Despite Budget Standoff, North Carolina Implements Sales Tax Base Expansion

August 1, 2019

On July 26, North Carolina Governor Roy Cooper (D) signed into law S.B. 523, “An Act to Make Various Clarifying and Administrative Changes to the Revenue Laws.” What the bill lacks in a catchy name, it makes up for with sound tax policy by expanding North Carolina’s sales tax base and creating consensus in divided government. Even though the state is currently in a budget standoff, S.B. 523 passed without a dissenting vote in either chamber of the General Assembly. Among dozens of other changes, the new law expands the Tar Heel State’s sales tax by making more digital property taxable. Expanding the sales tax base is becoming increasingly necessary as states respond to shifting consumer behavior in our modern economy.

Previously, North Carolina’s sales tax only applied to digital property with a “taxable, tangible corollary,” according to a guide from the General Assembly’s Legislative Analysis Division. That’s a tricky standard to meet in conjunction with existing digital property definitions. The guide gives the example of e-learning materials for an online class. E-learning materials would meet the state’s legal definition of an “audiovisual work” under digital property laws, but the state’s Department of Revenue ruled that they were not subject to sales tax because they lack a taxable, tangible corollary.

According to a Department of Revenue notice, the sales tax expansion to digital property with the taxable, tangible corollary standard was made law in 2009. That’s worth noting because it only took 10 years for that standard to become outdated. Think about the digital purchases you made in 2009 compared to the digital purchases you make today: it’s almost certainly more today. Then realize that all others in the United States have behaved similarly, and you begin to see how much of a difference shifting consumer behavior can make for sales tax administration.

To fully grasp the problem with shrinking sales tax bases, though, we must look back further than 2009. Of the 45 state sales taxes, 22 (including North Carolina’s) were implemented in the 1930s. Since the economy of the 1930s consisted primarily of tangible goods, the sales tax applied to tangible goods. What people buy has changed significantly since before World War II–try searching “iceman” online (you will find a lot about movies and very little about ice harvesting and delivery). Sales tax administration has not kept up with those changes; consequently, the sales tax applies to fewer sales every year. North Carolina’s sales tax base comprises just 36 percent of state personal income, and that’s actually not bad (it ranks 23rd among the states).

The fact that 36 percent is not bad reveals the struggle states face in sales tax administration. A well-structured sales tax is a consumption tax, and where consumption goes, administration should follow. American consumption is shifting to services and digital property, so administration should follow to maintain the sales tax base. A broad base allows for low rates and stable revenue, which makes the sales tax less distortive for consumers and more dependable for the state.

North Carolina’s expansion of the sales tax base to include more digital property is progress toward modernizing the sales tax to reflect the realities of the modern economy. By removing the taxable, tangible corollary requirement, digital property will be taxed under the state’s general sales tax for sales occurring on or after October 1, 2019. Although promising franchise tax reforms languish in the state’s ongoing budget standoff, this sales tax expansion is a positive development.

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