Sales Tax

A sales tax is, in essence, a levy. A financial imposition, if you will, collected by some semblance of authority for the privilege of exchanging certain goods and services. The typical arrangement, and one that rarely deviates from the script, involves the seller acting as an unwilling collector, extracting the funds from the consumer at the precise moment of transaction. It’s a rather pedestrian concept, isn’t it?

Federal Sales Taxes

When the government, in its infinite wisdom, decides to extract a tax directly from a consumer for a purchased good or service, it often dons the guise of a use tax. Most legislative frameworks, in their paternalistic way, allow for certain items to be conveniently overlooked, exempting them from the sales and use tax net. Think of the usual suspects: sustenance, education, and the ever-so-precious medicines. A value-added tax (VAT), which is collected on goods and services, shares a lineage with sales tax, though their operational nuances are, shall we say, distinct. One might consult the Comparison with sales tax section for a more detailed dissection of these differences, should one possess the fortitude.

Types

Observe the humble cash register receipt, a testament to the 8.5% sales tax it proudly displays.

The conventional, or retail, sales tax operates on the principle of taxing the sale of a good to its ultimate consumer. This tax is applied with each retail transaction. However, sales destined for businesses that intend to resell the goods are typically exempt. For such transactions, the purchaser, if they are not the final consumer, usually presents a "resale certificate" – a rather bureaucratic document, really – to the seller. This certificate, or its associated identifier, serves as a pass, signaling that the item is intended for resale, thus sidestepping the tax at that particular juncture. Without this credential, the tax is duly applied to all purchasers who fall under the jurisdiction of the taxing authority.

Beyond this standard model, other forms of sales taxes, or their close relatives, exist:

Manufacturers' sales tax: This is levied on the sales made by manufacturers and producers of tangible personal property. It’s a tax at the source, so to speak.
Wholesale sales tax: This tax targets sales at the wholesale level, specifically when tangible personal property is packaged and prepared for shipment or delivery to its final users and consumers.
Retail sales tax: As the name implies, this is the tax imposed on the retail sale of tangible personal property, aimed squarely at the final consumers and industrial users.
Gross receipts taxes: These are rather more encompassing, levied on all sales made by a business. Critics often point to their "cascading" or "pyramiding" effect, a rather unappealing phenomenon where an item is taxed multiple times as it traverses the production and distribution chain before reaching the retail counter.
Excise taxes: These are more specialized, targeting a select group of products—think gasoline or alcohol. They are typically imposed on the producer or wholesaler, rather than the retailer.
Use tax: This tax is levied directly on the consumer for goods purchased without incurring sales tax. It often comes into play when items are bought from vendors outside the taxing jurisdiction, perhaps from another state. While states with sales taxes often have corresponding use taxes, their enforcement is usually reserved for substantial items like automobiles and boats.
Securities turnover excise tax: A tax specifically applied to the trading of securities.
Value added tax (VAT): In this system, tax is applied to all sales, which conveniently negates the need for those cumbersome resale certificates. The tax cascading is circumvented by applying the tax only to the increment—the "value added"—between the purchase price and the subsequent selling price of an item.
FairTax: A proposed federal sales tax in the United States, envisioned as a replacement for the existing federal income tax. A rather ambitious proposition.
Turnover tax: Similar in spirit to a sales tax, but it’s applied to intermediate goods and potentially capital goods as well, functioning as an indirect tax.

Implementation

The world, it seems, is rather fond of sales taxes or their VAT cousins. Most nations incorporate these taxes at various governmental levels – national, state, county, or city. The Western Europe region, particularly Scandinavia, is known for some of the highest value-added tax rates globally. Norway, Denmark, and Sweden hover around a 25% VAT, while Hungary boasts the highest at 27%. Of course, there are exceptions, with reduced rates often applied to necessities like groceries, art, books, and newspapers.

The prevailing global inclination is to transition from traditional sales taxes to the more pervasive value-added taxes. VATs are estimated to contribute a significant 20% of worldwide tax revenue, and over 140 countries have embraced this model. The United States, in contrast, remains one of the few nations clinging to conventional sales taxes.

In certain parts of the United States, the complexity escalates with multiple levels of government imposing their own sales taxes. Take Chicago, for instance, within Cook County, Illinois. The sales tax there reaches a notable 10.25%, a sum composed of 6.25% state, 1.25% city, 1.75% county, and an additional 1% for the regional transportation authority. For those indulging in dining out, Chicago adds a Metropolitan Pier and Exposition Authority tax of 1%, pushing the total to a rather eye-watering 11.25%. In Baton Rouge, Louisiana, the combined rate is 9.45% (4.45% state and 5% local), while Los Angeles, California sits at 9.5% (7.25% state and 2.25% county).

In California, sales and use taxes are a tapestry woven from state, county, and city levies. The state tax is officially imposed upon "all retailers" for the "privilege of selling tangible personal property at retail." Technically, the retailer bears the primary responsibility for payment; when they pass this tax to the consumer, it's essentially a contractual reimbursement. However, for goods purchased from out-of-state vendors who are not obligated to collect California tax, the consumer is theoretically liable for a "use tax," identical in rate to the sales tax. This use tax applies to the "storage, use, or other consumption in this state of tangible personal property." Consumers are expected to report these purchases on their annual income tax filings, though it's a rare occurrence. An exception arises with out-of-state automobile purchases, where the use tax is collected by the state during vehicle registration.

Electronic Commerce

The landscape of sales tax on online purchases is, shall we say, less clearly defined. Generally, electronic commerce is categorized into four types: intermediaries, retail, business-to-business, and media, each influenced by consumer reactions to sales tax. While consumers are technically obligated to pay sales tax on cross-border transactions, enforcement is, to put it mildly, impractical. This has historically granted online retailers a distinct advantage, as they were not compelled to charge sales tax. Consequently, economists have delved into consumer price sensitivity regarding sales taxes. Some studies suggest a considerable elasticity—around 2.3—for online purchase probability with respect to sales tax, while others report lower figures, closer to 0.5. This implies that imposing an online sales tax might have a rather negligible impact on overall sales volume.

Effects

The Organisation for Economic Co-operation and Development (OECD) has undertaken studies on the impact of various tax types on economic growth in developed nations. Their findings suggest that sales taxes are among the least detrimental taxes to economic expansion.

Due to their nature, where the tax rate doesn't fluctuate based on an individual's income or wealth, sales taxes are generally considered regressive. This means they disproportionately affect lower-income individuals. However, some propose that this regressive impact can be mitigated through measures such as excluding rent from taxation or exempting essential items like food, clothing, and medicines. Investopedia defines a regressive tax as "[a] tax that takes a larger percentage from low-income people than from high-income people. A regressive tax is generally a tax that is applied uniformly. This means that it hits lower-income individuals harder."

Effects on Local Economies

Elevated sales taxes can exert a multifaceted influence on local economies. When taxes rise, consumers are increasingly inclined to reconsider their purchasing habits and locations. A study conducted in Minnesota and Wisconsin, for instance, observed the effects of a cigarette sales tax increase. The impact wasn't immediate, but rather emerged about six months after the tax hike. High sales taxes can, in theory, provide relief from property taxes, but only if those property taxes are subsequently reduced. Research in Georgia, where cities raised sales taxes while lowering property taxes, has indicated this correlation. To offset potential sales losses, a city must possess the capacity to attract consumers from outside its borders. Conversely, excessively high local sales taxes can drive consumers to seek their purchases elsewhere.

Enforcement of Tax on Remote Sales

Within the United States, every state with a sales tax law also incorporates a use tax component, designed to cover purchases made from out-of-state mail order, catalog, and e-commerce vendors—a category collectively termed "remote sales." As e-commerce has surged, the non-compliance with use tax laws has increasingly impacted state revenues. The Congressional Budget Office estimated that uncollected use taxes on remote sales could have amounted to as much as $20.4 billion in 2003, with projections for 2011 reaching as high as$ 54.8 billion.

However, enforcing these remote sales taxes presents significant challenges. Unless a vendor maintains a physical presence, or nexus, within a state, they cannot be legally compelled to collect that state's tax. This limitation was established by the Supreme Court, stemming from the Dormant Commerce Clause, in the 1967 decision in National Bellas Hess v. Illinois. The Court reiterated this stance in the 1992 case of Quill Corp. v. North Dakota, overturning an attempt to require a Delaware e-commerce vendor to collect North Dakota tax. Despite numerous arguments from various observers and commentators, calls for Congress to codify this physical presence nexus test have thus far gone unanswered.

The Internet Tax Freedom Act of 1998 established a commission to explore the feasibility of internet taxation, but it ultimately offered no concrete recommendations. In a 2003 report, the Congressional Budget Office cautioned against the economic burden that a "multiplicity of tax systems, particularly for smaller firms," could impose.

In an effort to streamline compliance with the tax laws of multiple jurisdictions, the Streamlined Sales Tax Project was initiated in March 2000. This collaborative endeavor, involving 44 state governments and the District of Columbia, culminated in the Streamlined Sales and Use Tax Agreement in 2010. This agreement sets forth standardized criteria for simplifying and harmonizing sales tax laws. As of December 2010, 24 states had enacted legislation aligning with this agreement. However, the practical application of the Streamlined Sales Tax to remote sales ultimately hinges on Congressional approval, as the Quill v. North Dakota decision affirmed that only the U.S. Congress possesses the authority to enact interstate taxes.

Effect of Electronic Commerce

Electronic commerce businesses are also subject to the influence of consumption taxes. This can be broadly divided into four categories: retail, intermediaries, business-to-business, and media (Goldfarb, 2008). These categories experience varying degrees of impact. Intermediaries, for instance, are affected by retail sales tax as they provide platforms for transactions between different parties, such as the Amazon marketplace. Business-to-business transactions find themselves in different circumstances depending on whether the transaction is subject to tax within the U.S. Electronic commerce goods often face inconsistent taxation, particularly across different U.S. states. Each state maintains its own sales tax regulations; some apply their standard sales tax laws to digital goods, while others have specific legislation. Enforcing taxes on electronic commerce, especially for digital goods traded internationally, remains a complex endeavor.

The impact of sales tax on consumer and producer behavior is considerable. The price elasticity of demand for online products is high, indicating that consumers are quite sensitive to price changes, and their demand can fluctuate significantly with even minor price adjustments. This suggests that the tax burden tends to fall primarily on the producer. To avoid impacting demand, producers may either seek ways to circumvent the tax, perhaps by relocating their fulfillment centers to areas with lower sales taxes, or they may absorb the cost of the sales tax themselves, maintaining the same consumer price but reducing their profit margins.

History

Early Examples

Evidence of taxes levied on the sale of goods dates back to ancient Egypt, with depictions found in tombs dating to around 2000 BC. These murals illustrate the collection of taxes on specific commodities, such as cooking oil.

In Piraeus, Greece, in 415 BC, sales tax amounts, recorded in drachmas at a rate of one percent, were documented in a separate column of a record detailing the auction of 16 slaves. Nearby Athens levied duties on the import and export of commodities, recorded at a rate of two percent in 399 BC. At that time, Athens did not rely on government agencies for tax collection; this responsibility was delegated to the highest bidder, a practice known as tax farming.

The Roman emperor Augustus, in AD 6, collected funds for his military aerarium through a one percent general sales tax, known as the centesima rerum venalium (the hundredth of the value of everything sold). The Roman sales tax was later reduced to a half percent (the ducensima) by Tiberius, only to be abolished entirely by Caligula.

In the United States

Although the United States federal government has never implemented a general sales tax, an excise tax on whiskey, enacted in 1791, was among its initial revenue-generating efforts. The significant unpopularity of this tax among farmers on the western frontier ultimately led to the Whiskey Rebellion in 1794.

Throughout the 19th century, federal and state sales taxes in the United States remained selective rather than general in scope. However, during the Civil War, excise taxes were applied to such a wide array of commodities that, collectively, they functioned much like a general sales tax.

The first broad-based, general sales taxes in the United States emerged in Kentucky and Mississippi in 1930, though Kentucky subsequently repealed its sales tax in 1936.

The federal government's per-gallon tax on gasoline (initiated at one cent per gallon in 1932) and its per-package tax on cigarettes (set at $1.01 per package since 2009) are perhaps the most recognizable current sales taxes administered by the federal government.

Twenty-two additional states introduced general sales taxes in the latter half of the 1930s, followed by six in the 1940s and five in the 1950s. Kentucky reinstated its sales tax law in 1960. Eleven more states enacted sales tax legislation during the 1960s, with Vermont being the last in 1969. Currently, five states—Alaska, Delaware, Montana, New Hampshire, and Oregon—do not impose general sales taxes.

The 2010 health care reform law introduced a 10 percent federal sales tax on indoor tanning services, effective July 1, 2010. Unlike previous federal excise taxes, this tax is collected directly from the consumer by the seller and is based on the sale price rather than a quantity. However, this new tax is selective, not general, applying solely to a specific service.

In Canada

Canada employs a federal Goods and Services Tax (GST), a value-added tax with a rate of 5 percent, in effect since January 1, 2008. Alberta, Yukon, the Northwest Territories, and Nunavut are exempt from territorial sales taxes, meaning only the GST is collected. Other provinces have either a Provincial Sales Tax (PST) or the Harmonized Sales Tax (HST), which is a consolidated rate combining the GST and PST.

Sales Tax Mitigation

Businesses can strategically reduce the impact of sales tax, both for themselves and their clientele, by meticulously planning for the tax implications of all their operations. Sales tax reduction or mitigation strategies encompass several approaches:

Invoice Design: Crafting invoices to minimize the taxable portion of a sale. For instance, in Maryland, a delivery charge can be exempt if it's itemized separately from handling and other taxable charges.
New Facilities: The selection of a site for a new manufacturing plant, warehouse, or administrative office might logically consider jurisdictions with no sales tax or broad exemptions for specific business operations.
Delivery Location: For businesses operating across multiple jurisdictions, choosing the optimal location for taking delivery can significantly reduce or even eliminate sales tax liability. This is particularly crucial for items intended for sale or use in another jurisdiction with a lower tax rate or an exemption for that particular item. Businesses should also investigate whether a temporary storage exemption applies to merchandise initially received in a jurisdiction with a higher tax rate.
Record-Keeping Review: A periodic assessment of sales and use tax record-keeping procedures is essential. Adequate supporting documentation, including exemption and resale certificates, invoices, and other relevant records, must be readily available to substantiate the company's position in the event of a sales and use tax audit. Without proper documentation, a seller could be held liable for tax that was not collected from the buyer.