Saturday, December 02, 2006
State Sales Taxes
This is the latest tax article out of a series that I am writing for the blog. Previous posts include 1) the Alternative Minimum Tax or AMT 2) tax withholding 3) Democrats and taxes 4) state income taxes and 5) social security 6) corporate taxes.
WHAT ARE SALES TAXES?
State sales taxes are levied as individuals purchase goods at retail. The tax rate is a percentage of the sales price and collected by the retailer, then remitted to the state and local authorities. Like most US taxing regimes, the taxes are often hidden because they are built into everything that you purchase a bit at a time, and the retailer collects the money and sends it to the state (and de-facto to the local municipality). The government likes these types of tax policies (similar to Federal tax withholding) because it makes the retailer the “bad guy” rather than the government and it nickels and dimes you rather than making you send a single big check all at once to the government, which would likely spark a tax revolt.
Sales taxes are not “graduated” – if you spend $1000 and the rate is 9%, you pay $90 in sales taxes, and if you pay $1, your sales tax is 9 cents. Of all the tax types, this is the most universally applied. Even if you are an undocumented employee, working for cash, you still are paying sales tax on everything you buy at the store. Sales taxes are ubiquitous and inescapable, unless you live and purchase goods in a state that does not levy them, or take other actions like buying online (rapidly disappearing) or shipping across state lines (often technically illegal).
Sales taxes are usually applied to goods purchased, not services. For example, if you get your hair cut or your car washed, sales taxes are not applied. Sales taxes are applied to virtually everything else that you buy in a store or restaurant. Sales taxes may not be applied to all goods; some states have lower rates on medicine or food staples (groceries) and higher taxes on other items. There are exceptions, of course, but this is the basic model.
When I was a kid we used to go to Montana and I was struck by the absence of sales taxes. If something cost $9.99, you gave them a ten dollar bill and received a penny back. Sadly, virtually every state has now implemented a sales tax to a varying degree. The only holdouts are Montana, Alaska (oil wealth), Delaware (corporate excise taxes), New Hampshire (anti-tax, don’t tread on me) and Oregon (taxing everything else to death). State sales taxes range from 4% to 7%. In addition to the state sales tax rate, counties and municipalities also levy an additional amount as a percentage. The total City of Chicago sales tax rate is 9%, among the highest in the nation.
A relatively unique item relating to sales taxes is the occasional use of tax “holidays”, where the state temporarily forgoes collecting sales taxes. These holidays are usually related to “back to school” and may also be withdrawn for certain types of items. I am not aware of holidays for other types of taxes (don’t try this on your Federal tax return).
According to the Tax Foundation, the “state” portion of sales taxes (not including local city or county additions) totaled approximately $100 billion in 2005, representing 15% of state tax collections. State tax collections as a percentage of total state income varied from 33% in Nevada, where it represents a primary source of state funding (there is no state income tax), down to Alaska, where it represents only 10% of total collections (it is good to have oil wealth, I guess).
SALES TAXES ARE REGRESSIVE
For those not familiar with tax terminology, a tax is called “regressive” if it falls on the poor at the same (or worse) rate than the rich. A tax is called “progressive” if the poorer pay less than the rich. A common “progressive” tax tactic is the use of brackets where a certain portion of income is not taxed, then some is taxed at 15%, then some at 28%, and so on (the Federal system).
Sales taxes are the most REGRESSIVE of all taxes, because they fall on goods bought by everyone, regardless of income. The poor also consume a much higher percentage of their total earnings than the rich, so they in fact pay a higher rate. For example, if someone with a family makes $30,000 and lives in Chicago, they probably spend $6000 on food, clothing, gas and other essentials. In Chicago, the sales tax rate is 9%, so $6000 of purchases would mean that this individual pays $540 in sales taxes, or about 2% of their total earnings. Note that at this rate they would receive a REFUND from the Federal government (the Earned Income Tax Credit) and have a negative tax burden. A family that earned $500,000, for example, might spend $50,000 on these types of purchases and pay $4500 in sales taxes, or about 1% of their total earnings. These numbers are made up, of course, but virtually all analysis states that sales taxes are regressive.
SALES TAXES ARE COMPLICATED
Sales taxes are complicated. In the State of Illinois, the “Illinois Sales Tax Rate Reference Manual” or ST-25 is ONE HUNDRED AND TWENTY EIGHT pages long. The manual is long because every single city has the option of creating their own rate, and some cities (like Chicago) also sit astride more than one county, which means that there is a different collection rate in each geographical area. The Illinois cities range from 6.25% up to 9% (Chicago, the worst, of course). In addition, sales taxes are calculated differently depending if you are buying a car, food or some other “qualified” items.
For a long time internet retailers received an advantage because goods sold online were not subject to sales taxes while goods purchased for retail were taxed. A significant portion of the (admittedly self-serving) argument advanced by retailers is that the complex geographic rates by location were so complicated that they could not accurately be calculated. At this point, however, most major internet retailers calculate sales tax on goods purchased. If you buy something from Amazon.com or Walmart.com or a similar large retailer, sales taxes are typically included in the purchase price. This is a relatively new development; several years ago it would have been uncommon to see sales taxes applied. The lack of sales taxes contributed to the early boom years of the Internet; now Internet retailers need to compete (mostly) on other elements (selection, price, delivery, etc…).
A group called the “Streamlined Sales Tax Governing Board” is designed to simplify the sales tax collection process and work in the interest of the taxing authorities (against your interest as a consumer). Here is a link to their web site in case you have insomnia.
SALES TAX AVOIDANCE
Art galleries and jewelers have been frequent targets of raids when they fail to remit the appropriate sales taxes. In the past many jewelers sent rings out of state to other locations and thus avoided sales tax in the current state; many times the other person was theoretically supposed to report the sale and voluntarily remit these taxes to the state but for obvious reasons this did not occur. In fact, one of the major scandals with Dennis Kozlowski (former CEO of Tyco) started with the fact that he was alleged to have avoided sales taxes on art purchases by sending them out of state; this investigation was the start of a long process that landed him behind Federal bars.
Sales taxes are regressive, complicated, and easy for politicians to raise because a small percentage change (1/2 of one percent) seems small but adds up to a large amount across the state.
The only positive elements for sales taxes are that they apply to everyone, even people who earn their income “off the books” because everyone needs to shop in stores for essential goods. They also reward savings (because it isn’t taxed) and punish consumption, and savings ultimately can be reinvested in productive capital uses. Sales taxes have less distortion on economic activity.