How State Sales Taxes Work

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.