Exemptions Continue to Narrow Sales Tax Breadth

Sales & Use Tax

If you’re looking for a thoughtful overview of the effectiveness of US states’ sales tax programs – or lack of it – dig into this Tax Foundation report, State Sales Tax Breadth and Reliance, Fiscal Year 2021. There’s a slab of data on total tax revenues by state, per capita revenue, sales tax revenue as a percentage of personal income and so on. Another chunk of data sheds light on reliance (collections as a percentage of total state tax revenue) and breadth (the share of the state’s economy included in the sales tax base).

The data itself is worth a look, but what caught my attention was the Tax Foundation’s analysis of states’ strategies. The report draws a picture of the advantages of consumption-based taxation and what a sales tax ideally should look like, in the form of broadly accepted “precepts and observations.” It then looks at the current reality in light of that picture.

The precepts and observations provide are a useful refresher on the basic rationale behind indirect tax:

  1. An ideal sales tax is imposed on all final consumption, both goods and services.
  2. An ideal sales tax exempts all intermediate transactions (business inputs) to avoid tax pyramiding.
  3. Sales taxes should be destination-based – they are owed in the jurisdiction where goods and services are consumed.
  4. Sales tax is more economically efficient than many other forms of taxation, including income tax, because it doesn’t impact savings or investment.
  5. Because lower-income individuals spend more of their income on necessities, the sales tax can be regressive – but broadening the tax base can counter this.
  6. Sales tax scales well with ability to pay because it grows with consumption and is more discretionary.
  7. Consumption is a more stable tax base than income, though the failure to tax services is eroding revenues.

States’ current tax strategies fall short on some of these principles, notably the first two, according to the report. On point one, for example, there’s huge variability in the sales tax base among states. In Massachusetts, the base is extremely narrow, at around 20%. In Hawaii, it’s around 94%. But in the vast majority of states, “sales taxes continue to be imposed on artificially narrow bases.”

In addition, “sales tax breadth has narrowed in recent years, as personal services (largely exempted) have grown as a share of final consumption and lawmakers have continued to carve out existing tax bases.”

For enterprise tax leaders, it’s worth bearing in mind that fact that the long-term narrowing of the state sales tax base means that rates will fluctuate more at sub-state levels as those jurisdictions respond to declining revenue from state sales taxes. You can find a useful overview of the current state of play at the local levels here

On the second point, tax pyramiding is very much a reality: “To varying degrees, these business-to-business transactions are taxed in every state with a sales tax, meaning that the sales tax is often embedded in the final price of a good or service several times over.”

Having laid out the challenges, the report goes on to discuss possible ways to tackle sales tax modernization, and I’ll cover those in my next post.

Blog Author

Michael J. Bernard, Chief Tax Officer – Transaction Tax at Vertex Inc. Vertex's Chief Tax Office (CTO) provides insight regarding the impact of tax regulations, policy, enforcement, and emerging technology trends on global tax department operations.

Michael J. Bernard

Vice President of Tax Content and Chief Tax Officer

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Michael Bernard is the Chief Tax Officer of Transaction Tax. In his role, he provides insight and thought leadership around tax department operations, U.S. indirect tax, tax risk management, and tax policy, as well as emerging tax trends. He is an executive-level tax attorney with a diverse portfolio of experience in corporate tax, administration, and finance, including a substantive knowledge of U.S. and international tax laws.

Prior to joining Vertex, Michael was in various tax leadership roles at Microsoft Corporation for 28 years, the most recent being Senior Director – Tax Counsel. Michael led teams in the following functional areas: direct and indirect tax controversy, sales and use, business license, property, tax IT, SOX, and telecommunications. He also co-led a corporate taxpayer advocacy group with the Washington Department of Revenue and was a Director on the Board of the Washington Research Council. Michael has also testified before administrative and lawmakers at both the federal and state level.

Michael earned both a J.D. and a Bachelor of Science in Business Administration from Creighton University. He is a part-time lecturer of Law in the LLM program at the University of Washington School of Law. Michael also served on the board of directors, executive committee, and chaired committees for The Tax Executives Institute (TEI) for nearly 25 years.

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