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Sales Tax and Fiscal Sustainability

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The Texas economy has been a top performer for many years. Indeed, even with the ups and downs of the national economy, since 2002, Texas’ economy grew at an 5.7 percent annual compound rate. As the economy changes, however, all states, including Texas are facing a fiscal challenge. As the economy includes more services and fewer goods, traditional sales taxes are bringing in less revenue.

Based on reports from the Texas Comptroller of Public Accounts, Texas has seen its taxable sales activity grow by only 3.1 percent annually.  With no income tax, sales taxes are a major source of state revenue (26.4 percent of the total in 2015).

Another way of looking at this is to compare taxable sales to total economic activity. Even as the economy has grown, the amount of taxable sales has continued to shrink (see chart.) In 2002, a dollar of gross state product generated 6 cents of taxable sales. That amount fell to 5 cents in 2008 and was down to just over 4 cents by 2015 (most recent data.) This is clearly an unsustainable path. Since cities in Texas also rely heavily on sales taxes, they are facing the same situation. Local conditions may differ and some cities have healthier economies than others, but the trend will be the same.

Texas taxable sales per dollar of state GDP

A changing economy means less sales tax revenue even with growth.

With growth, there is more demand for services: schools, police and fire being the largest categories for local governments. But the available resources are not keeping up. If the circumstances get bad enough, a future Legislature will face pressure to broader the sales tax base to cover more services. As a fiscally conservative state, however, cities, towns and the state government in Texas will likely choose to cut spending rather than seek new revenue sources.

This makes it critical for local leaders to focus on how to make their communities more sustainable through their development policies, land-use patterns, regulations and municipal operations.

Sales Tax and Retail Sales

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Introduction

This week we look at sales tax revenue. We also report the latest retail trade statistics. In Texas, many industries pay sales tax. Retail sales is a major part of that total, especially in some smaller communities.

Sales Tax System in Texas

For most Texas cities, sales tax is the second largest source of general revenue, after the property tax. According to information we received from the Texas Municipal League, statewide, 28 percent of general fund revenues come from sales taxes. Property taxes contribute 35 percent. Most cities levy a sales tax. Other local jurisdictions also have the opportunity to levy a sales tax under some circumstances.

The Texas Comptroller administers the sales tax. The Comptroller collects the entire sales tax levy statewide. It keeps the State’s portion, then allocates each localities’ share. The State of Texas levies a 6.25 percent tax on certain items. There are many exemptions. In fact, according to the latest Comptroller data, only 25% of gross sales are subject to the sales tax. Total gross sales in Texas were $432 billion in the first quarter of 2016. Of that total, $109 billion was subject to sales tax.

Local governments may levy up to an additional 2.0 percent sales tax. Many cities levy a one cent tax for general revenues. Also, by referendum, communities can levy additional sales tax designated for special purposes such as offsetting the property tax rate, streets and economic development. Transit authorities also absorb some of this local tax capacity. If a city is not using its maximum 2.0 percent, the local county can claim the unused amount and levy a sales tax. This is not common in Texas.

Latest Sales Tax Performance

We assessed the latest Texas Comptroller data. The recent slump in the energy industry continues to take a toll on the Texas economy. For September, total sales tax revenues are down 3.9% compared to September 2015. Because of slower reporting for the local allocation, we will look at data ending in August for local governments. For the twelve months, ending in August, localities pulled in 6.2% less sales tax revenue than in the twelve prior months. The situation will differ from place to place.

Retail Trade and National Retail Sales

In Texas, 24% of gross sales come from the retail sector. Other industries like utilities and media account for the majority of sales tax revenue so local leaders need to consider their overall industry health when assessing their sales tax revenue prospects. The retail share will tend to be higher for small cities, especially if they have a lot of highway frontage or large tourist sectors. Within the retail category, less than half of gross sales are subject to tax. Groceries are a notable and large example of exempt sales.

We can get detailed retail performance information from the Census Bureau’s monthly retail trade survey. Nationally, retail sales are doing better than they are in Texas. From September 2015 to September 2016, national sales are up 2.7%. These number, however, are not as robust as they seem because they are not adjusted for inflation. This means sales are probably positive, but not booming. Over the last year, several retail sectors have seen growing sales including: furniture and home furnishings (+2.7%), building and garden materials (+5.6%), clothing and accessories (0.7%) and food and drinking establishments (+0.8). Sectors that saw falling sales over the year include: electronics and appliances (-3.8%), gas stations (-3.4%) and department stores (-6.4%).

This is not a great report. National data continue to paint the picture of an economy that is moving sideways. There are some benefits to consumers from lower gas prices, but as can be seen in this data, there are even bigger hits to major retail sectors. Since the Great Recession, wage growth has been slow and many jobs added during the last few years do not pay as much as the jobs that were lost.

Local governments in Texas are accustomed to booms and busts. The current slowdown should not be a surprise. There are ways to prepare for lean times. Prudent budget and operational planning, maintaining adequate fund balances and making surgical economic development investments are critical to prevent unnecessary budget pain down the road. It is also essential for local leaders to pay attention to their local economies and the wider state and national situation. We encourage you to reach out to us if you want to discuss how Axianomics can help you make more confident fiscal choices in these uncertain economic times.

What’s Next

Next week, we will look at local property taxes in Texas. Tax bills are going out and a common challenge for local leaders is helping their communities understand the composition of the total tax burden, which supports more than just cities.