J. OF PUBLIC BUDGETING, ACCOUNTING & FINANCIAL MANAGEMENT, 16(1), 63-79
SPRING 2004
THE PROSPECTS FOR GENERAL SALES TAXATION IN
AMERICAN STATE AND LOCAL GOVERNMENT FINANCE:
CHALLENGES FOR A FISCAL WORKHORSE UNREADY FOR
THE NEW MILLENNIUM
John L. Mikesell*
ABSTRACT. The retail sales tax has provided a strong foundation for
American state government finance since its beginnings in the Great Depression.
However, its position as a productive, reliable, and administrable revenue source
is now under challenge from three forces. First, it continues as a tax primarily
on purchases of tangible personal property, despite the shift in consumption
toward services. Second, the physical presence rule for taxation of sales by
remote vendors creates an intolerable imbalance between local and remote
sellers. And third, legislatures keep gnawing away at the base with politically
attractive but fiscally unjustifiable exemptions. In total, the position of the sales
tax as a viable and defensible revenue alternative is at risk.
INTRODUCTION
The general sales tax served as the foundation for fiscal autonomy of
American state and local governments for more than half the twentieth
century. From its beginnings as a means of desperation finance for state
governments in the Great Depression, it became the largest single source
of state tax revenue by 1947, a rank it retained for fifty years by
consistently contributing about one-third of tax revenue to state budgets.
It provided a strong foundation for enhanced state government in the post
WWII era and still continues as a strong second to personal income taxes
in aggregate state finances (Mikesell, 2000). While five states (Alaska,
Delaware, Montana, New Hampshire, and Oregon) levy no state sales
tax, across the nation the sales tax consistently has yielded about
----------------------* John L. Mikesell, Ph.D., is Professor, School of Public and Environmental
Affairs, Indiana University. His research interest is in state and local tax
structure and administration, particularly sales and property taxes.
Copyright © 2004 by PrAcademics Press
64
MIKESELL
one-third of state tax revenue. At the local level, it yields considerably
more revenue than any other non-property tax, although the tax on real
property is the unchallenged local revenue leader. Of course, the sales
tax is an extremely important revenue source for local government in
some urban areas, notably New York City, Washington, and Chicago.
Replacing any considerable share of the revenue from such an important
fiscal contributor would be no simple task.
Table 1 offers an overview of the role of the retail sales tax in state
government finances and of the structural variations in these taxes across
the states. Among the forty-five states levying the tax, states collect
from 18.8 percent of their total tax revenue from the tax (New York) to
60.8 percent (Texas). Eleven raise more than 40 percent of their total tax
collections from the tax; the median is 33.6 percent. It is a source of
considerable fiscal significance to most of the states. To raise this
revenue, states levy statutory rates ranging from 2.9 percent (Colorado)
to 7 percent (Mississippi and Rhode Island). Sixteen states apply rates of
6 percent or higher, but 5 percent is the median.
The structure of the taxes is not the same across the states. When the
implicit sales tax base is measured against the size of the state economy
for each state, the differences are striking.1 Table 1 shows base breadth,
measured by implicit sales tax base as percent of state personal income,
to range from 115.4 percent in Hawaii to 26.5 percent in Illinois; the
median is 46.6 percent. That comparison means that the same statutory
rate will yield dramatically different amounts of revenue from the
economy according to the legislative structure of the tax base; those
states with few exemptions from the sales tax will raise considerably
more revenue from a given tax rate than will those with narrower base
structures. The structures and resulting bases differ considerably among
the states, but – regardless of how structured – the tax yields revenue that
would be difficult to replace.
The status of the sales tax as a reliable, administrable, and equitable
revenue producer for state and local governments is being challenged by
technology, economic change, and political forces. There are three
primary challenges.2 First, the sales taxes continue their traditional
structuring as taxes limited to the purchase (or sale) of tangible personal
property. Second, states remain shackled by the physical presence rule
in their efforts to include purchases made from remote vendors (Internet,
GENERAL SALES TAXATION IN AMERICAN STATE AND LOCAL GOVERNMENT FINANCE
65
TABLE 1
Breadth of
Base
Standard
Rate
Food
Exemption
Clothing
Exemption
Extensive
Service
Coverage
States
Alabama
Arizona
Arkansas
California
Colorado
Connecticut
Florida
Georgia
Hawaii
Idaho
Illinois
Indiana
Iowa
Kansas
Kentucky
Louisiana
Maine
Maryland
Massachusetts
Michigan
Minnesota
Mississippi
Missouri
Nebraska
Nevada
New Jersey
New Mexico
New York
North Carolina
North Dakota
Ohio
Oklahoma
Sales Tax
Reliance
State Sales Tax Reliance and Characteristics (Fiscal Year 2001)
28.6
44.4
36.1
26.9
26.0
32.8
59.6
33.9
44.5
30.6
28.4
35.3
34
34.9
33.8
37
30.6
30.8
21.8
34.5
35.2
49.1
31.7
33.6
53.5
29.9
43.2
18.8
22
32.8
32.1
24.4
43.6
58.2
58.7
38.6
48.4
41.6
55.4
53.3
115.4
50.9
26.5
44.1
45.4
48.2
45.4
64.6
50.5
37.3
31.3
44.3
46.6
56
43.6
42.9
52.8
30.7
86.6
32.2
39.5
50.7
39.6
42.2
4.0
5.6
5.125
6.0
2.9
6.0
6.0
4.0
4.0
5.0
6.25
5.0
5.0
4.9
6.0
4.0
5.0
5.0
5.0
6.0
6.5
7.0
4.225
5.0
6.5
6.0
5.0
4.0
4.5
5.0
5.0
4.5
T
E
T
E
E
E
E
E
T
T
RR
E
E
T
E
RR
E
E
E
E
E
T
RR
E
E
E
T
E
E
E
E
T
T
T
T
T
T
E
T
T
T
T
T
T
T
T
T
T
T
T
E
T
E
T
T
T
T
E
T
E
T
T
T
T
No
Yes
Yes
No
No
Yes
Yes
No
Yes
No
No
No
Yes
Yes
No
No
No
No
No
No
No
Yes
No
No
No
No
Yes
Yes
No
No
Yes
Yes
66
MIKESELL
Breadth of
Base
Standard
Rate
Food
Exemption
Clothing
Exemption
Extensive
Service
Coverage
States
Pennsylvania
Rhode Island
South Carolina
South Dakota
Tennessee
Texas
Utah
Vermont
Virginia
Washington
West Virginia
Wisconsin
Wyoming
Sales Tax
Reliance
TABLE 1 (Continued)
32.1
31.2
40.8
47.5
57.3
60.8
36.4
22.9
23.9
47.9
31.7
30.7
36.1
33.2
32.6
52
59
50.6
49.3
59.4
43.4
38.8
50.7
46
47.9
74.8
6.0
7.0
5.0
4.0
6.0
6.25
4.75
5.0
3.5
6.5
6.0
5.0
4.0
E
E
T
T
T
E
T
E
RR
E
T
E
T
E
E
T
T
T
T
T
E
T
T
T
T
T
Yes
No
No
Yes
No
Yes
Yes
Yes
No
Yes
Yes
Yes
No
Sources: U.S. Bureau of Census, Governments Division (2002), Research
Institute of America (2001), unpublished data from the Governments
Division, and correspondence with State Tax Departments.
telemarketers, etc.) in the tax base. Finally, state legislatures themselves
gnaw away at sales tax coverage by more and more household
consumption exemptions. These challenges, as well as ways of dealing
with them, are discussed in detail in the sections that follow.
THE GOODS FOCUS
From their beginnings in the Great Depression, state sales taxes have
broadly taxed retail purchases of tangible personal property, but taxed
service purchases only selectively. As Table 1 shows, even today, 25 of
the 45 sales tax states levy no sales tax on service purchases beyond
some utilities, tangible personal property rentals, or transient lodging -not even on installation, repair, or maintenance of taxable items. The
American economy, however, has changed substantially, even if the sales
tax structure has not. In 1960, only one-third of gross domestic product
outside of government purchases came from personal consumption of
GENERAL SALES TAXATION IN AMERICAN STATE AND LOCAL GOVERNMENT FINANCE
67
services; by 2000, 48 percent of the economy was from these services
(Bureau of Economic Analysis, 2001, Table 1.1 Gross Domestic
Product). That represents a considerable change in the economic base to
which the tax structure will apply. A tax structure that was acceptable
for a commodity-driven economic base will not be adequate with this
secular swing toward a service economy.
The logic for including services in a retail sales tax on the same basis
as purchases of goods is simple. The first point is fundamental: a
government should levy a retail sales tax only if it intends a broad-based
levy on household consumption expenditure. In other words, the tax
“should apply to all expenditures for personal consumption purposes, but
not to any transactions involving use in business activity” (Due, 1982, p.
2000). An exclusion of services, an important element of household
consumption, will relieve individuals spending relatively high amounts
on those goods or services of part of their fair share of government cost,
will reduce revenue generated at the advertised tax rate, will distort
consumption and production patterns toward the untaxed categories, and
will complicate collection. There is no logical reason to exclude
household purchases of services from the tax, nor to include business
purchases of services in the tax.
Some elements of the case for including services in the sales tax base
merit particular emphasis. The first is yield: for any statutory rate, a base
that includes services will produce more revenue, the relative amount of
the increase depending on the services being added and the transactions
already taxed. Seldom would the increase exceed 10 percent of existing
yield, but that amount is not insignificant. In addition, the expanded base
likely would have higher growth prospects, in light of the secular trend
toward greater consumer service purchases, although the exact pattern
depends on what services are taxed.
Second, expanding the tax to include services would reduce the
discrimination by consumer preference that now characterizes the tax.
The current practice favors the purchase of services over purchases of
commodities and persons with relatively high preferences for services
over those with greater preference for commodities. This violates the
principle of horizontal equity; however, evidence suggests that the
typical extension of the tax to services would have no significant impact
on regressivity of the tax (Siegfried & Smith, 1991).
68
MIKESELL
Finally, taxing services would end some operational problems and
reduce some business distortions. Vendors selling both goods and
services no longer would need to divide sales records between goods and
services, and it no longer would be necessary to distinguish between
goods and services on joint or difficult-to-define transactions, i.e.,
computer software, custom- made goods, optometric work, etc. It would
also end the incentive for separate invoicing of labor and materials in
repair, installation, and service contracting. Audit would be somewhat
more difficult because the physical ingredient trail of value through the
production and distribution process becomes less well defined, and some
new firms will need to be registered, although many service sellers
already will be registered because they also sell goods. Nevertheless,
these complications have been resolved without great difficulty in the
handful of instances where the tax base has been extended.
Great attention in the past decade has been given to the prospects of
extending sales taxes to service, but only the same states as a decade ago
-- Hawaii, New Mexico, and South Dakota -- apply general taxation of
services (Mikesell, 1990). Many states have made aggressive but
selective extensions of the sales tax to enumerated services, notably in
Iowa, Minnesota, Texas, and Ohio, but roughly half the states still do not
even tax repairs of goods, the purchase of which would be taxable. In
recent years, Massachusetts and Connecticut moved in exactly the wrong
direction, taxing services that are almost exclusively business inputs, but
quickly rescinded the action. Florida made an even broader grasp.
Although it specifically continued exemption of a number of household
consumption services, Florida repealed the extension after a year.
A broad extension of the tax to purchases of services, however,
would not be sound tax policy because many services, including many
that are among those in typical legislative proposals for sales tax base
expansion (advertising, for instance), are sold exclusively as production
or distribution inputs and others have considerable mixed sales, partly as
business inputs and partly to households (legal services, for example).
Purchases by businesses should be exempt if there is a desire to nurture
(or least not to discourage) small businesses and their economic
development potential and to maintain transparency in taxation.
Unfortunately, evidence indicates that legislatures do not easily accept
the distinction between sales to business and sales to households. A
broad extension of sales tax coverage to services may thus be less
reasonable than a narrower approach that adds repair, installation,
GENERAL SALES TAXATION IN AMERICAN STATE AND LOCAL GOVERNMENT FINANCE
69
maintenance, and similar services rendered to taxable personal property,
utility services sold to household consumers, and selected personal
services rendered to individuals, with no claim of general service
taxation.
Revenue would be considerable and the tax would be
consistent with the logic of sales taxation. However, there appears to be
no practical, politically palatable way to add services generally to the
retail sales tax base without creating difficult problems of administration
and compliance, discrimination against less integrated firms, avoidance
through sham business combinations, and general disincentives for
business service-oriented economic activity.
THE REMOTE VENDOR CHALLENGE
New information technology should improve productivity, reduce
costs, expand horizons, and generally improve business and government
operations and household standards of living. In particular, the Internet
provides an inexpensive communication, display, and delivery system
that can open new markets for both old and new businesses and expand
options for customers. However, commercial activity through the
Internet (electronic commerce or E-commerce) endangers the continued
use of the general sales tax for the finances of these governments. State
revenue policy and administration – and the legal environment in which
they function – continues to assume an economic world of immobile
large producers of manufactured goods that no longer exists.
The problem is not one of “taxing the Internet.” To tax this vast,
flexibly connected mixture of private and public computer networks that
constitutes the Internet is neither meaningful nor administratively
feasible. Furthermore, it would be poor public policy to subject one
means of transacting business, particularly a means that seems to have
exceptional advantages to an environment other than one that provides an
even and level playing field so that consumers can be serviced through
the most efficient means possible. Even if “taxing the Internet” were
meaningful and feasible, it would not be reasonable tax policy.
The federal moratorium on internet taxation is, realistically, not a
critical issue for state and local government finance.3 The greatest
concerns about Internet and E-commerce impacts on state and local
taxation are in regard to the retail sales tax and the companion
compensating use tax. The current situation is untenable because local
70
MIKESELL
and remote vendors, including those operating through the Internet, are
not treated uniformly by the sales and use tax system.
The problem emerges from the rule for requiring vendors to register
as tax collectors on purchases made from them. The physical presence
requirement for registration was prescribed by the U. S. Supreme Court
in National Bellas Hess v. [Illinois] Department of Revenue (1967) and
reaffirmed in Quill v. North Dakota (1992) as a bright-line test for
requiring registration, part of the effort to avoid having states place
undue compliance burden on business in interstate commerce.
Unfortunately, the changes in channels of business operations have made
the line fuzzy. The problem is made more difficult because of the rule
on affiliate enterprises. A business can organize two affiliates, one an
electronic storefront and the other a conventional brick-and-mortar
storefront, without having the physical presence of the latter imply a
registration requirement for the other. That allows the former to operate
outside the sales and use tax system, thus gaining a competitive
advantage against conventional businesses and threatening the sales tax
base. It is the combination of the physical presence standard and the
treatment of electronic affiliates as separate entities that creates the
revenue and equity problem for state and local government finance – and
creates the competitive disadvantage for conventional retailers.
The current situation may be simply summarized. A local storefront
must register as tax collector and remit sales tax collected from
purchases made from the store. A remote vendor, electronic or
otherwise, with a physical presence in the taxing jurisdiction must
register as a tax collector and remit compensating use tax collected on
purchases delivered into the jurisdiction.4 A remote vendor, electronic or
otherwise, with no physical presence in the taxing jurisdiction need not
register and need not remit compensating use tax on purchases delivered
into the jurisdiction. In this last case, remitting the appropriate use tax is
the responsibility of the purchaser and tax administrators can enforce the
tax only by pursuit of the purchaser. What this means is that, for sales in
which the vendor has physical presence, the tax is collected indirectly
from the vendor who is expected to collect from the purchaser, and, for
no physical presence transactions, the tax must be collected directly from
the purchaser. It is not feasible to attempt direct collection of a
transaction based tax like the sales and use tax.
Sales and use tax revenue lost through E-commerce is not yet huge,
although it is an irritant to states and to local vendors with remote
GENERAL SALES TAXATION IN AMERICAN STATE AND LOCAL GOVERNMENT FINANCE
71
competitors. A good estimate for fiscal 1998 placed the loss at 0.1
percent of sales and use tax revenue, a tiny piece of overall state
government finances (Cline & Neubig, 1999). But E-commerce was in
its infancy then and the loss is certainly larger now. Internet penetration
spread to many more households, people have become more comfortable
with such shopping, and vendors are developing wider and more
convenient shopping opportunities. State governments have become
more sensitive as sales tax collections lag (although the economic
recession that began in March 2001 is certainly a bigger villain than the
Internet in this experience) and brick-and-mortar vendors have become
more aware of the issue. The impact is certain to increase unless there is
a change in the rules of administration. Bruce and Fox now estimate that
by 2006 states sales and use tax revenue lost from E-commerce will grow
to 5.6 percent of total state tax revenue, ranging from 3.4 percent in
Massachusetts to 10.3 percent in Texas (Bruce & Fox, 2001). Certainly
revenue loss from uncollected sales (use) tax is an important concern, but
damage to basic economic balance, economic efficiency, and competitive
fairness among vendors is at least as worrisome as a policy matter.
States can do little to cope with this registration problem. A number
of states are working together to develop a less burdensome system for
sales tax compliance – the Streamlining project to produce a uniform and
simplified sales and use tax administration – but the outcome of this
work is neither certain nor conclusive in ending the problem.5 However,
to change the physical presence rule requires Congressional action
because it is the role of Congress to judge when state requirements no
longer constitute an undue (and hence unconstitutional) burden on
interstate commerce. So far, Congress continues with the view that
physical presence is the appropriate preventive measure against that
burden.
BASE-GNAWING LEGISLATION
The 1990s gave state legislatures an opportunity for tax reform and
restructuring without the pressure of financial need looming over them.
While the early years of the decade presented fiscal difficulties for most
states, the last half fully reflected the longest national economic
expansion on record and virtually all states enjoyed strong fiscal health.
State legislatures could restructure and reform their revenue system
without being driven by stark revenue necessity or fiscal crisis.
72
MIKESELL
The states generally squandered the opportunity. Zodrow observed
in the case of federal government finances that good economic times can
be a barrier to sensible reform: “the main effect of a budget surplus may
simply to be to create a feeling that the tax system is functioning
perfectly well and that efforts at reform are unnecessary” (Zodrow, 1999,
p. 429). States did use the prosperity to stop the steady increase in state
sales tax rates: the median statutory tax rate had been increased at a rate
of one percentage point per decade in the sixties, seventies, and eighties,
but the median rate on the first day of 2000 was the same as it had been
in 1990. In terms of the structure of the taxes, however, states not only
did not reform their sales taxes, they frequently made them less
consistent with revenue policy standards. In many respects, the states
seem to have been determined to provide supporting evidence for
Brunori’s Law: “The more learned experts criticize a tax policy, the
more likely it is that political leaders will embrace the policy” (Brunori,
2001, p. 605).
According to the consensus standards outlined by John Due, a sales
tax should be structured to provide i) a uniform burden distribution by
consumption category to prevent discrimination against individuals
because of their preferences, ii) neutrality across methods of production
and channels of distribution; and (iii) easy compliance for taxpayers and
administration for tax authorities (Due, 1957, pp. 41-42). A sales tax
structure that fails to conform to these requirements will not perform
well against broader expectations of revenue policy, i. e., yield, equity,
economic efficiency, collectability, and transparency. Unfortunately,
states have been increasing exemption of purchases that the philosophy
of general consumption taxation suggests should be taxed. Three
examples deserve particular attention as explored below.
Food Exemption
The food exemption enjoys great popularity, being a tax preference
that appears to benefit everyone (except those who eat only in
restaurants), that reduces regressivity, and that provides a tax-free
necessity. Since 1995, new food preferences have been added by
Georgia, Missouri, North Carolina, and Virginia.6 Only fourteen states
(see Table 1) now tax food at the full standard rate, compared with
twenty-nine in 1970. However, the general food exemption removes
around 15 to 20 percent of the typical sales tax base and, accordingly,
results in higher general sales tax rates on the transactions remaining in
GENERAL SALES TAXATION IN AMERICAN STATE AND LOCAL GOVERNMENT FINANCE
73
the tax base (Bahl & Hawkins, 1997; Kent, 1998). Higher statutory tax
rates are, of course, faulted from the revenue policy standpoints of
efficiency, horizontal equity, and administrability, so should be avoided
if at all feasible. Furthermore, exempting food removes a source of
stability for the sales tax, thereby making it more reliant on cyclically
volatile expenditure categories, particularly durable goods.
Because the percentage of income spent on food declines as income
rises, the exemption does reduce sales tax regressivity. The problem is
that the aid is not effectively targeted – more than forty percent of the
total tax relief goes to families with incomes above $50,000, for instance
(Bureau of Labor Statistics, 1999). Much of the relief is wasted because
people with higher incomes also purchase food, and tax relief goes with
those purchases; the higher income households receive the relief just as
do people with much lower incomes.
This relief to high-income people as a collateral effect of giving
relief to lower income people is particularly unfortunate because another
more targeted mechanism provides relief to the most deserving even in
states without a general exemption for food purchases. The federal food
stamp program requires that food stamp purchases be exempt from tax as
a requirement for state participation and, of course, all states include
such a provision in their sales tax laws. Under the assumption that food
stamp recipients are the most deserving of assistance, then going beyond
that necessary exemption simply extends relief to those less deserving of
public charity. According to data from the Consumer Expenditure
Survey, 93.4 percent of a general food exemption goes to individuals not
receiving food stamps (Bureau of Labor Statistics, 1999). That represents
a considerable loss of revenue without social purpose. With the
exemption of food stamp purchases in place, the rationale for the general
food exemption is extremely shaky – the marginal benefits from the
exemption go heavily to households not qualifying for need-targeted
assistance. To limit the exemption to food stamp purchases targets relief
to the deserving and provides for improved administrative control
through tracking of food stamp revenues to the vendor against claimed
exempt sales.7
Clothing Exemption
For many years, six states (Pennsylvania, Rhode Island, New Jersey,
Connecticut, Massachusetts, and Minnesota) stuck to their clothing
exemption in the face of evidence that the provision provided vastly
74
MIKESELL
more relief for higher income households than it did for lower income
households (the highest income quintile spends roughly four and one half
times as much on clothing as does the lowest quintile), that the
percentage of income before taxes spent on apparel generally falls as the
income quintile rises so that the relief has a regressive impact, and that
the exemption complicates administration and compliance, particularly
when the states tried to target the tax preference by limiting it to clothing
priced below some ceiling or to clothing for children.8 Now New York
and Vermont have added clothing exemptions. This exemption is not
possible to justify as part of sound sales tax policy. It makes even less
sense than does the general food exemption, because, in addition to the
effects from making the tax base narrower than household consumption,
it adds to sales tax regressivity.
Holidays
Sales tax holidays have emerged as one of the new gimmicks of state
tax policy.9 The holidays enjoy great popularity, particularly with
retailers (the ability to have a price reduction without losing any revenue
is understandably attractive) and with the public (apparently lower taxinclusive prices!). The state loses revenue, of course, but the problem is
with the accompanying damage as assessed against the standards of
revenue policy. The holiday will complicate tax collection because sales
will need to be segregated by date of sale and by type of merchandise for
vendor reporting and for audit by the tax authorities. Furthermore,
higher income households make a large amount of the purchases most
often included in the holidays – clothing and computers – so much of the
relief will accrue to those least deserving. Finally, there will be
distortion of economic activity – much of the increase in sales
experienced in a holiday is spending that would have occurred at either
end of the holiday period or in a neighboring non-holiday area – meaning
no net improvement in economic activity, just shifting around of existing
activity. There is another interesting feature of the holidays. Evidence
shows that retailers respond to a holiday by increasing their net-of-sales
tax prices (or by reducing their normal seasonal mark-downs), thus
earning extra profit at the expense of the state. In effect, the state
forgives its sales tax, the retailer increases its pre-tax prices a bit, and
consumers receive only a portion of the savings from the forgiven sales
tax (Hawkins, 2001).
GENERAL SALES TAXATION IN AMERICAN STATE AND LOCAL GOVERNMENT FINANCE
75
If state finances do not require the revenue foregone in a tax holiday,
reducing the statutory tax rate – or even giving general rebates to state
residents, as recently has been done by Minnesota – makes more sense in
terms of efficiency, state competitive position, and operating cost.
A FINAL NOTE
Where should the retail sales tax be heading? The consumption base
makes sense in a market economy. Its logic is that the consumer’s own
assessment of capacity to afford private goods and services is a good
standard for distributing the cost of services provided by the government.
The retail sales tax is defensible on those consumption-based grounds.
Then how should sales tax policy be formed? The following affords a
reasonable guide:
The principle issue in devising general sales tax policy with
regard to treatment of spending…is not whether the transaction
at issue involves a good, a service, or a combination of the two.
The question is whether the transaction forms a part of
household consumption expenditure, the base for which there is
some logic as a standard for distributing a share of the cost of
government. The issue would be neither the nature of the
transaction, in terms of good or service, nor the nature of the
seller, as predominantly a service or good provider, nor whether
the seller may be affluent or not. Rather, the issue is whether the
buyer is a household or a business, whether the purchase is final
consumption or an input” (Mikesell, 1992, p. 89).
Laying this standard against the three challenges outlined above
shows the problem. Partly by state policy action and partly by external
forces, the state sales taxes are drifting from that justifiable logic, putting
the sales tax in jeopardy as a reliable and acceptable source of revenue.
First, the focus on goods in the tax base allows a large and growing
component of household consumption to go untaxed and throws the cost
of government on a relatively narrower share of the potential tax base.
Second, the physical presence rule and its shackles on the capacity of
states to include purchases made from remote vendors (Internet,
telemarketers, etc.) in the tax base challenges the yield, economic
balance (neutrality), and fairness of the tax. Finally, new exemptions,
made feasible by the good economic times of the 1990s, have eroded
sales tax coverage by more and more household consumption
76
MIKESELL
exemptions, adopted usually for arguably noble motives but ultimately
reducing the yield, stability, neutrality, and ease of administration of the
tax.
Because of these challenges, states face an important policy choice:
to seek to preserve the sales tax as a viable and defensible revenue
alternative for distribution shares of the cost of government services or to
seek revenue options other than the sales tax to finance these costs. The
discussions need to begin, before pressing need drives governments to
alternatives that could threaten the American tradition of fiscal
independence and autonomy that has been the hallmark of this federal
system.
NOTES
1. The approach to calculating the implicit sales tax base is outlined in
detail in John F. Due and John L. Mikesell (1994).
2. Should supporters of a retail sales tax for the federal government
succeed (two recent proposals: the Individual Tax Freedom Act of
2001 (H.R. 2717) and the Fair Tax Act of 2001 (H.R. 2525)), the
competition between federal and state/ local government for sales tax
revenue and the complications associated with multiple-tier
administration would constitute a fourth, and possibly
overwhelming, challenge. Using the value added tax format for
taxing consumption at the federal level would cause fewer problems.
3. The “Internet Tax Nondiscrimination Act” (Enrolled H. R. 1552) that
Congress approved in November 2001 extends for two years the
initial three-year moratorium against new taxes on Internet activity.
The state tax most endangered is the existing use tax, as explained
here. It is not affected by the moratorium because it pre-exists the
moratorium.
4. The problem is primarily one of purchases made through the Internet
(or other remote vending formats) and delivered through
conventional means (postal service, delivery firms, etc.) and not of
purchases delivered through the Internet. Only purchases subject to
digitization can currently be delivered by that means, and that is a
small component of the possible tax base. Furthermore, many such
purchases are not taxable, even if purchased from a local storefront –
part of the general failure of state sales taxes to keep up with
economic change.
GENERAL SALES TAXATION IN AMERICAN STATE AND LOCAL GOVERNMENT FINANCE
77
5. Twenty states plus the District of Columbia had adopted a simplified
system by the beginning of December 2001. California and New
York are notable for their absence from the list.
6. Louisiana restored an exemption that had been suspended
temporarily because of state fiscal problems.
7. 7. Relief can also be provided by direct rebates (South Dakota,
Wyoming, and Kansas) or by income tax credits (Hawaii, Oklahoma,
Idaho, and Georgia) to return a portion of sales tax collected to
households in the state. Flat payments provide relatively greater
relief to low than to high income households and thus reduce
regressivity of the tax; the payments can have even greater impact on
regressivity if they diminish as household income is higher. The
credit / rebate structure can have greater impact on regressivity at
lower revenue loss than would be the case for a food exemption.
8. Bureau of Labor Statistics Consumer Expenditure Survey (1999)
data show the lowest quintile to spend $788 per year on apparel and
related services while the highest quintile spends $3,478. That
amounts to 10.8 percent of income before tax for the lowest and 3.2
percent for the highest.
9. The list of tax holidays includes Michigan (June 27 – July 31, 1980,
reduced rate for certain motor vehicles), Ohio (September 19 –
November 18, 1980, reduced rate for certain motor vehicles), New
York (six holidays, the first from January 18 – 24, 1997, for
clothing), Florida (Aug. 15 - Aug. 21, 1998, July 13 – August 8,
1999, July 29 – August 6, 2000, and July 28 – August 5, 2001 for
clothing and accessories), Texas (August 6 – 8,1999, August 4 – 6,
2000, and August 3 – 5, 2001 – legislated as an annual event -- for
clothing and footwear), Connecticut (August 20 – 26, 2000 and
August 19 – 25, 2001– legislated as an annual event -- for clothing
and footwear), South Carolina (August 4 – 6, 2000 and August 3 – 5,
2001 – legislated as an annual event -- for clothing, computers, and
supplies), Pennsylvania (August 6 – 13, 2000, February 18, 25,
2001, and August 5 – 12, 2001 for computers), Iowa (August 4 – 5,
2000, August 3 – 4, 2001 – legislated as an annual event for the first
Friday and Saturday of August -- for clothing and footwear),
Maryland (August 10 – 16, 2001 for clothing), Illinois (July 1 –
December 31, 2001 – gasoline), Indiana (July 1 – October 25, 2000
for gasoline), Illinois (July 1 – December 31, 2000 for gasoline), and
78
MIKESELL
the District of Columbia (August 3 – 12, 2001 for clothing, footwear,
and school supplies and November 23 – December 2, 2001 for
clothing, shoes, and accessories costing $100 or less).
REFERENCES
Bahl, R.W., & Hawkins, R.R. (1997). “Does a Food Exemption Lead to a
Higher State Sales Tax Rate?” Proceeding of the Ninetieth Annual
Conference on Taxation of the National Tax Association, 90, 447454.
Bruce, D., & Fox, W.F. (2001, September). State and Local Sales Tax
Revenue Losses from E-Commerce: Updated Estimates (working
paper). Knoxville, TN: Center for Business and Economic Research,
University of Tennessee.
Bureau of Census, Governments Division. (2002). 2001 State
Government
Tax
Collections.
[On-line].
Available:
www.census.gov/govs/www/statetax01.html
Bureau of Labor Statistics. (1999). Consumer Expenditure Survey: 1999.
[On-line]. Available: www.bls.gov/cex/1999/Standard/income.pdf.
Bureau of Economic Analysis. (2001, November 30). National Income
and Product Accounts (Revised). Washington, DC: Author. [Online]. Available: www.bea.doc.gov.
Brunori, D. (November 19, 2001). “Introducing Brunori’s Law,” State
Tax Notes, 22, 605.
Cline, R., & Neubig, T. (1999, July 5). “The Sky Is Not Falling: Why
State and Local Revenues Were Not Significantly Impacted by the
Internet in 1998,” State Tax Notes.
Due, J.F. (1957). Sales Taxation. Urbana, IL: University of Illinois Press.
Due, J.F. (1982). “Sales Tax Exemptions -- The Erosion of the Tax
Base,” Revenue Administration, 50, 199-203.
Due, J.F., & Mikesell, J.L. (1994). Sales Taxation: State and Local
Structure and Administration. Washington, DC: Urban Institute
Press.
GENERAL SALES TAXATION IN AMERICAN STATE AND LOCAL GOVERNMENT FINANCE
79
Hawkins, R.R. (2001, October). Price Effects around a Sales Tax
Holiday. Unpublished working paper. City, FL: University of West
Florida, Department of Economics.
Kent, C., Burton, M., Hatcher, R. V. (1998, November 9). “The Impact
on the Economically Disadvantaged on the Sales Tax on Food,”
State Tax Notes, 15, 1202.
Mikesell, J.L. (1991). “Sales Tax Coverage for Services – Policy for a
Changing Economy,” Journal of State Taxation, 9 (4), 31 – 50.
Mikesell, J.L. (1992, Spring). State sales tax policy in a changing
economy: Balancing political and economic logic against revenue
need. Public Budgeting & Finance, 12 (1), 83-91.
Mikesell, J.L. (2000, February 21). Retail sales taxes, 1995 – 98: An era
ends. State Tax Notes, XVIII, 83-91
Research Institute of America. (2001). 2001 guide to sales and use
taxes. New York: Author.
Siegfried, J.J., & Smith, P.A. (1991, March). The distributional effects of
a sales tax on services. National Tax Journal, XLIV, 583-595.
Zodrow, G. (1999, September). The sales tax, the VAT, and taxes in
between – Or, is the only good NRST a ‘VAT’ in drag? National
Tax Journal, 52, 429-442.