Tax Analysts Blog

What You Should Know About the Sales Tax

Posted on Jul 20, 2016

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 communications@taxanalysts.org, and we'll be happy to answer your questions.

Read Comments (6)

Edmund DantesJul 21, 2016

Professional services already cost too much. You can't seriously suggest that we add a sales tax to doctors' fees? To health insurance premiums? To car insurance premiums?

How about to lawyers' contingent fees? What about in class action situations? Talk about a can of worms.

The issue of sales tax on internet sales is receding, as Amazon has agreed to collect it in more and more states.

dbrunoriJul 22, 2016

Edmund, I must disagree. Professional services should be taxed -- when purchased by consumers. All consumption should be taxed, less we favor some purchases over others. Ideally we would lower overall sales tax rates as well. That being said, there is nothing harder to do politically than tax professional services. And, taxing professional services would be easier than taxing non professional services, which tend to be cash businesses.

The internet issue is a little less important because Amazon is in more states. But it will continue to be a problem as long as Quill stands. Again, I take the position that all consumption should be taxed at a very low rate. But you can't have low rates if you are effectively excluding internet sales and services. Thanks for writing!

Mike55Jul 25, 2016

The trouble with taxing services is that doing so offers little opportunity to export the tax base. Services are often produced and consumed locally, while nearly all goods are produced outside the state, purchased from retailers owned by investors mostly outside the state. Since consumers don't bear 100% of a sales tax, taxing goods (and not services) shifts part of the tax burden to out-of-staters.

It's true that picking and choosing what you decide to tax exacerbates the economic deadweight loss inherently created by taxation, but the upside is making someone else bear that loss. Any politician I vote for ought to be representing MY interests, not the interests of the greater macro economy. This means states will continue to export their tax bases where they can, unless/until a serious push towards uniform SALT taxation is launched.

The whole "low rates + broad base = good tax policy" mantra just doesn't hold true when you've got thousands of different taxing jurisdictions with economically meaningless borders dividing them. It might be true we'd all be better off if every state applied a low sales tax rate to everything, but it doesn't follow that this would be good policy for any one state acting alone.

MichaelJul 24, 2016

Here in Connecticut, several years ago, sales tax reform was suggested. They went over the list of sales tax exemptions, with the corresponding loss of revenue for each line, upon eliminating the exemptions , the sales tax rate was whittled down to 2.75 percent, even a lower rate then when the tax was introduced in 1947. One of the issues were, CT residents crossing state lines to go grocery shopping, but with people's busy schedules, and extra expense, I don't think that a 2.75% tax rate would cause that much border hopping. Who were the loudest protesting the reform, business people, you know, the one's with an above average income, who benefits from a regressive tax system, themselves. Since the Connecticut state budget remains in permanent supply-side recession, that 2.75% rate would had been a target to jack up, maybe more than once, to balance the budget, without the benefit of property tax reform, and sending more CT residents across state lines to shop groceries, and maybe purchase tax-free clothing. My CT state/local tax burden is almost 20% of my income, while the rich get off the hook at 8%, but the rich are the bigger complainers.

Edmund DantesJul 25, 2016

So, let's say I just got a cancer diagnosis. The treatment is projected to cost $200,000, and I will be out of work for several months. Mr. Brunori, you think this is a good time for the state to hit me with $12,000 in sales taxes?

Let's say that I have "good" insurance and so my deductible is "only" $5,000. Do you limit the sales tax to amount of the deductible? Or the full amount of medical services I consume? I'm quite certain my medical plan won't cover those taxes.

I'm paying $15,000 per year in health insurance premiums--this is a good time for the state to ask for a quick $900 or so in sales taxes on the insurance? So that when I make a claim, I can pay still more sales taxes?

The reason that it's "hard" to tax professional services is that the idea is completely impractical. It imposes huge costs on people who cannot plan for it at a time they are most vulnerable. It looks like what it is, a naked power grab by the government.

Similar arguments can be made for attorney's fees. I win a tort judgment, the attorney takes 40% for which I get no tax deduction, and now the state should hit me up for sales tax on the 40%? Seriously? How does that help make me whole?

I understand the theoretical appeal of treating services like products, Mr. Brunori, but I don't think it is remotely practical in the real world.

Dhanraj SinghJul 27, 2016

There is a big misconception about taxes that often scares people away from the topic let alone the discussion. The burden of a tax does not fall on the consumer alone, it falls on the suppliers also. In fact, depending on the nature of the market (say for accounting services) the tax may fall on service providers more than customers. What we don't often see is that when the tax is imposed and there is competition in the market, suppliers will have to lower their prices or their profits a little to remain in business. So yes, if we are really serious about tax fairness, we must address the regressivity of sales tax. In Florida for example, people making less than $17,000 a year pays almost 13 percent of their income in taxes whereas people making in excess of $487,000 a year pays less than 2 percent of their income in taxes. agree professional services must be taxes, according to a report from Florida Policy Institute. There are policy options that states can adopt to address the unfairness of sales taxes, but this requires bipartisan support and yes a common sense approach to policymaking.

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