State and Local Tax Policy: How do state and local sales taxes work?
Forty-five states and the District of Columbia impose a general sales tax, applied with only specified exemptions to sales of all types of goods, and in some states to certain services as well. In 2013 state sales tax rates ranged from 2.9 percent in Colorado to 7. 5 percent in California. Thirty-six states (including one, Alaska, that has no state sales tax) also allow sales tax at the county, municipal, or special district level. In 2012 maximum local sales tax rates ranged from 0.25 percent in Mississippi to 8 percent in Alabama. The highest maximum combined state and local sales tax rate in 2008 was 13.73 percent in parts of Alabama; the lowest (among states that have a sales tax) was 4.5 percent in Hawaii. General sales taxes have accounted for a roughly constant percentage of state and local general revenue over the past thirty years, varying from 12.8 percent in 1977 to 14.5 percent in 1988. This stability in revenue reflects tax rate increases that have offset the shrinking of the tax base due to changes in economic behavior.
- Only seven states fully tax food sales, and five of those states allow a rebate or an income tax credit to offset the burden on poor households. Seven states tax food at a lower rate than other goods, and the remaining 31 states and the District of Columbia exempt food completely.
- Only Illinois taxes prescription drug sales, and it taxes them at a lower rate than other goods. Other common exemptions include nonprescription drugs, textbooks, and clothing.
- Local sales tax is generally imposed on the same goods and services that are taxable at the state level, with a few notable exceptions. Georgia, Louisiana, and North Carolina allow local governments to tax certain products-in particular, food-that are exempt from state sales tax.
- As economic activity has shifted from manufacturing to services over the last several decades, some states have incorporated services into their sales tax base, but to greatly differing extents. For example, out of 168 services tracked by a 2008 Federation of Tax Administrators survey, Hawaii taxes 160 while Illinois taxes only 17. Services commonly subject to taxation include event admissions, utilities, and lodging.
- Most states also apply selective sales taxes to particular goods and services separately from the general sales tax. The most common such taxes are on alcoholic beverages, motor fuels, and tobacco products. Between 2000 and 2013, 33 states raised taxes on motor fuels while 3 states lowered them. The three states that lowered them were Connecticut, Nevada, and Utah. Between 2001 and 2013, 47 states and Washington D.C. increased their cigarette taxes, often substantially. California, Missouri, and North Carolina are the three states that kept cigarette taxes the same. In 2001, the median cigarette tax was 34 cents per pack. In 2013, the median tax had grown to 136 cents per pack. Between 2000 and 2013 eight states raised alcohol excise taxes, the largest increase occurring in Alaska where they raised taxes by 82 cents per gallon increase, raised taxes on beer, while Georgia was the only state to lower taxes on beer during this period. Total selective sales tax collections increased from $16 billion in 2000 to $27 billion in 2010, even though the share of general revenues has slightly declined from 6.1 percent to 5.9 percent in 2010.
- One selective sales tax that has recently been gaining publicity is a soda tax. As of 2011, 22 states and the District of Columbia taxed soda at a rate higher than food in grocery stores. Soda taxes range from 3 percent in Colorado and West Virginia to 7 percent in California, Indiana, Minnesota, New Jersey, Rhode Island, and Washington. Additionally, seven states levy an excise tax or fee on soda at the manufacturer, wholesaler, distributor, or retailer level. Three of those states already subject soda sold at grocery stores to higher taxes than other food and drink while the other four states exempt foods, including soda.
- Use taxes are similar to sales taxes but are levied on taxable purchases on which taxpayers do not pay sales tax, online purchases being the most prominent example. All states that impose a sales tax have a use tax as well. Currently, most consumers do not pay them and most consumers do not even know they are liable to pay them. Some states try to collect use taxes on the personal income tax form.</>
- State and local governments may impose taxes only on sales that occur in their jurisdiction, but can only require retailers with sufficient physical presence, or nexus, in the state to collect the tax. Because of the difficulty collecting the tax from the consumer, these remote transactions, primarily from catalog and online retailers, go untaxed. The rules allowing states to assert nexus complicated and many questions about their application to online transactions remain unresolved.
- The lack of coordination in tax rates and definitions of goods across states complicate the ability for states to require remote venders to collect the use tax, equivalent to sales tax but for purchases used in the state regardless of where purchased. Nearly all states that levy use taxes participate in the Streamlined Sales Tax Project, whose goals are to increase uniformity in definitions and rules across states and to simplify tax rates and administration within states.
- The Marketplace Fairness Act of 2013 (MFA), if it passes, may make it easier for states to require retailers to collect taxes on remote sales. The MFA was passed in the Senate on May 6th, 2013, but it has yet to move through the House. If passed by the House, it will allow states that have certain simplified procedures to have out-of-state vendors with more than $1 million in sales to require vendors to collect taxes owed on items purchased for in-state use.