senators Sherrod Brown and Marco Rubio are teaming up on legislation aimed at protecting small-business borrowers from predatory lenders. On December 6, the two lawmakers introduced the Small Business Lending Fairness Act, which would extend certain Federal Trade Commission protections for consumer loans to small-business borrowers as well.
The bill would ban the use of “confessions of judgment,” a debt-collection practice that has devastated many small businesses. Some financial firms that offer quick money require their customers to sign confessions to get loans. By signing, the borrowers forfeit their right to defend themselves in court before obtaining a loan. Armed with a confession, lenders can accuse borrowers of not paying and legally seize their assets to satisfy the debt.
Although many states have banned this practice for small-business loans as well as individuals, borrowers are still exposed because the FTC left open a loophole, which has enabled predators to devastate many small businesses across the country. The Small Business Lending Fairness Act closes the loophole, and provides small businesses with the same protections consumers already have.
Bloomberg recently published an in-depth investigative report on this small-business lending tactic. The lenders that use the confessions call themselves merchant cash-advance companies. It’s an industry that has been booming since the financial crisis, as banks pulled back from lending to small businesses. They lure small-business owners with offers of fast cash and charge interest rates that can top 400 percent annualized. The confessions are generally filed in New York State courts, no matter where the borrower is located. Cash-advance companies have secured more than 25,000 judgments in the state since 2012, worth an estimated $1.5 billion, according to data compiled by Bloomberg. On December 3, New York’s attorney general opened an investigation into the cash-advance industry in response to these articles.
The Small Business Lending Fairness Act codifies the FTC’s 1985 ban on confessions of judgment in law in consumer loan contracts, and expands the ban to provide these protections to business borrowers as well.
Sen. Brown plans to push for the proposal to be passed next year, either on its own or as part of a larger bill.