|Types of Tax|
|Ad valorem tax · Consumption tax |
Corporate tax · Excise
Gift tax · Income tax
Inheritance tax · Land value tax
Luxury tax · Poll tax
Property tax · Sales tax
Tariff · Value added tax
|Flat tax · Progressive tax |
Regressive tax · Tax haven
Sales tax is a consumption tax charged at the point of purchase for certain goods and services. The tax is usually set as a percentage by the government charging the tax. There is usually a list of exemptions. The tax can be included in the price (tax-inclusive) or added at the point of sale (tax-exclusive). Sales tax is a regressive tax, meaning that its impact decreases as one's income increases.
Ideally, a sales tax is fair, has a high compliance rate, is difficult to avoid, is charged exactly once on any one item, and is simple to calculate and simple to collect. A conventional or retail sales tax attempts to achieve this by charging the tax only on the final end user, unlike a gross receipts tax levied on the intermediate business who purchases materials for production or ordinary operating expenses prior to delivering a service or product to the marketplace. This prevents so-called tax "cascading" or "pyramiding," in which an item is taxed more than once as it makes its way from production to final retail sale.
The design and implementation of sales tax has many problems, some due to the difficulty in collecting taxes on sales across jurisdictions especially when tax rates and collection systems are not standardized, others due to the continuous technological advances that make it hard to distinguish between taxable goods and tax-free services. Others, though, are due to the fact that people try to avoid paying taxes, particularly when they are in a lower income bracket and the sales tax coupled with income tax threatens the individual or household with poverty. Others simply take advantage of the difficulties in collecting sales tax to make purchases through e-commerce and avoid paying any tax. Many of these problems cannot be solved by legislation. It is only when human nature changes from selfishness to caring for others and society as a whole that the problems inherent in sales tax can be resolved, both by those designing the system and by those paying and collecting the taxes.
Sales taxes consist of two types: excise and general sales. The excise tax is placed on specified commodities and may be at specific rates or on an ad valorem basis. The general sales tax may be a manufacturers' excise tax, a retail sales tax paid by consumers, a "gross income" tax applied to sales of goods and provision of services, or a "gross sales" tax applied to all sales of manufacturers and merchants.
A corollary of the sales tax is the use tax. This levy is on the use or possession of a commodity or service. It is also levied on taxable items bought in a state other than the state of residence of the purchaser for the privilege of using the item in the state of residence. In such cases the rate structure is the same as that of the sales tax. Automobiles are the most significant item in the yield of use taxes.
Structure and collection
The rate structure used in the general sales tax is proportional; that is, the rate is constant as the base increases. For ease of administration and determination of the tax due, bracketing systems have been adopted by nearly all states. The rates in use in the mid-1970s varied from 2 percent to a high of 7 percent; 4 percent was the most common rate.
A selective sales tax applying to a single commodity may have much higher rates. At the time of initial adoption of many of the sales taxes in the United States in the 1930s, tokens were used for the collection of the tax on small sales where the tax was less than one cent. Ohio used stamps to show that the tax had been collected. Nearly all these systems have been abandoned in favor of collection of the tax in full-cent increments.
Specific sales taxes on selected commodities have long been used by the states. Selective sales taxes were used in the colonial period, with liquor the most frequently taxed commodity. Gasoline was selectively taxed by Oregon in 1919. However, the great disadvantage of specific sales taxes is that they do not produce the revenues a general sales tax does.
The impact of sales taxes is on the seller, for in nearly all cases he makes the payment to the state. However, the incidence or final resting place of the tax burden is on the purchaser of the taxed commodity or service; the price increases or the price is constant, but the tax is stated separately on the sales slip and added to the sum collected from the purchaser. In fact, the laws of some states require forward shifting of the tax to the consumer.
A great deal of attention is given to the "regressive effect" of the sales tax because an individual with a low income spends a greater portion of his or her income on consumption goods that are taxed than do those with higher incomes. When the necessities of food and clothing are excluded from the sales-tax base, the regressive effect is reduced.
History in United States and Canada
During the nineteenth century several states adopted tax levies resembling sales taxes. The sales tax in its modern form was first adopted by West Virginia in a gross sales tax in 1921. During the 1930s, many states adopted the sales tax in its various forms as a replacement for the general property tax that had been their chief source of income. The adoption of sales taxation slowed somewhat during the 1940s, but became more popular after World War II. During World War II a national sales tax was proposed, but no action was taken by Congress. The proposal has been revived periodically, but changes in personal and corporate income taxes have been preferred over a national sales tax.
At the end of 1971, forty-five states and the District of Columbia levied a sales tax in some form. During the 1950s and early 1960s, Michigan used a business receipts tax that was an adaptation of the value-added tax more commonly used in Europe.
Several forms of sales taxes have been used in other countries. Canada has used a manufacturers' excise in the belief that a levy at that level of the distribution process offers fewer administrative problems because of the small number of business units with which to deal. The value-added tax has been extensively used in Europe and has been adopted by the European Economic Community nations as a major revenue source with the goal of uniform rates within each member nation.
In the late twentieth century, sales taxes became a preferred method of paying for publicly funded sports stadiums and arenas. A growing chorus of critics has argued that the use of sales taxes to finance professional sports facilities is tantamount to corporate welfare. They point out that the biggest financial beneficiaries of such facilities are the wealthy owners of professional sports franchises, who typically gain a controlling interest in the stadium's ownership.
Nevertheless, sales taxes remain a popular way for state legislatures to avoid raising income tax rates, which usually alienate voters more than sales taxes do.
Streamlined sales tax in the US
The Streamlined Sales Tax (SST) program is a cooperative arrangement among state governments in the United States for the collection and payment of retail sales taxes when the seller and the purchaser are located in different tax jurisdictions.
Until recently, sales tax did not apply to retail purchases made by a buyer located in a different state than the seller. The main reason was difficulty enforcing and collecting sales taxes among multiple jurisdictions. This was not considered a serious problem until the proliferation of Internet-based sales during the 1990s. As increasing numbers of buyers made remote purchases using e-commerce in states other than their state of residency, state governments experienced revenue losses because such purchases were not taxed.
While the use of toll-free telephone numbers and direct mail has always caused some loss of tax revenue for states, the e-commerce boom motivated state governments to work together to find a way to recover lost tax revenue. The multi-state agreement, drafted by representatives from 44 states and the District of Columbia, was named the Streamlined Sales and Use Tax (SSUT).
In October 2005, SSUT officially went into effect. As of April 2008, there are 21 states in compliance, (Arkansas, Indiana, Iowa, Kansas, Kentucky, Michigan, Minnesota, Nebraska, Nevada, New Jersey, North Carolina, North Dakota, Ohio, Oklahoma, Rhode Island, South Dakota, Tennessee, Utah, Vermont, West Virginia, and Wyoming), collecting tax revenue through the program.
Provincial sales tax in Canada
The Provincial Sales Tax, commonly referred to as PST, is a provincial tax imposed on the consumers of most goods and specific services in a particular province. Because the PST is administered by each province and territory, the provincial sales tax goes by many other names, from the Retail Sales Tax (RST) in Ontario and Manitoba through the Social Service Tax in British Columbia. In Nova Scotia, New Brunswick, and Newfoundland and Labrador, the PST is part of the HST (Harmonized Sales Tax), effectively combining the PST and GST. The PST rate also varies from province to province and is even calculated differently.
Any business that sells products and many businesses that provide services need to register for, collect and remit the PST or RST (except in Alberta, Yukon, Nunavut, or the Northwest Territories where there are no provincial sales taxes).
Sales tax around the world
Value added tax, or VAT, remains a major source of tax income for most of the European Union, Mexico, and other countries which charge on average a 15-25 percent VAT rate.
Most countries in the world have sales taxes or value added taxes at all or several of the national, state, county, or city government levels. Countries in Western Europe, especially in Scandinavia have some of the world's highest valued-added taxes. Norway, Denmark and Sweden have the highest VATs at 25 percent, although reduced rates are used in some cases, as for groceries and newspapers.
The following is a list of tax rates around the world. It is focused on value added taxes (VAT) and/or good and services taxes (GST). It is not intended to represent the true tax burden to either the corporation or the individual in the listed country.
|Country||VAT / GST / Sales|
|People's Republic of China||17%|
|New Zealand||12.5% GST|
|Poland||22%, 7% (reduced rate on certain goods)|
|United States||0-10.25% (state and local sales tax)|
Sales tax: a regressive tax
There are two types of taxation: progressive and regressive. In a progressive tax, the more you earn, the higher your tax rate. The classical progressive tax is income tax.
In a regressive tax, on the other hand, the less you earn, the higher is your tax rate. The classical regressive tax is sales tax.
Example of an applied sales tax
Let as imagine this simple example of the two traveling salesmen. They each have to buy a new automobile every four years to “keep up appearances,” and, also, because they need a reliable transportation.
The first salesman makes $20,000, and the second makes $100,000 a year. Let us—for the sake of concentrating on the sales tax argument—forget all about potential income tax differential (which in most cases is not as big as the income differential anyway). What we consider here are only sales tax rate, say 5 percent, and their total annual incomes ($20K and $100K respectively).
Suppose the first salesman buys a $20,000 car and (due to 5 percent sales tax rate) pays $1,000 in sales tax. This also happens to be 5 percent of his income.
The second salesman buys a $60,000 car and pays $3,000 (due to the same sales tax rate) or 3 percent of his income; the more expensive car notwithstanding.
If the cars—or any other products, say a pair of jeans—had the same price, the tax rate discrepancy vis-à-vis their income differential would have become even more disproportionate. To make this clearer, suppose that both salesmen would buy a $20,000 car, which was 5 percent of the first salesman income. Now the same car would be 1.7 percent of the second salesman’s income (instead of 3 percent when the much more expensive car was bought).
Problems with sales tax assessment
Historically, the sales and use tax statutes applied largely to retailers and manufacturers, that is, purveyors of tangible personal property. As economies have shifted to a service-oriented one, the sales tax base has been broadened to encompass intangible services as well. High-tech industries are particularly susceptible to challenge.
Consider, for example, action that has sprung up around the telecommunications industry. Taxes on these services are of two types: on sales and on gross receipts. The taxes are functionally equivalent, except that the former is imposed on the purchaser while the latter is imposed on the seller.
Tax statutes usually require that taxable telecommunications either originate or terminate within the state and also be charged to an in-state service address. In most cases in which interstate telecommunications charges are subject to a sales or gross receipts tax, "interstate" is similarly defined. “Intrastate" telecommunications are usually defined as those originating and terminating within the state. However, there are exceptions to these generalized definitions.
The difficulty that state legislators have had in understanding new technologies may be seen in the bewildering variety of exemptions to sales tax on telecommunications offered by states that cannot clearly delineate where telecommunications end and information services begin. To deal with this a number of states have enacted broad-based services taxes, extending the traditional sales/use tax structure to a vast panoply of services.
Confusion typically results, however, when a broad-based service tax is enacted in the context of a state tax code designed for a manufacturing and retail economy. Consider, for example, a traditional exemption for machinery and equipment used in manufacturing. The theory behind the manufacturing equipment exemption, ubiquitous in the sales tax codes of most states, is that the purchase of inputs to the production process, which include capital equipment, ought not to be taxable if the output is taxable. A side economic benefit is shifting of the tax burden associated with the product from producer to consumer.
To close this loophole, in 1989, the District of Columbia passed new legislation to tax a broad array of information and data processing services, not to mention such other services as telecommunications (discussed above), real estate maintenance and landscaping. Under the statute, a taxable data-processing service is defined as processing of information for compilation and production of records of transaction, the maintenance, input, and retrieval of information, and provision of access to a computer to process, acquire or examine information.
Transactions with affiliates
Another problem for business taxpayers can occur when one member of an affiliated group of companies performs services for another member. Originally, no exemption was provided in the statute for information or data-processing services performed by one affiliate for another. Later on, the law was amended to exempt data-processing services performed in the context of the affiliated group. However, no such exemption was added for information services.
Thus, for example, if a headquarters organization within an affiliated group prepares a consolidated financial report on behalf of the entire group, each member may be taxable on its portion of any inter-company charge for the report. A similar situation can occur if one company performs credit investigations on behalf of an affiliate.
A unique set of issues has arisen with respect to the taxability of services provided in one state, but used outside the state. The Department of Finance and Revenue has expressed its intent to tax only those services in which the beneficial use of the service occurs in the state. Such an interpretation is clearly needed to prevent an exodus of service providers serving a multi-state region from the state.
A number of concerns are raised by all these provisions. For example, what constitutes "delivery" of a service? For instanced, if a Maryland company engages a District of Columbia consultant for data processing advice and the advice is communicated via telephone from the District to Maryland, what documentation must be maintained to support delivery outside the District? If, instead, the Maryland client picks up a written report in the District, is this a taxable District sale even though the beneficial use of the service will occur in Maryland?
In short, the evolution of technology and, above all, technology-based services has caused a lot of head-aches to governments the world over as the taxation systems are constantly in need of revision to catch up with new and always changing service environments.
Sales tax possibilities in the United States
Much of the early twenty-first century US administration's tax reform to date has been aimed at cutting taxes on accumulated wealth and the "income" it generates. The idea is that by shielding this wealth from taxation, that money is more likely to be re-invested in new businesses, which helps the economy grow. This is the same principle Arthur Laffer suggested to president Ronald Reagan a few decades earlier; which, on the whole, worked well.
Replacing the income tax with a national sales tax
Shifting to the sales tax would push this idea even further. The goal of taxing consumption (things you buy) instead of income (the wealth you create) would give people more incentive to save. Then, in theory, this savings would be available to expand and create businesses through investment in stocks, bonds, CDs, and so forth.
Fair Tax Act
Since the 1990s, the idea of replacing income tax with a national sales tax has been floated in the United States; many of the actual proposals would include giving each household an annual rebate, paid in monthly installments, equivalent to the percentage of the tax (which varies from 15 percent to 23 percent in most cases) multiplied by the poverty level based on the number of persons in the household, in an effort to create a progressive effect on consumption. While many political observers consider the chances remote for such a change, the Fair Tax Act has attracted more cosponsors than any other fundamental tax reform bill introduced in the House of Representatives.
In the United States, if a consumer purchases goods from an out-of-state vendor, the consumer's state may not have jurisdiction over the out-of-state vendor and no sales tax would be due. However, the customer's state may make up for the lost sales tax revenue by charging the consumer a use tax in an amount equal to the sales taxes avoided.
For example, if a person purchases a computer from a local "brick-and-mortar" retail store, the store will charge the state's sales tax. However, if that person purchases a computer over the internet or from an out-of-state mail-order seller, sales tax may not apply to the sale, but the person could owe a use tax on the purchase. Some states may also charge a use tax on the in-state transfer of used goods such as automobiles, boats and other consumer goods. NOTE: Because of exemptions, not all goods and services are taxed. The typical consumer will pay sales tax on approximately one third of all expenditures, such that a 7.5 percent tax will collect on average about 2.5 percent of a person’s income.
As the sales tax shift means to replace the income tax with a national sales tax, this would entirely eliminate the need for individuals to file a tax form. (And, if the taxes were collected by the states, the need for the IRS as well.) The federal government would set a federal sales tax rate, and people would simply pay as they bought.
However, a straight sales tax is, as seen in the above paragraph, also the ultimate in regression. Advocates say there are ways to make it less hard on the poor, by exempting such essentials as food, medical care, and housing from the sales tax—or, alternately, giving everyone a substantial rebate every year. But raising needed revenue in either of those circumstances might require an unpalatably high tax rate on the remaining items. On top of local and state taxes, a federal sales tax of 30 percent or more could make people nostalgic for their old tax forms.
Critics also note that enforcement of sales taxes is notoriously difficult, and that a high tax rate would increase the temptation to cheat. Another structural problem with the sales tax is the potential for double taxation, or more, as goods go through several owners on their way to the consumer market.
Imposing extra tax on consumption (sales and use) by the federal government might lead to results supporting the saying that:
- “relying on the sales tax is like riding a horse that is rapidly dying” (Vest 2002).
One reason for this is that people buy fewer products and more services—the problems associated with taxing high-tech inter-state services have been discussed above—not to mention the fact that growth in internet sales has made it difficult to collect tax due on products. Lack of standardization across jurisdictions compounds the difficulty.
The most significant argument however, one we have seen in the numerical example above, is that such a tax, being regressive in nature, hits low income householders harder than anybody else.
Granted, some provisions can be made to exempt spending on basic necessities like food, clothing, and shelter. This is also difficult to put into practice though, since one set of clothing is clearly a necessity but a hundred pairs of shoes for one individual are not. But, how can the retailer know whether the customer is buying their first or hundredth pair of shoes? Also, once exemptions for specific spending categories are invoked, government is inundated with lobbyists for an ever-increasing list of items apparently in need of exemption.
Such problems cannot be solved by legislation, for they belong in the minds of people. It is only when human nature changes from selfishness to caring for others and society as a whole that the problems inherent in sales tax can be resolved.
ReferencesISBN links support NWE through referral fees
- 1963. "Luckenbach Steamship Company v. Franchise Tax Board." 219 Cal. App.2d 1710. (petition for Sup. Ct. hearing denied).
- 1977. "Complete Auto Transit, Inc. v. Brady (Chairman), Mississippi Tax Commission." 430 U.S. 274; 97 S. Ct. 1076.
- 1984. "Communications Satellite corporation v. Franchise Tax Board." 156 Cal. App. 3rd 726; 203 Cal. Rptr. 779.
- 1984. "In the Matter of the Appeal of American Telephone and Telegraph Company." Cal. SBE, Slip Op.
- "Burke & Sons Oil Co. v. Missouri Director of Revenue." 757 S.W. 2d 278 (Mo. Court of Appeals, July 26,1988,(rehearing overruled 8/30/88).
- Due, John F., and John L. Mikesell. 1994. Sales Taxation: State and Local Structure and Administration. Washington, DC: Urban Institute Press. ISBN 9780877666271
- Mikesell, John L. 2002. Fiscal Administration: Analysis and Applications for the Public Sector. Wadsworth Publishing. ISBN 9780155058552
- Vest, Marshall J. 2002. Theory and Reality: Arizona’s Tax Structure. Tucson, AZ: Eller College of Business, University of Arizona.
All links retrieved December 22, 2022.
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