Sales Tax

A sales tax is a tax imposed on the retail sale of goods and, in many places, services, calculated as a percentage of the purchase price and collected by the seller at the point of sale. It is a transaction tax: the taxable event is the sale itself, not the ownership of anything and not the income of either party. In the United States it is entirely a state and local tax. There is no federal sales tax, which is why the rate on the same item can differ between two towns twenty minutes apart.

Sales tax is often confused with two neighbors. An excise tax is also charged on a transaction, but it is narrow, applying to a specific product such as fuel or tobacco, and is usually built into the shelf price rather than added at the register. A use tax is the companion charge a state imposes on something bought elsewhere and used at home, designed to close the gap a seller's failure to collect would otherwise open.

Who legally owes the tax is a state-by-state question, and it is not always the buyer. Some states impose the tax on the seller for the privilege of making retail sales and let it be passed on; others impose it on the consumer and make the seller the collection agent. The distinction rarely matters at the register and matters a great deal in an audit, because it decides who the state pursues for tax that was never remitted. Federal law sidesteps the question for deduction purposes: Internal Revenue Code section 164(b)(5)(G) provides that where the tax is separately stated and paid by a consumer to the seller, it is treated as "a tax imposed on, and paid by, such consumer."

The base varies more than the rate, and the exemptions are not the ones people assume. Most states that tax sales exempt or reduce the rate on groceries, and exemption for prescription drugs is close to universal. Clothing is the outlier: it is fully exempt in only a handful of states and capped at a per-item price in a few more, so grouping it with groceries and prescriptions inverts the picture. Many states also exempt most services while taxing goods, which is why two households with identical spending can face very different effective rates depending on how much of their budget goes to services.

Where a sale happens is a rule, not a fact. States apply sourcing rules to decide whether the rate is the buyer's or the seller's. Destination sourcing, which uses the delivery address, is the predominant approach but is not universal: about a dozen states source intrastate sales to the seller's location instead. The distinction is invisible to most shoppers and decisive for anyone selling across a state.

Online sales changed in 2018. In South Dakota v. Wayfair, Inc., decided June 21, 2018, the Supreme Court overruled the physical-presence rule that had let a seller with no premises in a state decline to collect that state's sales tax. States responded with economic nexus laws keyed to a seller's sales or transaction volume, which is why an out-of-state online retailer now charges sales tax on most orders. Where a seller still does not collect, the state's use tax is what fills the gap. Describing South Dakota's regime, which it noted many states mirror, the Court wrote that "if for some reason the sales tax is not remitted by the seller, then in-state consumers are separately responsible for paying a use tax at the same rate."

Sales tax takes the same slice of a purchase from every buyer, and that is the source of the fairness argument around it. A household that spends most of what it earns pays sales tax on most of what it earns. A household that saves or invests a large share pays it on a smaller share. Grocery exemptions and sales tax holidays are the usual legislative responses; neither changes the underlying arithmetic much.

A seller registers with each state where it has an obligation to collect, charges the combined state and local rate that applies to the sale, holds the money, and remits it on a filing schedule the state sets. The buyer's only involvement is paying it at checkout, unless the seller does not collect, in which case the buyer's state generally expects a use tax return instead.

For a household, the two decisions that involve any judgment are both at tax time. First, an itemizer may elect under section 164(b)(5)(A) to deduct state and local general sales taxes in place of state and local income taxes. Both sit inside the same capped deduction for state and local taxes, so the election is a choice of which to count, never a way to count both. Second, the deductible amount can be substantiated either with actual receipts or from the optional tables the IRS publishes, and section 164(b)(5)(H) expressly allows the table route. The election tends to favor residents of states with no income tax and anyone who made an unusually large purchase during the year.

A hypothetical example. Devon buys a $1,200 laptop in a jurisdiction with a 6 percent state rate and a 2 percent county rate. The combined 8 percent produces $96 of sales tax and a $1,296 total. If he instead orders the same laptop from an out-of-state seller that does not collect his state's tax, the purchase price is $1,200 and his state expects $96 of use tax from him directly. The tax owed is the same in both cases; only who is supposed to hand it over changes.

A shopper does not choose whether to pay sales tax, so the useful lens is what the tax does well and where it lands hardest.

Arguments in its favor

• Collection is cheap and near-automatic, since the seller does the work and the tax is paid in small amounts as spending happens.
• It falls on consumption rather than on saving or investing, which is the main argument economists make for consumption taxes generally.
• Revenue is broad-based and less volatile than income tax revenue, which swings with capital gains and layoffs.
• Visitors and non-residents contribute to local services through it.

Arguments against, and practical costs

• It takes the same percentage of a purchase whatever the buyer's income, so households that spend nearly all of what they earn pay it on nearly all of what they earn.
• Rates and bases differ by state, county, city and special district, and a single delivery address can sit inside several overlapping jurisdictions.
• The rules on what is taxable are genuinely intricate, which puts a real compliance burden on small sellers that large ones absorb more easily.
• Use tax is widely owed and rarely paid, which leaves honest buyers paying more than inattentive ones.
• Sales tax holidays are popular and narrow, and they shift the timing of purchases more than they change the total tax a household pays.