Is Indirect Tax Policy Off-Base?
Last year, the Tax Foundation published a report for state tax policymakers that provides guidance for modernizing sales taxes. The analysis identified several modernization needs including exempting business inputs to avoid tax pyramiding, broadening the sales tax base to cover digital products and certain services, maintaining destination-based sourcing, and implementing centralized administration.
The report also has much to say about the ongoing erosion of the sales tax base. In the late 1970s, the sales tax base captured 45% of personal income. By the 2010s, the sales tax base captured only about 30% of personal income. The base decline has several causes. Consumption habits have shifted from goods to services in recent decades. Most services remain exempt from sales taxes, and the number of digital offerings continues to soar. The eroding sales tax base also figures prominently in the Tax Foundation’s latest State Tax Competitiveness Index.
The 2026 Competitive Index assesses the quality of each state’s sales tax base on five criteria:
- Whether the base includes a variety of business-to-business transactions such as machinery, raw materials, office equipment, farm equipment, business leases, and several digital goods and services (software-as-a-service, platform-as-a-service, payroll services, B2B digital goods)
- Whether the base includes goods and services typically purchased by consumers, such as groceries, clothing, gasoline, e-books, and digital video services
- Whether the base includes services, such as financial, fitness, landscaping, repair, parking, dry cleaning, barber, and veterinary
- Whether the state leans on sales tax holidays, which temporarily exempt select goods from the sales tax (As a note, we are currently seeing many jurisdictions scaling back sales tax holidays due to the administrative burden on businesses as the complexity often outweighs the benefits.)
- Whether the state embraces unity and uniformity in its sales tax base and collections, and whether it provides robust safe harbor provisions for remote sellers
Not surprisingly, the most “tax-competitive” states in this sales tax base subindex are the NOMADs – those that do not have a state sales tax (New Hampshire, Oregon, Montana, Alaska, and Delaware). Indiana, Kansas, Iowa, Wisconsin, Nebraska, Idaho, and North Carolina also have highly rated tax bases because they apply sales taxes to a broad range of consumer goods and services while generally avoiding taxes on business inputs.
On the other hand, states that rank lowest on the base subindex have sales tax structures that cover too many business inputs, exclude too many consumer goods and services, and impose “excessive” rates of excise taxation, according to the Tax Foundation. These culprits include Hawaii, Louisiana, South Dakota, Ohio, West Virginia, New Jersey, Arizona, New Mexico, Maryland, and Washington.
The Tax Foundation emphasizes that a well-structured sales tax does not apply to business inputs. There are better ways to expand the sales tax base, such as including more final retail sales of goods and services, including digital services, as taxable items.
State tax policymakers will want to keep this in mind as they explore base-expansion options in 2026, and weigh those implications against raising sales tax rates.
