National Retail Sales Tax: What has been the state and local experience?
The first sales tax in the United States was a tax of last resort, established in Mississippi in the 1930s to raise revenue during the Depression. Today sales taxes are relatively common in the United States, used by 45 states, the District of Columbia, and over 6,000 localities. State sales tax rates currently range from 3 percent to 7 percent (in tax-exclusive terms). The tax base used varies widely across states. The states with higher-yielding sales taxes tend to have tourist economies, so that taxes in these states are collected in large measure from nonresidents.
The state sales taxes appear to be poor models for broad-based federal tax reform, for several reasons. States show little inclination to exempt producers completely. But without a much more complete exemption of producer purchases in a national retail sales tax, cascading would present a significant problem. Furthermore, states make little effort to tax services, and they exempt broad categories of purchases for reasons relating to social and economic policy, tax administration, and political pressure. The federal base would have to be much broader than the typical state base, or else rates would skyrocket. The states offer only limited and varied experience in taxing government, but the federal proposals envision taxing every dollar of government purchases and investment. Finally, in state systems relief for low-income households is provided through product exemptions, as opposed to the demogrants proposed for a national tax.
- A uniform retail sales tax would cover consumption of all goods and services. State sales taxes, however, deviate from this norm in numerous ways. About twenty-five states exempt food, twenty exempt electricity, seventeen exempt telephone service, and six exempt at least some type of clothing. The most commonly exempted good is prescription medicine. Commodities subject to excise taxes-motor fuel, alcohol, and cigarettes-are usually exempt, even though this at least partly defeats the purpose of imposing separate excise taxes.
- Product exemptions raise important issues. Family cash allowances would be simpler to administer, would induce fewer distortions of household behavior, and-according to some studies-would be at least as progressive as specific product exemptions. Yet product exemptions are quite popular. State legislatures may find them attractive because they appear progressive, and industry groups that benefit from them may effectively advocate their continuance.
- The taxation of services is even more problematic. Although many states do tax some services, only three-Hawaii, New Mexico, and South Dakota-attempt to place all services in the tax base. Twenty-three states make no real effort to tax services at all.
- The taxation of purchases by state and local governments varies significantly across states; only eight states generally apply the sales tax to such purchases. (The federal government is exempt under the Constitution.) Sales to nonprofits and to educational, hospital, religious, charitable and similar organizations are exempted in twenty-seven states, and another fifteen exempt certain purchases by these groups. Sales of goods by nonprofits are usually subject to tax.
- Enforcement of sales taxes on services has proved difficult. These taxes are hard to administer and easy to evade, since there are fewer records to audit. This raises several red flags for a national retail sales tax. Besides the obvious erosion of the tax base, the state experience suggests that items that are difficult to tax are simply excluded from most retail sales tax systems and, again, that political pressures can easily affect the form and substance of a retail sales tax.
- A retail sales tax should exempt all business purchases, but most state-level sales taxes do not come close to this ideal. A variety of estimates indicate that, on average, between 20 and 40 percent of state sales tax revenue comes from business-to-business sales. Estimates for individual states range as high as 70 percent.