Skimming the Sales Tax, a new report from Good Jobs First, shines a light on a little known aspect of state tax policy: the practice in about half the states of compensating retailers for collecting sales taxes on behalf of state and local governments. This is called by a variety of names such as vendor discounts and collection allowances. We use the term retailer compensation, but we also refer to it as a legal form of skimming.

These programs, often unfamiliar even to tax experts, turn out to cost the states involved more than $1 billion a year. Much of the money is going into the pockets of giant retailers such as Wal-Mart. At a time when nearly all states and cities are experiencing fiscal distress, this diversion of taxpayer revenue should be a matter of public concern.

Twenty-six states provide some form of retailer compensation. Nineteen states and the District of Columbia do not. Five states don’t have a state sales tax.

In all 26 states the compensation is calculated as a percentage of the sales tax collected by a company. Half of the 26 states put a ceiling on the amount a given retailer can receive, though the ceilings vary widely—from less than $1,000 a year in states such as Florida and New York to as much as $10,000 or more. The highest ceiling by far is in Michigan, where it can go up to $240,000 a year.

But perhaps the bigger problem is in the 13 states that put no ceiling on what a retailer can receive. These states can end up giving away quite a bit of money. We found the largest loss in Illinois at $126 million. Second was Texas at $89 million followed by Pennsylvania at $72 million and Colorado at $68 million.

States do not disclose how much is given to individual retailers, but we were able to estimate how much is being received by the country’s largest retailer—Wal-Mart. Using state-by-state figures disclosed by Wal-Mart on its sales tax collections, we estimate that the company is receiving a total of $60 million from the 26 states. In Missouri, for instance, we estimate that Wal-Mart is receiving about $10 million, or about 25 percent of all the retailer compensation paid by the state.

Soon retailer compensation may be an issue even in the states that don’t currently provide it. There’s a movement among states to adopt streamlined sales tax policies as part of an effort to get online and mail-order retailers to collect tax on their sales. Pending federal legislation that would authorize states to collect taxes on interstate transactions would also require them to provide “reasonable” compensation to retailers for all their sales (though there is a small business exception). It would be left up to each state to decide what the compensation should be.

The report also looks at another way local governments give up sales tax revenues. This occurs when they uses sales tax receipts as a form of economic development subsidy, such as when they allow large retailers to keep millions of dollars in taxes generated by a new store. There are no national figures available on this practice, but we document a loss of $130 million over the past decade in projects involving Wal-Mart alone.

Finally, we offer some policy options to state and local officials. As for retailer compensation, we urge those states that allow the payments to review their programs. We especially urge states without ceilings to consider adopting them. As for subsidies, we note that retail incentives encourage sprawl and overbuilding, and we urge officials to avoid those subsidies except in those limited instances where they are the only way to bring essential retail services such as groceries and drugstores to underserved areas.

For years Good Jobs First has been warning of the dangers of subsidizing retail development—overbuilding, sprawl, fiscal weakness, creation of low-quality jobs, etc.—so it is reassuring when we see our message starting to get through in unlikely places.

Recently, the Montgomery Advertiser published a 2,000-word story that dared to raise some questions about the wisdom of continuing to pile on sales tax rebates and other deals for retailers in Prattville, a suburb of Montgomery that is apparently a shopping paradise. The town, with a population of some 32,000, has added some 1.3 million square feet of retail space over the past three years, much of it for national chains such as J.C. Penney, Best Buy, Target, Home Depot, Circuit City and Bass Pro. It already had other big boxes such as a Wal-Mart Supercenter and a Lowe’s home improvement store.

Given the town’s location along Interstate 65, this kind of development was probably inevitable. But rather than letting the market work its magic, officials in Prattville made abundant use of a 2004 change in Alabama law that permitted localities to offer low-cost financing and other incentives directly to developers. For Prattville this included, for instance, a $23 million sales tax rebate for a Bass Pro hunting and fishing superstore (photo).

Local officials were comfortable with the subsidies as long as economic growth was strong. Now that hard times are looming, some of those officials began to show resistance to a new $9 million subsidy package sought by the developer of a shopping center featuring a Kohl’s. The Advertiser quoted City Councilman Bill Gillespie as saying: “I don’t think the customers are there to support the retail space we have now, much less these new stores. The economy is soft, and there’s a lot of empty stores up at High Point. I think we need to fill up what we have now, not add space. It’s a poor use of public dollars.”

Alas, Gillespie failed to persuade his fellow council members. A few days after the Advertiser article was published, the council voted 5-2 to approve the new package. I guess the effort to stop retail giveaways still has a long way to go.