How State Sales Taxes Work

Illinois State Rep. Jay Hoffman speaks to the press about his plan to eliminate a 5 percent state sales tax on motor fuels.
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That new TV ought to be able to fit into the family budget -- barely -- at the sale price of $579. Of course, that may not be the case once the store's cash register spits out the total and the price has soared to more than $600. What happened? It's simple: The dreaded state sales tax has struck again.

Actually, state sales tax charges don't really come as a surprise. They're more an unpleasant fact of life than anything else. Unless you live in one of the five states that don't have sales taxes, you're probably used to coughing up a set percentage in addition to the ticket price of most things you buy.


Forty-five U.S. states and the District of Columbia rely on levying sales taxes on most things residents and visitors buy to help keep the state government functioning. In those states, sales taxes are an important source of income. The revenue from sales taxes is an essential part of the state's general budget. It goes into the pot with revenues from other sources and helps keep the public schools, universities, courts, highway departments, state police, medical programs and all sorts of other institutions and activities running. Without sales taxes, those states would find it difficult -- if not impossible -- to stay in business.

And when times get tough and state income tax revenues are stagnant or go down, an increase -- even if temporary -- in the state sales tax often looks to state legislators like the easiest way to keep things in the black.

With the five exceptions, the U.S. seems to be unusually fond of state sales taxes as a way of raising money. Some other countries have sales taxes, and others have other forms of consumption taxes. But the United States uses sales taxes on a much greater scale than does any other modern, developed nation [source: Fox].

What are state sales taxes? And how much do people in various states pay? Read on to find out.


Calculating the Pain

A sales tax is classified as a consumption tax. An income tax goes after the money you earn; a consumption tax targets only the money you spend [source: Froomkin]. Some economists argue that state sales taxes aren't true consumption taxes. That's because most states have lots of exemptions -- sales of some goods and most services aren't taxed. Also, often businesses have to pay the sales tax on things they buy, although the businesses aren't the final consumers. Many foreign countries use a different sort of consumption tax -- known as a Value Added Tax (VAT) -- that gives a tax credit to businesses when the goods reach the consumer.

Whether you call it a sales tax or a gross receipts tax, it's usually tacked onto the price of an item. The consumer pays the tax to the retailer, who's responsible for keeping records and sending the revenue to the state at regular intervals.


Consumers in most states don't care about the fine distinctions. A sales tax feels like a consumption tax to them. How much does it hurt?

First, there are the tax-free states:

  • Alaska does allow local governments to levy sales taxes, and many do.
  • Delaware does impose a tax on businesses' receipts, at a lower rate (a maximum of 2.07 percent) than sales taxes in other states.
  • New Hampshire imposes excise taxes on hotel rooms, some restaurant meals and communications services. For practical purposes, these excise taxes work like sales taxes.
  • Montana levies a 4 percent tax on rental vehicles.
  • Oregon imposes small taxes on cigarettes and gasoline.

Then, there are the other 45 states. Some, such as New Mexico, don't call it a state sales tax on buyers, but rather a gross receipts tax of 5 percent on businesses, but since businesses routinely pass the tax on to consumers, it works the same way.

Your home state determines what you pay. California leads the nation with a state sales tax of 8.75 percent. On its heels are Indiana, Mississippi, New Jersey, Rhode Island and Tennessee at 7 percent. Next highest are Minnesota at 6.875 percent, Nevada at 6.85 percent, Washington at 6.5 percent, and Texas and Illinois at 6.25 percent.

On the low end is Colorado, with a 2.9 percent state sales tax. Next are seven states with 4 percent sales taxes: Alabama, Georgia, Hawaii, Louisiana, New York, South Dakota and Wyoming [source: Tax Policy].

How did the sales tax become so important to state governments? You'll find a brief history on the next page.


History of State Sales Taxes

Who's responsible for the state sales tax? Some say Kentucky came up with the precursor of modern state sales taxes back in 1930, when it imposed a tax on retailers. Four years later, Kentucky revised that to a 3 percent flat sales tax. In 1936, Kentucky scrapped the sales tax until 1960. Other sources point the finger at Mississippi, which started a state sales tax in 1930.

One thing is clear, however: The Great Depression inspired desperate state governments to try sales taxes. Two dozen of the states that use sales taxes today started in the 1930s. Six more joined the trend in the next decade. Five states got on the bandwagon in the 1950s, and in the 1960s, 11 more imposed the tax. The last state to do so was Vermont, in 1969 [source: Fox].


Back in the 1930s, the U.S. economy largely had to do with selling goods. Legislators didn't like the idea of taxing people's labor. That's how sales taxes came to focus on goods rather than services [source: Duncan].

Sales taxes are vitally important to state budgets. In 1970, sales taxes became the largest single source of revenue for state governments. Since the late 1990s, personal income tax revenues have brought states more money than sales taxes, but these taxes still amount to a big chunk of the money that comes into states' budgets. In fact, some states raise nearly 60 percent of their tax revenue from sales taxes [sources: Fox and Duncan].

The many states that count on sales taxes for a lot of income may face trouble down the road. Whenever the economy turns down, legislators are tempted to raise the sales tax. Often, temporary increases are rolled back when times get better. But then something happens, and the tax goes up again. "The trend is clear, and that is upward," says journalist and author Paul T. O'Connor [source: O'Connor].

A lot has changed since the 1930s, however. A far greater share of the economy now is based on services rather than goods, but services historically haven't been taxed. In recent years, states have been moving toward taxing services, but changes in tax law are controversial and tough to accomplish. In March 2010, for example, Michigan Gov. Jennifer Granholm sparked an outcry when she proposed cutting the state's sales tax rate from 6 to 5.5 percent and imposing the reduced tax on a number of specific services, including legal services and landscaping [source: Hornbeck].

Do consumers ever get a break from sales taxes? Read on for some good news.


Tax Holidays

A family examines a selection of backpacks at a Brooklyn, N.Y., clothing store during a state-wide tax holiday in 2003.
Stephen Chernin/Getty Images

In the 1990s, a few states came up with an idea that would spread like wildfire. They would suspend the collection of state sales tax on certain items for a weekend in August to give parents a break on back-to-school purchases like backpacks, supplies and clothes for their children. It was a win-win situation for many retailers and shoppers. The retailers came out ahead because the tax break encouraged a lot of shopping. And the parents saved money.

For 2010, at least 15 states have sales tax holidays scheduled. They range from one day to one week [source: Taxadmin].


Sales tax holidays usually are targeted toward certain items. They often have upper limits on the price of items that can be bought tax-free. Back-to-school sales tax holidays are popular, but they aren't the only kind. Several states have recently started tax holiday weekends for appliances with the federal Energy Star efficiency rating.

Some sales tax holidays appear to be designed to influence behavior as well as to save shoppers' money. Louisiana and Virginia, for example, have tax holiday weekends for hurricane preparedness items. Louisiana also has a tax-free weekend for the sale of ammunition, hunting supplies and guns in honor of the Second Amendment.

In Vermont, the Legislature approved two one-day sales tax holidays in 2009, during which people can buy anything costing $2,000 or less tax-free. When shoppers turned out in droves on one of those holidays, March 6, 2010, retailers said it gave them a needed boost in a down economy. One speculated that the sales tax holidays encourage shoppers to buy locally rather than online [source: WCAX]. Buying online can be an easy way to avoid state sales tax. (Consumers are technically required to pay any sales taxes directly to the state -- even when the online store doesn't collect it -- but this rule is rarely enforced.) When tax isn't an issue, buying locally becomes more attractive because it's quicker and there are no shipping costs.

There's a catch, though: Sales tax holidays can be a victory for retailers and shoppers. But they're not great deals for the states that are losing the tax revenue. Some states have repealed tax holidays when the economy worsened. Others require that legislators authorize the holiday every year or two, and in some states such as Florida and Massachusetts, they've decided not to. New York, which was one of the first states to have a tax holiday, did away with the holiday in favor of removing state sales tax on clothing and shoes costing $110 or less year-round.

State sales taxes are a widely used fact of life in the U.S. But are they a good idea? Read on for some criticisms.


The Down Side of Sales Taxes

Some sales tax critics believe that online shopping makes it easier for customers to buy goods in other states and avoid extra sales taxes.
Antonio M. Rosario/Getty Images

Many observers say that Americans accept sales tax more willingly than they do other taxes [source: Duncan]. We pay it in small amounts, we're used to it and there's no paperwork for the consumer.

The main criticism of sales taxes has to do with fairness and social justice. Sales taxes are regressive, meaning that they hit the poor harder than the rich. Poor people have to spend a larger percentage of their income just to get by. Richer people can save more of their income or use it in other ways that don't involve paying sales tax [source: Froomkin].


But that's not the only rap on sales taxes:

  • Too many exemptions With the exception of Hawaii, most states with sales taxes exempt a number of items. Some of these exemptions lessen the tax burden on the poor. Food is often exempt, as are prescription medications. Other exemptions are more politically motivated and draw criticism.
  • Too complicated Exemptions are one reason sales taxes are complicated and sometimes confusing for retailers. Another is the fact that various states have different rates, rules and ways of collecting from retailers. This maze of tax laws can be a nightmare for retailers doing business in more than one state.
  • Double taxation Businesses usually are treated as consumers and charged sales tax on office supplies and other items they use that don't go directly into the products or services they sell. This expense raises the price they charge on their goods or services, on which consumers pay sales tax [source: Duncan].
  • Can't keep up with the times The economy has changed faster than sales taxes have. Services are a much bigger part of the American economy today than they were in the 1930s. States are beginning to tax some services like telephone and cable and satellite TV, but they encounter a lot of resistance.
  • Lack of online taxes The Internet has affected sales taxes in at least two important ways. Online shopping makes it easier for consumers to buy goods in other states and avoid sales taxes on most purchases. And downloading music, movies, books, games and software allows people to buy things they want without paying state sales tax [source: Fox].

Sales taxes aren't the perfect way for states to raise revenue. And if states are going to continue to rely heavily on sales taxes, they'll have to figure out how to deal with changing times. But shoppers should know that state sales taxes won't disappear anytime soon.


Lots More Information

Related HowStuffWorks Articles

  • California State Board of Equalization. "Applying Tax to Your Sales & Purchases."
  • Duncan, Harley T. "State and Local Retail Sales Taxes." Report from Federation of Tax Administrators presented to the President's Advisory Panel on Federal Tax Reform. April 2005.
  • Federation of Tax Administrators. "2010 Sales Tax Holidays." (Accessed March 7, 2010)
  • Fox, William F. "History and Economic Impact." Sales Taxation, edited by Jerry Janata, with Donald Bruce and Matthew Murray, Contemporary Economic Policy, October 2002.
  • Froomkin, Dan. "Tax Policy: Ripe for Reform?" The Washington Post, April 28, 1998. Accessed March 4, 2010
  • Hornbeck, Mark. "Granholm Faces Battle Over Proposed Sales Tax on Services." The Detroit News, Detroit, Mich., Feb. 12, 2010. Accessed March 7, 2010
  • New Hampshire Department of Revenue Administration. "Taxpayer Assistance: Does NH have an Income Tax or Sales Tax?"
  • O'Connor, Paul T. Political Journalist, Raleigh, N.C. Personal interview, March 3, 2010.
  • Retirement Living Information Center. "Taxes by State." Accessed March 4, 2010
  • Urban Institute and Brookings Institution. Tax Policy Center. "Tax Facts: Sales Tax rates 2000-2010)." Accessed March 5, 2010
  • Vermont Department of Taxes. "Sales Tax Holiday Q&A." Accessed March 3, 2010
  • "Vt. Tax holiday draws shoppers." South Burlington, Vt. March 6, 2010. Accessed March 8, 2010