Editor’s Note: Periodically, we’re going to publish a short series covering the basics of various types of taxes. The posts will be curated so you’ll also be able to find them as backgrounders under the “For the Press” tab on our home page. We’re starting off with David Brunori discussing the sales tax.
The sales tax is one of the most important sources of tax revenue for state governments. This will provide some basic information about why it’s important and some things you should know about the tax if you are studying, researching, or writing about it for the first time.
The tax is calculated as a percentage of the purchase price. In all states the tax is collected from the vendor or store and remitted to the state. Ideally, the tax should fall on all final personal consumption – everything people buy. And it should never fall on business purchases. More on how that ideal is rarely met later.
The sales tax is important in terms of how much money it raises. In 2014 it raised about $270 billion, or just a third of total state tax revenue. Moreover, the tax is imposed in 45 states. Only five states -- Alaska, Delaware, Montana, New Hampshire, and Oregon – don’t tax sales. Those states make up only about 2 percent of the population, so the vast majority of Americans live under the sales tax. Some states are much more reliant on the sales tax. The states with no income tax, like Texas, Florida, and Tennessee, receive about 50 percent of their tax revenue from sales.
Let’s start with the good. The sales tax has long been considered a “good” tax by public finance experts. There are several reasons for this. First, the tax is easy to administer and comply with. The tax is collected by the store and sent to the state. Store owners face stiff penalties for failing to do so. The government spends very little money collecting the tax. Complying with the tax is easy as well. The purchaser pays the tax at the cash register, and his or her obligations are over. Few taxes are as easy on the government or the taxpayer. There is a cost to the store to collect and send the tax to the government. But most states allow the store to keep a percentage of the tax to defray those costs.
Second, the tax is widely accepted by the public, politicians, and economists. There have been no tax revolts over the sales tax. People accept the tax because they have been paying it their entire lives and it does not affect their buying habits – in the short run. Politicians accept the tax because they think that alternatives, like income and business taxes, deter economic development. And most economists believe taxing consumption is better than taxing income in terms of economic growth.
So the tax raises a lot of money. It is easy to collect and comply with. And it is generally accepted by the public and politicians. Sounds good. But there is one big problem: The tax is regressive. The poorer you are, the greater the share of your income goes to sales taxes. Very few people would say that regressive taxes are good or fair. But no one can deny that despite lots of positive attributes, the sales tax treats poor people worse than rich people. The real reason for the regressivity of the sales tax is that rich people spend most of their money on goods and services that are not subject to tax.
Here are the issues facing the sales tax. The biggest one is the failure to tax all consumption. For example, states do not tax most services. Yet services make up over half the U.S. economy. This failure results in higher rates on goods and lower revenue, and adds to the regressivity of the tax. But taxing services, especially professional services, is very difficult politically. People who sell services oppose such taxes. States also do not subject real estate and intangible property (stocks and bonds) to sales tax.
States also exempt a lot of necessities from the sales tax. Food for home consumption, prescription medicine, and rent are not taxed in most states. There are many such exemptions, and their goal is to alleviate the burden on the poor. But they are costly (the wealthy are exempt as well). And they greatly complicate the tax system, making both administration and compliance more difficult.
That states also cannot collect sales tax from most internet sales is another big problem. The Supreme Court has held that states cannot require vendors with no physical presence in their states to collect the tax. This presents several issues. First, failing to tax internet sales means all other purchases are taxed higher. Second, it puts stores that must collect the tax at a competitive disadvantage. Third, it costs the states billions in lost revenue.
But the problems with the sales tax aren't limited to what is not taxed. As noted, business purchases should never be subject to sales tax. When they are, businesses pass the tax down to customers in the form of higher prices. Those higher prices are often subject to sales tax. So consumers pay the tax and often are taxed on the tax without knowing it. This problem is difficult to resolve because exempting business purchases would require raising rates on individual purchases.
There is a lot more to know about the sales tax. If you are interested, contact us at firstname.lastname@example.org, and we'll be happy to answer your questions.