Cities and states try to put bed tax debate to rest

It may seem a trivial thing, but a battle for “bed taxes” that has been brewing between state and local tax collectors and the online travel industry for the better part of a decade shows no signs of slowing. Recent actions in Montana, Oklahoma, New York, California, Maryland and elsewhere join four or five dozen other jurisdictions in converging on an issue rife with politics, lobbying, taxes and budgeting.

Hotel occupancy taxes, also known as transient occupancy taxes, are a major source of revenue for local governments. According to a 2008 hotel industry economic impact report, from American Economics Group, Inc, nearly $12.5 billion in occupancy and related sales taxes were collected that year. And a large portion of that money is redirected to fund tourism costs, such as convention centers, historic preservation, and visitor centers. The report also estimates 25 percent of all hotel taxes go directly to tourism marketing efforts, which can have powerful multiplier effects on a region’s economy. The official tourism website of Virginia, for instance, says every dollar spent on tourism marketing generates five dollars in tax revenue for the Commonwealth.

At issue is whether companies like Expedia, Orbitz or Travelocity, known as online travel companies – OTCs – are paying enough in state and local hotel occupancy taxes.

First defined in 2000, OTCs use what is referred to as “the merchant business model.” According to a June 2000 Securities and Exchange Commission filing from Expedia, the company “acquires inventory at discounted wholesale prices from preferred suppliers and then determines the retail price.” OTCs then collect funds from consumers that cover the wholesale price, the occupancy tax and a service fee at the time rooms are booked. They then remit taxes based on what it owes the hotel, rather than what it collected from the consumer.

A typical example involves a $100 hotel room and a 10 percent occupancy tax. If the room is bought through the Sheraton’s website, the traveler pays $110, $10 of which is remitted to the government as the hotel tax. But if the room is bought through Travelocity, for example, and the wholesale rate was set at $80, the customer still pays $110, but only $8 is sent to government, leaving Travelocity with $22 in profit.

Exact numbers are hard to estimate since estimates are used to calculate the number of rooms reserved through OTCs and by how much above the contracted wholesale rate is being charged. But this gap could be worth as much as $258 million to state and local governments per year, says one report by the Center on Budget and Policy Priorities.

After several years of litigation, states and municipalities are beginning to update their occupancy tax laws – many of which were written, or last updated, several decades ago.

“Some states have been on the offensive, like New York, proactively changing their laws,” says Randi Knott, Vice President of Government & Legal Relations of the California Hotel & Lodging Association, “because most TOT ordinances were written before internet was invented.”

But a spokesperson for the Internet Travel Services Association – a trade organization for online travel companies – says that’s irrelevant. Andrew Weinstein contends those laws, “were still drafted in an era where there were intermediaries who charged facilitation fees,” such as travel agents and tour operators, and that OTCs are one in the same.

“States who change statutes will find it is counter productive in the short-term and could be destructive to the travel industry in the long-term,” Mr. Weinstein said. “Some municipalities could be stepping over dollars to get to pennies on this issue.”

Such arguments have been made repeatedly across the country when the issue has reached full legislative tilt. And at times, it has worked. Local economies have suffered – two, nearly infamous, cases in Columbus, Georgia and South San Francisco, California pursued litigation and then found themselves “de-listed” from travel site search results. In Georgia’s case, most regional travelers were shifted across state lines into Alabama.

But these two cases are not the works of free-market ebbs and flows. Travelers who wished to stay in Columbus or South San Francisco did not consciously choose to stay in neighboring jurisdictions as a sign of protest. Nor did tour operators and travel agents coax would-be visitors away for fear of lost profit margins. These were both instances where OTCs, acting as one, created a self-fulfilling prophesy.

According to Marlene Colucci, executive vice president of public policy for the American Hoteliers & Lodging Association, the issue is gaining interest from their members – and that consensus is building about how they feel.

“The whole sentiment has changed, particularly from hoteliers,” she continued. “There’s a level of frustration with OTCs, with their behavior and with their activities in the states.”

California’s backdoor budget

California’s perennial budget crisis was particularly difficult to iron out this year. Lawmakers in the Golden State went one hundred days past the deadline to enact a budget for the next fiscal cycle this fall. And as one might expect, a rash of budget trailer bills were introduced at the last minute. Budget trailers, or budget implementation bills, are pieces of legislation, which necessitate changes to existing law in order to implement the new budget.

One such bill, SB848, introduced as a tax preference for online travel companies. According to Ms. Knott, the bill was voted on nearly 25 times, never receiving more than 12 of the needed 54 votes to go to a full floor vote.

“When legislators understood what the bill was going to do, they were absolutely incensed,” she said. “And we were opposed to the end-run without any input or consultation from lodging industry. It was politically unacceptable.”

So the California Hotel & Lodging Association joined with the California League of Cities and a few other advocacy groups to stop passage of SB848. “Hoteliers feel that they’re in a bind to support municipalities and OTCs – for fear of retribution. Major tourist destinations don’t worry, but small towns do.”

New York, New York

In 2009, New York City passed an ordinance that forced OTCs to collect occupancy taxes on the full amount paid by occupants. Additionally, it made OTCs responsible for taxes on money collected above the hotel contract rate (the $22 in the earlier example). OTCs and a group of tour operators took the city to court in late 2009, but a ruling in October of this year found that NYC had not violated the state’s constitution in amending its hotel occupancy tax laws. Additionally, the NY state legislature included language that clarified the matter as part of its budget bill earlier in 2010, saying that room remarketers are required to collect sales and New York City occupancy taxes. NYC estimates this will generate upwards of $20 million annually in additional tax revenue.

But Mr. Weinstein contends that NYC’s law was too broad in grouping online and offline intermediaries. He said a survey of travel agents and tour operators indicates they have or are planning to shift business “across the river” to New Jersey because of the laws.

A bipartisan issue?

Last month two red states, Oklahoma and Montana, initiated lawsuits against a number of online travel companies. Their claims mirror the dozens of other suits already being waged, but neither administration could be characterized as activist or even politically friendly towards the litigation process.

Despite the right-leaning bend of many incoming governors and legislators, these suites are just further evidence that lines continue to be drawn by state and local tax administrators, treasurers and legal councils. And with the economic plight of local governments expected to yield prolonged revenue shortages, no one should be too surprised to see this issue remain atop legislative agendas into the future.

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