Sales Tax | Investing in the Future

Investing in the Future

Sales and Excise Taxes

Generating State Revenues with Sales and Excise Taxes

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National Policy Experts

Meg Wiehe
State Tax Policy Director, Institute on Taxation and Economic Policy
Contact Meg with questions regarding application of the sales tax to services.

Carl Davis
Senior Policy Analyst, Institute on Taxation and Economic Policy
Contact Carl with questions regarding online sales taxes

Michael Leachman
Director of State Fiscal Research, Center on Budget and Policy Priorities

Sales and/or excise taxes are levied in every state in the country, together representing close to half of all state tax revenues.1 While options exist for increasing the revenues collected through these taxes, it is important to note that sales and excise taxes tend to be very regressive, meaning that low and moderate income families pay a larger share of their income toward these taxes than high-income households do.2 This is because low and moderate income households typically must spend all of their income to acquire life's basic necessities, while high-income households are able to save and invest a portion of their income.3 As a result, a greater share of the income of low and moderate income households is subject to the sales tax.

Making changes that increase tax collections from these sources is thus very likely to affect low and moderate income households negatively and disproportionately, making a state's overall tax structure more regressive.  If sales and excise options are pursued, it will be important to consider how these changes can be embedded within a larger revenue package, one that offsets the regressive effects of increased sales and excise tax collections with other, progressive elements, such as an accompanying sales tax rate reduction and/or an increase in the state's Earned Income Tax Credit.4

Apart from their regressivity, sales and excise taxes nevertheless have a number of attractive attributes, principal among which is their stability; from year to year, the amount of revenue collected from these taxes is more consistent than collections from other important tax revenue sources (such as personal and corporate income taxes).5 This greater level of stability is very helpful for budget planners, allowing them to better project tax collection totals and to maintain smoother funding levels for public programs and services.

Year-to-year stability, however, has not translated automatically into stability over the long term. Instead, to the extent that sales and excise tax collections have remained consistent over time, this consistency often has been maintained by raising tax rates (and in some cases, broadening the tax base) in order to offset what otherwise would be a steady decline in collections.6 For the sales tax, two of the largest causes of the decline are 1) the shift in consumer spending patterns away from the purchase of tangible goods (most of which are taxed) and toward services (which generally are not subject to sales taxes), and 2) the rapid growth in online shopping, without corresponding action by Congress to allow states to require online retailers to collect and remit state sales taxes.

For excise taxes, the decline primarily results from a failure by states to regularly update these "per unit" taxes to account for inflation. Thus, for example, a twenty cent-per-gallon gasoline tax or dollar-per-pack cigarette tax that has remained unchanged since 1990 is worth far less to a state today than it was when enacted over two decades ago; a dollar simply does not purchase as much today as it did in 1990. 

In the discussions below, we examine several ways for states to reverse a portion of the sales tax revenue declines seen over the last decade and more. We also discuss one option for generating additional revenue through changes to state excise tax laws. While each of these options has the potential for bringing in tens of millions or even hundreds of millions of additional dollars annually, we again underscore the high potential for negatively and disproportionately affecting low and moderate income households. Sales and excise tax options must be considered especially carefully and most likely as part of a larger package of revenue options which together can reduce rather than increase the regressivity of a state's tax system.  The revenue enhancing options that we consider here are the following:

  • Expand sales tax base to include services
  • Collect sales tax from online sales
  • Apply an excise tax to soft drink sales

METHODS OF IMPLEMENTATION

Expand Sales Tax Base to Include Services

As alluded to in the overview above, absent the repeated rate increases that lawmakers have enacted over the last several decades in most states with a sales tax,7 sales tax collections over this period would have undergone a marked decline. This decline has been driven in large part by a steady shift in consumer spending patterns away from the purchase of goods and toward the purchase of services, many of which are not subject currently to state sales taxes. 

It is worth noting that much of this shift results from the growing share of consumer spending directed toward the purchase of health care services - and that most health care services are likely to remain exempt from state sales taxes. As such, only a portion of the decline in sales tax collections can be reversed by modernizing state sales tax laws to include taxation of the remaining, non-health care related services.

In most states, relatively few related services are subject to the state's sales tax. The Federation of Tax Administrators (FTA) identifies over 160 such taxable services, but a majority of states tax less than a third of these services. 8 As a result, these states forgo significant amounts of revenue annually. If all 45 states with a sales tax were to apply the tax comprehensively to household (i.e., not business) purchases of services (exclusive of housing, health care, and a few other services states are unlikely to tax), states would generate, collectively, more than $80 billion annually in revenue.9 While this figure includes revenues currently being collected on items already subject to state sales taxes, comprehensively taxing services used by households still would generate billions of additional dollars annually for states. Even small states would raise several hundred million in sales taxes each year, while the largest states would generate additional billions each year.10 

Again, assuming that progressivity is a primary consideration when looking to generate additional state tax revenue, then collecting additional income through the sales tax – whether through rate increases or a broadening of the base – raises significant and possibly insurmountable challenges. In order to avoid exacerbating the regressivity of current state tax systems, any expansion in the sales tax base needs to be offset by other measures that will reduce tax costs for low and moderate income households. These additional, progressive measures will reduce the net revenue gain the state will experience from taxing more services, but will limit the regressive impacts resulting from the expansion of the sales tax base.

Collect Sales Tax from Online Sales

While shifts in consumer spending patterns over the last half-century and more – from the purchase primarily of goods, to the growing focus on services – have steadily eroded state sales tax collections, a more recent change in consumer behavior has accelerated this decline: the rise of internet shopping.

It is estimated that, collectively, states lose more than $11 billion annually in sales tax revenues due to online shopping.11  Were states able to collect even a portion of the sales taxes they are owed , but which currently go uncollected by many online retailers, this would provide individual states with tens and even hundreds of millions of additional tax dollars annually. (For state-by-state revenue loss estimates see Table 5: http://cber.utk.edu/ecomm/ecom0409.pdf

While online shoppers legally are required to pay, directly to the state, any sales tax they may owe on their online purchases (if the retailer has not collected these sales taxes already, as some retailers do), in practice, few online shoppers do so.12 The only practical means by which states can collect this revenue is to require online sellers to collect the sales tax on behalf of the state at the time of sale.
The ultimate solution to this problem lies at the federal, rather than the state level. Unfortunately, Congress has not yet acted to provide states with the necessary authority to require online sellers to collect state sales taxes. Efforts are underway to encourage Congress to act on this matter.13 In the meantime, however, there are steps that states can take to limit the sales tax losses they experience due to online shopping.  

A number of states - including New York, Rhode Island, North Carolina and California - now require online vendors that use in-state "affiliates" to collect and remit state sales taxes. ("Affiliates" are small online retailers that are located within the state and who, for a fee, use their websites to promote the websites of large online vendors.) In an effort to avoid collecting sales taxes on the products they sell, some online vendors have challenged this approach in court. So far state courts, have handed down rulings favorable to the states.14

Another approach, one adopted in Colorado, offers larger online vendors the option of either collecting and remitting the state sales tax or providing both its online Colorado customers and the Colorado Department of Revenue an annual summary of the sales taxes owed to the state by the online shopper.15 As it is administratively easier for the online vendor - and likely better for their customer relations simply to collect the tax at time of sale - it is hoped that online vendors will adopt this alternative. Online vendors have challenged the law in Federal District Court. In response, the court has delayed implementation of the law until the judge issues a decision regarding the merits of the challenge.16

Finally, it is worth noting that extending sales tax collections to online purchases may reduce somewhat the regressivity of the sales tax.17 In general, a disproportionate amount of online shopping is done by higher- income households, allowing these shoppers to avoid sales tax on some of their purchases.18 New revenues generated by collecting the sales tax on online purchases, therefore would tend to come from these higher-income households.19 Additionally, collecting taxes on these purchases would help to level the playing field between online sellers and bricks-and-mortar shops. Main Street businesses are required to collect all applicable sales taxes from their customers, while many online retailers currently do not.20  

Apply an Excise (or Sales) Tax to Soft Drink Sales

Excise taxes are similar to sales taxes, differing primarily in that they are applied to individual products - such as gasoline, alcohol, and tobacco – rather than to a wide array of products, as is the case with general sales taxes. Additionally, excise taxes typically are levied on a per-unit basis (e.g., a gallon of gas, a quart of hard liquor, a pack of cigarettes) rather than as a percentage of the purchase price of a given product.21

Another notable feature of excise taxes is that they often are applied to products that are considered socially undesirable (such as alcohol and tobacco) in an attempt to limit consumption of these products and to pay for mitigation of the social harms created by use of the product being taxed. In most cases, while some portion of the revenue generated by the given excise tax is directed toward these mitigation efforts, a substantial portion of the revenue often remains available to pay for other state priorities.

In recent years, it has become increasingly clear that soda and other heavily-sweetened beverages are a class of products generating sizeable social harms with large, associated, private and public costs.  The research links overconsumption of soda and other heavily-sweetened beverages to rising rates of obesity and other types of disease, in both adults and children.22 The research likewise connects these rising rates of disease to large healthcare cost increases.23 As major purchasers of healthcare services, federal and state governments will bear a significant share of the burden associated with these cost increases.

In response to this growing recognition of the private and public harms and costs caused by the overconsumption of heavily-sweetened beverages, many groups have begun to call for federal and/or state policies that would tax these products.24 Studies suggest that, by taxing these products and thus reducing consumption, states would experience significant declines in diabetes and obesity-related health care costs, on the order of tens of millions to hundreds of millions annually per state.25 States also could generate annual revenue gains of a similar magnitude by adopting a penny-per-ounce tax on sugar-sweetened beverages (see state and city revenue calculator at the Yale Rudd Center for Food Policy & Obesity: http://www.yaleruddcenter.org/sodatax.aspx ). Or, for those states that currently exempt food items from their sales tax base, this exemption could be repealed with regards to soda and/or candy (which, arguably, falls into a category other than "food").

As with the sales tax options discussed above, we again note that excise taxes fall most heavily on low and moderate income households. When considering increases to excise taxes, it therefore is important to develop additional mechanisms that will help to offset the regressive impacts of such increases, including reductions in the general sales tax rate and increases to low-income tax credits like the Earned Income Tax Credit.

Related Reports

Institute on Taxation and Economic Policy, "The ITEP Guide to Fair State and Local Taxes", (see Chapter 3) March 2011: http://www.itep.org/state_reports/guide2011.php

Center on Budget and Policy Priorities, "Four Steps to Moving the Sales Tax to the 21st Century", July 2013: http://www.cbpp.org/cms/?fa=view&id=3987

Center on Budget and Policy Priorities, “Expanding Sales Taxation of Services: Options and Issues”, August 2009: http://www.cbpp.org/cms/index.cfm?fa=view&id=2888

Institute on Taxation and Economic Policy, "How Can States Collect Taxes Owed on Internet Sales?", July 2011: http://www.itep.org/pdf/pb2quill.pdf

National Conference of State Legislatures, "Collecting E-Commerce Taxes – An Interactive Map": http://www.ncsl.org/research/fiscal-policy/collecting-ecommerce-taxes-an-interactive-map.aspx

National Conference of State Legislatures, "Tapping Into Online Sales", March 2012: http://www.ncsl.org/issues-research/budget/tapping-into-online.aspx

Center on Budget and Policy Priorities, “New York's "Amazon Law": An Important Tool for Collecting Taxes on Internet Purchases”, July 2009: http://www.cbpp.org/cms/index.cfm?fa=view&id=2876

Center on Budget and Policy Priorities, “State and Local Governments Should Close Online Hotel Tax Loophole and Collect Taxes Owed”, April 2011: http://www.cbpp.org/cms/index.cfm?fa=view&id=3467

Center on Budget and Policy Priorities, “Taxing High-Sugar Soft Drinks Could Help Pay For Health Care Reform”, May 2009: http://www.cbpp.org/cms/index.cfm?fa=view&id=2830

Congressional Budget Office, "How Does Obesity in Adults Affect Spending on Health Care?", September 2010: http://www.cbo.gov/publication/21772

California Budget Project, “Should California Extend the Sales Tax to Services?”, October 2011: http://cbp.org/publications/pub_statetaxes.html

Washington State Budget and Policy Center, “Increasing and Modernizing the Sales Tax”, January 2010: http://budgetandpolicy.org/reports/increasing-and-modernizing-the-sales-tax

Colorado Fiscal Policy Institute, "The Facts Behind Colorado's New Internet Sales Tax Law", March 2010: http://www.cclponline.org/uploads/files/Colorado_Sales_Tax_Amazon_whitepaper_final3.pdf

Yale Rudd Center for Food Policy & Obesity, Sugar-Sweetened Beverages/Taxes Homepage: http://www.yaleruddcenter.org/what_we_do.aspx?id=271

Center on Budget and Policy Priorities, “Using Economic Census Data to Estimate the Revenue Impact of Taxing Services”, February 2012: http://www.cbpp.org/cms/index.cfm?fa=view&id=3683

 



1. Institute on Taxation and Economic Policy, "How Sales and Excise Taxes Work", August 2011:http://www.itep.org/pdf/pb49salesex.pdf

2. Institute on Taxation and Economic Policy, Who Pays?", 3rd Edition: http://www.itepnet.org/state_reports/whopaysfactsheets.php

3. Institute on Taxation and Economic Policy, "How Sales and Excise Taxes Work", August 2011: http://www.itep.org/policy_briefs/policy_briefs.php

4. Institute on Taxation and Economic Policy, "Should Sales Taxes Apply to Services?", July 2011: http://www.itep.org/pdf/pb3serv.pdf
Five states (AZ, HI, ID, NM, and OK) have enacted low-income tax credits specifically designed to offset certain sales and excise taxes for low-income households. See pg. 6 of ITEP's "State Tax Codes As Poverty Fighting Tools", September 2012: http://www.itep.org/pdf/poverty2012report.pdf 

5. For more discussion of this issue, see ITEP's "In It for The Long Haul", March 2011: http://www.itep.org/pdf/volatility_0311.pdf

6.  Center on Budget and Policy Priorities, “Expanding Sales Taxation of Services: Options and Issues”, August 2009 (See pages 10-13): http://www.cbpp.org/cms/index.cfm?fa=view&id=2888

7. Center on Budget and Policy Priorities, “Expanding Sales Taxation of Services: Options and Issues”, August 2009 (See page 12): http://www.cbpp.org/cms/index.cfm?fa=view&id=2888

8. Many of the 160 services identified by the FTA are business-to-business services. In general, most states try to avoid taxing business-to-business sales, or what is also called "tax pyramiding." Therefore, not all 160 FTA-identified services are ones that states are likely to adopt.
Center on Budget and Policy Priorities, “Expanding Sales Taxation of Services: Options and Issues”, August 2009: http://www.cbpp.org/cms/index.cfm?fa=view&id=2888

9. Center on Budget and Policy Priorities, “Expanding Sales Taxation of Services: Options and Issues”, August 2009: http://www.cbpp.org/cms/index.cfm?fa=view&id=2888
These estimates are based on state-by-state sales tax rates and sales tax revenues as of 2007. 

10. Center on Budget and Policy Priorities, “Expanding Sales Taxation of Services: Options and Issues”, August 2009: http://www.cbpp.org/cms/index.cfm?fa=view&id=2888
These estimates are based on state-by-state sales tax rates and sales tax revenues as of 2007. 

11. Donald Bruce, "State and Local Government Sales Tax Revenue Losses from Electronic Commerce," April 2009: http://cber.utk.edu/ecomm/ecom0409.pdf The same study estimates that annual US losses could reach $12.7 billion if more optimistic assumptions about sales growth are employed.

12. Technically, the tax residents are required to pay in this case is not the state sales tax, but the state “use tax.” Typically, the use tax is set at the same rate as the sales tax and applies to all purchases on which the sales tax otherwise would be owed, but on which the seller did not collect the sales tax.

13. Institute on Taxation and Economic Policy, "How Can States Collect Taxes Owed on Internet Sales?", July 2011: http://www.itep.org/pdf/pb2quill.pdf
National Conference of State Legislatures, "Tapping Into Online Sales", March 2012: http://www.ncsl.org/issues-research/budget/tapping-into-online.aspx (NOTE: The higher figures presented in this paper include remotes sales both from online sellers as well as companies selling through catalogues distributed by mail.)
National Conference of State Legislatures, "Collecting E-Commerce Taxes – An Interactive Map": http://www.ncsl.org/research/fiscal-policy/collecting-ecommerce-taxes-an-interactive-map.aspx (NOTE: The higher figures presented in this paper include remotes sales both from online sellers as well as companies selling through catalogues distributed by mail.)

14. Center on Budget and Policy Priorities, “New York's "Amazon Law":  An Important Tool for Collecting Taxes on Internet Purchases”, July 2009: http://www.cbpp.org/cms/index.cfm?fa=view&id=2876

15. Colorado Fiscal Policy Institute, "The Facts Behind Colorado's New Internet Sales Tax Law", March 2010: http://www.cclponline.org/uploads/files/Colorado_Sales_Tax_Amazon_whitepaper_final3.pdf

16. Colorado Department of Revenue, Official Website (accessed 11/21/2012): http://www.colorado.gov/cs/Satellite/Revenue/REVX/1251581935193

17. Center on Budget and Policy Priorities, “Expanding Sales Taxation of Services: Options and Issues”, August 2009: http://www.cbpp.org/cms/index.cfm?fa=view&id=2888

18. Ibid

19. Ibid

20. Ibid

21. Institute on Taxation and Economic Policy, "How Sales and Excise Taxes Work", August 2011: http://www.itep.org/policy_briefs/policy_briefs.php

22. New England Journal of Medicine, "The Public Health and Economic Benefits of Taxing Sugar-Sweetened Beverages", October 2009: http://www.nejm.org/doi/full/10.1056/NEJMhpr0905723

23. Congressional Budget Office, "How Does Obesity in Adults Affect Spending on Health Care?", September 2010: http://www.cbo.gov/publication/21772

24. Yale Rudd Center for Food Policy & Obesity, "Sugar-Sweetened Beverage Taxes", October 2012: http://www.yaleruddcenter.org/resources/upload/docs/what/reports/Rudd_Policy_Brief_Sugar_Sweetened_Beverage_Taxes.pdf

25. Yale Rudd Center for Food Policy & Obesity, "Sugar-Sweetened Beverage Taxes", October 2012: http://www.yaleruddcenter.org/resources/upload/docs/what/reports/Rudd_Policy_Brief_Sugar_Sweetened_Beverage_Taxes.pdf