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May 19, 2020

Virginia Could Gain Budget Resources by Eliminating Antiquated Sales Tax Exemptions

The latest monthly revenue report from Secretary of Finance Aubrey Layne shows that state revenues are coming in more slowly as a result of the COVID-19 pandemic. Once the revenue situation becomes clearer, the governor is expected to call a special session later this summer or fall for state lawmakers to take further action on Virginia’s next two-year budget, which begins on July 1. At that point, the governor likely will have shared a revised revenue forecast. As policymakers begin to make additional decisions around the state budget, the governor and General Assembly should consider potential revenue options to help address some of these challenges. In particular, among states that have sales taxes, Virginia is one of only 12 that does not apply a general sales tax to streaming platforms (as of July 2019) and one of only 16 states that does not apply that tax to digital products generally (as of Oct. 2019). By updating the tax code to include these products, the state would put them on a level playing field with equivalent goods that have been traditionally included in sales taxes and generate an estimated $40 million in needed state revenues in the upcoming budget, as well as new local revenues, during this time of economic turmoil. 

Taking steps to modernize Virginia’s sales tax would help to shore up state and local budgets while better aligning the state revenue system with 21st century reality. The pandemic looks like it is accelerating the trend of economic activity shifting online. However, despite recent modernizations, much of this new consumer spending is exempt from Virginia’s state and local taxes. In particular, Virginia’s sales and use tax and a related communications sales and use tax, which applies to phone, television, and other services, do not extend to certain digital products and services, including streaming. 

These exemptions are not necessarily conscious policy choices and are likely unintentional. Virginia’s retail sales and use tax was established in 1966 before the digital economy existed. The more recently created communications sales and use tax also has not been modified since 2007, which was the first year Netflix began offering streaming content and before Spotify had launched. Instead, that law was written to apply to the technology from that time period (and earlier), including satellite TV and radio, fax services, pagers, and beepers. In 2015, the state Department of Taxation published a report to examine the communications sales and use tax and found that broadening the tax base by eliminating the exemptions for audio and video streaming services and prepaid calling services would increase revenues and create a more level playing field.

Graph showing which states tax digital products. Most states now generally include digital products to their tax base.

Many other states have taken action, and Virginia is among only 12 states that have sales taxes and do not apply a general sales tax to streaming platforms (as of July 2019). These services are subject to sales tax (or another tax) in the other 33 states that have sales taxes plus Washington, D.C., including all of Virginia’s neighboring states. Meanwhile, 29 states plus Washington, D.C., generally tax other digital products and services, including neighboring states North Carolina and Tennessee (as of October 2019). Florida is the only state that includes streaming services but not other digital products in its sales tax base. Taxing these products and services puts them on a level playing field with equivalent goods that have been traditionally included in sales tax bases (e.g., an e-book vs. a paperback book) as well as those recently added to the tax base (e.g., subscription-based streamed radio vs. subscription-based satellite radio).

During the 2018 General Assembly session, a bill that included provisions to apply Virginia’s sales tax to digital products was estimated to increase General Fund revenues in the 2021 and 2022 fiscal years by $19.6 million and $20.6 million, respectively, as well as additional non-General Fund revenues for K-12 education, transportation, and localities. A separate proposal from that year would have expanded the communications sales and use tax to cover audio and visual streaming services and prepaid calling. At the time, it was estimated to generate about $7.9 million annually in additional revenues for localities, though this may not account for the continued growth of these services in recent years.

Fortunately, state lawmakers have worked in recent years to modernize Virginia’s sales tax in other ways. Legislation passed during the 2019 legislative session updated Virginia’s sales and use tax requirements to include out-of-state online retailers. Previously, customers were required to send the state any tax they owed on their untaxed online and catalog purchases, but few people did so. Under the law change, online retailers and marketplaces themselves are responsible for collecting any sales and use tax owed — which is how traditional brick-and-mortar retail stores have long operated.

The new law is providing needed resources for state and local priorities, including K-12 public schools, transportation, and local services. Revenues generated from the new law had been coming in strongly compared to initial estimates and accounted for the bulk of sales tax growth in the months leading up to the economic slowdown. State policymakers should build upon these improvements and consider adopting additional measures to modernize the sales tax base.

Budget & Revenue

Chris Wodicka

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