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 2008 state sales tax rates ranged from 2.9 percent in Colorado to 7 percent in Mississippi, New Jersey, Rhode Island, and Tennessee. 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 2008 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 12 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 12.1 percent in 1972 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 eight 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 thirty-one states exempt food completely.
- Only Illinois taxes prescription drug sales, and it taxes them at a lower rate than other goods. Other common exemptions include books 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. Colorado, 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 2005 Federation of Tax Administrators survey, Hawaii taxes 160 while Colorado taxes only 14. 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. Revenues from these taxes have been falling despite increases in rates.
- State and local governments may impose taxes only on sales that occur in their jurisdiction, but determining the location of catalog or online sales may be difficult. A retailer with sufficient physical presence in a state to be obligated to charge the state’s sales tax is said to have nexus. A state or local government may tax sales by a retailer with nexus in the state or locality, but nexus rules are complicated, and many questions about their application to online transactions remain unresolved.
- Expanding sales taxes to cover remote sales is complicated by the lack of coordination in tax rates and in definitions of goods across states. Nearly all states that levy sales 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.