What It Means
As the name suggests, the sales tax is a fee charged by the government on the sale of a good or service, such as a car, a meal at a restaurant, the repair of a bicycle, or a soda. A sales tax is usually a percentage, such as 5 percent, of the price of the good or service. For example, if it cost $100 to buy new wheels for your bicycle and the sales tax were 5 percent, the sales tax of that sale would be 5 percent of $100, or $5. The store that sold the wheels would send the $5 to the government. Large corporations, banks, and other businesses also pay a sales tax when making a purchase.
All governments—national, state, and local—need to charge taxes in order to support themselves, to provide essential services, and to ensure the safety, health, and well-being of their residents. Police officers, hospitals, roads, schools, and clean tap water are among the many services funded by sales taxes. Other examples include the salaries of government officials, the maintenance of historic sites and state forests, government programs aimed at promoting new businesses, and aid to low-income, elderly, and disabled residents.
In the United States the national government does not charge a general sales tax—that is, a percentage charge on all consumer purchases—receiving its money from other sources, such as the income tax (which is based on the amount a person earns each year). It does, however, have a sales tax on particular items, such as gasoline, tobacco, and airline tickets. In 2007, for example, the U.S. government charged 18.4 cents on each gallon of gas purchased. Taxes on particular items are called excise taxes.
By contrast, most state governments and some local governments (counties and cities) charge a general sales tax. In 2007 the sales tax was 7 percent in Mississippi and 4 percent in Wyoming. In order to help low-income residents, some state and local governments do not tax essential items, such as food, prescription medicine, and clothing.
When Did It Begin
Early sales taxes in the United States were excise taxes, directed at particular products, such as liquor. During the War of 1812, fought against Great Britain, the United States needed to raise money quickly for military expenses. It introduced a tax on watches, jewelry, gold, silverware, and other expensive items. After the war the tax was abolished.
States, too, charged excise taxes. In 1919 the state of Oregon began taxing gasoline, which had become an important fuel for the newly popular automobile. Excise taxes, however, because they were limited to particular goods, did not produce as much money as a general sales tax.
In 1921 West Virginia was the first state to adopt a general sales tax. At that time, states received most of their money from taxing property, such as houses, land, and office buildings. During the 1930s, however, other states followed West Virginia’s example and replaced their property taxes with sales taxes. Sales taxes not only provided more money than property taxes but they were easier to collect. By 1971 45 states and the District of Columbia imposed some form of sales tax.
More Detailed Information
Each state in the United States has the freedom to establish its own system of sales taxes. For example, the sales tax in Massachusetts is 5 percent, while the state sales tax in Mississippi is 7 percent. Sales taxes, like taxes on property and income, are crucial sources of revenue for state governments. Many state governments get half of their income from sales taxes. A few states—Alaska, Florida, Nevada, South Dakota, Texas, Washington, and Wyoming—rely almost entirely on sales taxes for revenue because they do not impose an income tax. In contrast, Alaska, Delaware, Hawaii, Montana, New Hampshire, and Oregon do not collect a general sales tax at all; they raise money by other methods, such as income and property taxes. The states that have the highest sales taxes are California (7.25 percent), Mississippi (7.0 percent), New Jersey (7.0 percent), Tennessee (7.0 percent), Rhode Island (7.0 percent), Minnesota (6.5 percent), Nevada (6.5 percent), and Washington (6.5 percent).
Sales taxes are sometimes imposed by local governments, such as cities, counties, and independent public-service agencies, such as those that provide train and bus services. As a result, a consumer might have to pay several sales taxes on a single purchase. For example, if you were to buy a camera in Chicago, you would be charged a 5 percent state sales tax, a 2.25 percent city sales tax, a 0.75 percent county sales tax, and a 1 percent “transportation authority” tax, which would result in a total sales tax of 9 percent.
In general, city governments make more money from property taxes than from sales taxes, and state governments make more money from sales taxes than from any other type of tax. Together, property and sales taxes make up the bulk of income for city and state governments.
Sales taxes are sometimes called “regressive” taxes, meaning over the course of a year a poor person would pay a larger share of his income on sales taxes than a rich person would. In other words, although a sales tax might treat each purchase equally—charging, for example, 4 percent of the total price, regardless of the purchase—it would not treat each consumer equally. That is because people with lower incomes have to spend most of the money they make (on food, rent, utilities, transportation, and other basic items) in order to support themselves. Therefore, much of their income is charged a sales tax. In contrast, wealthier people tend to make much more than they need to support themselves and can more easily save money. The amount a person saves is not charged a sales tax.
In a state that charged a 4 percent sales tax, the effect of that tax could be much different for a low-income person than for someone with a much higher salary. If a person earned $160,000 a year and spent $40,000 of it on goods and services, he would pay $1,600, or 4 percent of $40,000, in sales taxes. This tax of $1,600 would be just 1 percent of his income of $160,000. Compare this to a person making just $12,000 a year who spent $8,000 on goods and services. He would pay $360 in sales taxes, or 3 percent of his $12,000 salary. Because the sales tax tends to have a much stronger impact on lower income residents, some states make certain essential goods (such as food and prescription drugs) and services (such as gas and water for the home) exempt from sales taxes.
Although some people view the sales tax as regressive and unfair, others believe it has many advantages. It is easy to collect, for example, and because the sales tax applies only to purchases, it encourages people to save money. The U.S. government has periodically considered a federal sales tax, one that would be imposed on retail sales throughout the country. Some have argued that the federal government should replace all income taxes, on businesses and individuals, with a national sales tax.
Many of the proposals for the national sales tax are complex and try to lessen the effect on low-income residents. In some plans the government would provide a sum of money, paid in monthly installments and based on the number of individuals living in the household, to each taxpayer. Some proposals have suggested a federal sales tax of between 15 and 23 percent.
A state or local-level tax on the retail sale of specified property or services. It is a percentage of the cost of such. Generally, the purchaser pays the tax but the seller collects it as an agent for the government. Various taxing jurisdictions allow exemptions for purchases of specified items, including certain foods, services, and manufacturing equipment. If the purchaser and seller are in different states, a use tax usually applies.
The vast majority of states impose sales taxes on their residents. The only exceptions are Alaska, Delaware, Montana, New Hampshire, and Oregon. Some states rely more heavily on sales taxes for a significant portion of revenue. Tennessee, for instance, does not impose anincome tax, so it relies heavily on sales taxes. The combined state and local sales taxes average about 9.25 percent per sale. The state of Michigan imposes a six percent sales tax, which accounts for about 28 percent of the state's total revenue. In 2002, the state collected $6.5 billion in sales taxes.
States have faced a long struggle to collect sales and taxes from retailers that are based outside the state and have no contacts with the state seeking to collect taxes. This is particularly true of companies that sell goods through mail orders or on the internet. Even if an out-of-state retailer is not required to pay sales taxes within a state, the purchaser is nevertheless required to pay the sales tax on goods and services purchased through the Internet or by mail order. However, states rarely collect these taxes from the purchasers. According to a study by researchers at the University of Tennessee, states and cities in the United States lost an estimated $13.3 billion in uncollected sales taxes in 2001.
The U.S. Supreme Court has addressed the issue of states requiring out-of-state retailers to pay sales taxes on several occasions. In Complete Auto Transit, Inc. v. Brady, 430 U.S. 274, 97 S. Ct. 1076, 51 L. Ed. 2d 326 (1977), the Court required a showing of a "substantial nexus" between a taxing state and the company providing goods and services before the taxing state can require the company to pay taxes. Without this substantial nexus, a state that taxes an outof-state retailer has violated the commerce clause of the U.S. Constitution.
Subsequently, the Court applied this test to a case involving a state's attempt to tax a mail order company. Quill Corp. v. North Dakota, 504 U.S. 298, 112 S. Ct. 1904, 119 L. Ed. 2d 91 (1992). In Quill Corp., the state of North Dakota sought a declaratory judgment that Quill Corporation, which had is main offices in Illinois, California, and Georgia, was required to pay taxes on sales with North Dakota customers. Quill had no outlets or any sales representatives in North Dakota, though it received $1 million of its annual $200 million in sales nationally from the state. The Court held that North Dakota could not tax Quill because Quill did not have a substantial nexus with the state.
In order to address the problems associated with the collection of sales taxes on the Internet, the National Governors Association drafted the Streamlined Sales and Use Tax Agreement, whereby states would agree to modify their sales and use tax laws to a more uniform structure. Thirty-one state representatives signed the agreement, though individual state legislatures would have to modify their tax statutes to conform. The agreement is designed to remove complications among the sales and use tax laws in the different states and to eliminate the potential for double taxation. Several commentators, however, have noted that such an arrangement could violate the Commerce Clause based on the decisions in Quill Corp., Brady, and similar cases.
Abrahms, Doug, and Brian Tumulty. 2003. "Legislators Consider Internet Tax." Herald Dispatch. Available online at <www.herald-dispatch.com/2003/January/28/LNtop1.htm> (accessed August 10, 2003).
Chi, Keon S. 2000. Electronic Commerce: Revenue Implications for States. Lexington, Ky.: Council of State Governments.
Due, John Fitzgerald. 1994. Sales Taxation: State and Local Structure and Administration. 2d ed. Washington, D.C.: Urban Institute Press.
Murray, Matthew N., and William F. Fox, eds. 1997. The Sales Tax in the 21st Century. Westport, Conn.: Praeger.