Sales Tax—Assessment, Collection, and Impact

What Laws Govern Sales Tax? What Items Are Subject to Sales Tax? What Is the Impact of a Sales Tax?

For most Americans, some form of sales tax is a part of life. While there is no such thing as a federal sales tax, the vast majority of states assess a levy on the sale of certain items. Currently, only four states—Delaware, New Hampshire, Oregon, and Montana—have no sales tax. (Alaska has no statewide sales tax but does allow individual municipalities to collect it.)

Sales tax is calculated by taking the total value of taxable goods or services and multiplying by the sales tax rate. The calculation and collection of sales tax is done at the time of sale. Because most states that assess sales taxes also allow municipalities to levy such taxes, the rates paid not only vary from state to state, but can also differ from city to city and county to county within the same state. The highest statewide sales tax currently assessed is in California, where consumers pay 7.25%, but when the state tax is combined with city and county sales tax, purchases in Los Angeles are taxed at 9.5%. In some places, purchasers can pay a combined state and local sales tax of almost 13%. (For example, the combined rate in Monroe, Louisiana, is currently 12.95%.)

What Items Are Typically Subject to Sales Tax?

Though sales tax is most often imposed on goods, rather than services, there is no state that assesses an across-the-board sales tax on all forms of merchandise. Taxes are most often assessed at the retail level. Most states have exemptions for transfers of goods that will be resold. As a general rule, transfers of real property are not subject to the general sales tax but may carry a separate transfer tax. The sale of gift cards is not taxable in any state, as the recipient of the gift card typically pays sales tax upon using it.

Only a few states (including Alabama, Mississippi, and South Dakota) impose full sales tax on groceries or other food purchased for preparation or consumption at home. Prescription drugs are generally not subject to sales tax (except for a 1% tax in Illinois).

Most services are not subject to sales tax, but almost every state assesses a tax on certain ones. Human services, such as medical care and legal services, are generally not subject to sales tax, but services related to tangible personal property—dry cleaning, home repair (plumbing, electrical, HVAC)—are often taxable.

What Are the Real-World Effects of a Sales Tax?

The imposition of a sales tax has been shown to have a number of consequences:

• Because the sales tax increases the total cost of the goods or services, merchants in communities with higher sales taxes may have to reduce the sales price of the goods to stay competitive with nearby merchants who are not subject to the same sales tax. As a consequence, merchants may choose not to sell goods or services with low profit margins as the result of high sales tax.
• Consumers may travel to other cities or states to pay lower sales tax, which can have a detrimental impact on their local economy.
• A sales tax is a form of regressive tax, which imposes a heavier burden on low income individuals. When low income consumers purchase goods, the sales tax levied eats up a greater portion of their disposable earnings than it does for a higher income consumer buying the same items.

Are There General Exemptions from Sales Taxes?

As noted above, each state and each municipality places limits on the applicability of sales taxes. Contrary to popular perception, charities and charitable organizations are not automatically exempt from sales tax. An organization may, however, seek “tax-exempt” status under Section 501 of the Internal Revenue Code.