The Sales Tax: Hitting Its Stride, Until. . . .

State and local governments are bracing for big hit to their sales tax collections as so many taxable activities have been shut down. But until March, the sales tax had been good to most local governments for a number of years, outpacing other measures of growth. The fall will start from a pretty good peak in many places.

An earlier story described the sources of sales tax revenue, which reaches further into the economy than just stores and restaurants. Each taxable activity will recover at a different pace.

Dip and recovery over 13 years

As the economy has grown rapidly over the past several years, sales tax collections have grown as well. Construction is throwing off a lot of tax, and rising incomes mean that people have more money to spend on taxable goods and services. We will look at four cities in King County to assess the growth in taxable sales ¹ since the previous peak in 2007.

Figures 1 through 4 show taxable sales by large categories for four cities for each year since 2007, adjusted for inflation. All cities saw a significant dip in taxable sales after the 2007 peak. Seattle and Redmond returned to their 2007 peak by 2013, while Bellevue reached its 2007 peak in 2015 and it took until 2019 for Federal Way to reach it.

The red line in Figure 1 shows the level of taxable sales that City of Seattle budget staff anticipate for 2020, under a slow recovery scenario. In this case, for 2020, Seattle would return to a level of taxable sales the city had experienced between 2014 and 2015.

Bellevue experienced a very sharp drop in taxable sales after 2007, most pronounced in construction, which was cut in half, and retail, which fell over 20 percent. Since the low in 2011, taxable construction has more than tripled, while taxable retail has grown more than 50 percent. Bellevue’s growing hospitality industry is heavily focused on business travel and entertaining, the future of which is a big unknown.

Federal Way, along with the other cities in the southwest part of King County, has grown more slowly. Sales tax revenue in Federal Way has been concentrated in retail, which dropped significantly after 2007 and only recently returned to those levels. Construction has grown as well, leading to a big spike in taxable sales in 2019.

Redmond did not see nearly as large a post-2007 dip in taxable sales as Bellevue. Retail remained fairly constant, and construction was slow. Construction has picked up sharply in the past two years, and other categories have jumped as well.

Productivity and stability

Let’s look at the sales tax in the context of two important goals of any tax regime. First is productivity. Is the tax base growing along with the population and economy and does the tax generate increasing revenues? One measure of productivity is the per-capita tax base, which should grow, at least nominally. Figure 5 shows inflation-adjusted per capita taxable sales for the four cities in 2007 and 2019.

Redmond and Seattle saw healthy per capita growth, while Bellevue and Federal Way remained flat. In the case of Bellevue and Federal Way, a flat sales tax base after adjusting for inflation and population growth is not all that bad. It could be worse. One of the challenges of the sales tax is that the economy in general is shifting away from spending on sales taxable goods and services, and towards non-taxable services like healthcare. One way around this problem has been to increase tourism and visitor spending, but that strategy is now proving problematic.

A second key goal of a tax regime is stability: are collections consistent through fluctuations in the economy. The sales tax is a moderately stable tax source. It is less stable than property taxes, which must be paid, or utility taxes, which are based on usage that does not vary much. Sales taxes can be more stable than individual income taxes in a downturn, depending on the structure of the income tax.

The principle vulnerability in the stability of sales tax systems comes from taxable construction. As noted, construction was cut in half in Bellevue after 2007, and fell by 30 percent in Seattle during that time. A hot construction market has increased taxable sales across the region, but the rate of construction is not sustainable over the longer term, and construction sales taxes will fall eventually.

Looking ahead

The pace of recovery of taxable economic activity depends on several factors, most of which are unknown. The first glimpse of the magnitude the downturn won’t come until early June, when the State Department of Revenue reports sales tax distributions of taxes paid by customers in the month of March (which are remitted to the state in April, distributed to local governments in May and reported in June).

Questions going forward are:

• Will we see a permanent reduction in the sales tax base from the overall downsizing of the food service and hospitality sectors?
• Will consumer spending continue to shift from taxable to non-taxable activities?
• Will economic uncertainty reduce construction, and, therefore, sales tax on construction?
• Will the loss of locally-owned retail concentrate the sales tax base in fewer large retail/commercial centers?
• To what degree will cities with poor brick-and-mortar retail benefit from a shift to on-line sales, and the destination-based sales tax?

1. We report taxable sales rather than tax collections themselves. The State Department of Revenue reports taxable sales in a uniform way that facilitates comparisons. Tax rates can differ among jurisdictions, and local governments have access to a number of special sales taxes that will affect overall rates paid by customers.