Will Pennsylvania follow Illinois, exempt sales tax from interchange?

Pennsylvania is taking a page out of the Illinois tax book with a proposed new law that would ban interchange from being assessed on the tax portion of retail purchases. The new Illinois law, which will take effect July 1, 2025, is the first of its kind in the nation.

Similar legislation passed the Pennsylvania House of Representatives Finance Committee last week, and that legislation is now pending before the full House. Following passage there, it would still require passage in the state Senate and be signed into law by the governor.

Illinois and Pennsylvania are not the first states to attempt such a move. Between 2006 and 2023 40 similar proposals to prohibit interchange on the sales tax portion of electronic transactions were considered, and all but the Illinois effort failed to pass and be signed into law.

"The potential unintended consequences of the swift passage of interchange sales tax in Illinois is yet to be seen," as implementation is nearly a year off, the Electronic Transactions Association wrote in a letter to leaders of the Pennsylvania House.

One reason most of these laws have failed to pass muster with lawmakers is the onerous cost and equipment changes that would fall disproportionately on smaller businesses, often surpassing any promised savings. "System-wide changes could potentially take years of design, testing and input from stakeholders to ensure feasibility and compatibility," the ETA stated.

The real winners of such a change would be big-box retailers, explained Joel Griffith, research fellow at the Heritage Foundation. "It's the big box retailers – rather than small businesses – that stand to benefit," he wrote in a December 2023 blog post. "These big box retailers will also gain market share at the expense of their small competitors who must raise prices to cover their increased net costs."

According to Griffith, 28 states already allow retailers to deduct at least a portion of the collection costs incurred from the total sales tax they are required to remit. Florida grants and allowance of 2.5 percent of the first $1,200 in sale tax collected each month. "This ensures that most businesses processing under $200,000 in credit card transactions already escape the sales tax collection costs."

In other words, the big-box retailers are the winners in this "cronyist attempt to use the force of law to shift costs from themselves onto financial institutions and consumers," Griffith wrote.

Pennsylvania should 86 the proposal

The ETA, which unsuccessfully urged the governor of Illinois to reject the scheme to exempt sales tax from interchange, has now turned its attention to Pennsylvania. Echoing the warnings from the Heritage Foundation, the ETA warned that small businesses will be the big losers if the pending bill becomes law.

The proposal "will require a systemic update to global payments systems, requiring nearly every small business to replace their current software and replace or update terminals to ensure compliance and accurate sales tax collection," the group wrote in a fact sheet provided Pennsylvania lawmakers. "If small businesses attempt to comply by collecting sales tax as a separate transaction by cash or check, frustrated consumers will abandon purchases causing small businesses to lose sales."

Consumer privacy is also at stake, the ETA warned, as payment systems will need to be redesigned to receive and analyze detailed receipts of every item purchased by a consumer to ensure the accuracy of sales tax calculations. "This cost-prohibitive process will subject small business owners to additional audit threats and expose consumers' individual purchases to third parties seeking to verify sales tax calculations on every transaction," the association warned.

Airlines for America, the principal trade association for the U.S. airline industry, echoed the ETA's warnings. In a letter to Pennsylvania lawmakers, it said the proposed law will require the creation of new customer purchase databases that would threaten customer privacy.

"These new requirements are being mandated on the electronic payment network, with no compensation," Airlines for America noted. "This legislation would make Pennsylvania a global outlier in how it treats payments to the detriment of businesses and consumers." The new requirements could also put at risk consumer benefits such as airline miles, cash back and travel points, the group added.

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