Sales tax

• 1. Introduction

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  Sales tax is one of the oldest levies in human history, and its story begins not in a legislature but on the painted walls of Egyptian tombs, dated as far back as 2000 BC. Those images record the collection of tax on specific commodities, including cooking oil. A practice that ancient is still shaping what you pay at the register today. How did a device used to fund pharaohs become the subject of Supreme Court battles, internet-age legal tangles, and a global shift that has left the United States as one of the last countries still clinging to the traditional model? And why does a shopper in Chicago pay a combined rate of 10.25 percent while a shopper in Oregon pays nothing at all? The answers stretch from ancient Greece to the 1992 Supreme Court decision in Quill Corp. v. North Dakota, and from the Roman emperor Augustus to the birth of e-commerce. The full picture is stranger, and more consequential, than the bland phrase on your receipt suggests.

• 2. Ancient Roots

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  In 415 BC, at an auction in Piraeus, Greece, the sale of 16 slaves was recorded in careful detail. Among the columns in that ledger was a separate entry for sales tax, measured in drachmas at a rate of one percent. That document is one of the earliest surviving records of a recognizable sales tax. Nearby Athens, meanwhile, collected duties on imported and exported commodities at a two percent rate recorded in 399 BC. Athens did not use government agencies to do the collecting. Instead, the right to collect taxes was sold to the highest bidder, a practice known as tax farming.

  Rome formalized the idea further. The emperor Augustus, needing funds for his military treasury, the aerarium, introduced a one percent general sales tax in AD 6. He gave it a Latin name: the centesima rerum venalium, meaning the hundredth of the value of everything sold. His successors were less committed. Tiberius reduced the rate to half a percent, and Caligula abolished it entirely. That cycle of imposition, reduction, and repeal would repeat itself across civilizations for the next two thousand years.

• 3. The American Story

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  The United States government has never imposed a general federal sales tax, but it has taxed specific goods since almost the beginning of the republic. An excise tax on whiskey, enacted in 1791, was among the new government's first revenue measures. Farmers on the western frontier despised it. Their anger boiled over in 1794 in the Whiskey Rebellion. Throughout the 19th century, federal and state taxes remained selective rather than broad-based. During the Civil War, excise taxes were applied to so many individual commodities that they collectively functioned as a de facto general sales tax.

  The first genuinely broad general sales taxes in the United States appeared in 1930, when Kentucky and Mississippi both enacted them. Kentucky repealed its tax six years later, in 1936, before re-enacting it in 1960. Twenty-two additional states followed in the rest of the 1930s, six more in the 1940s, and five more in the 1950s. The last holdout among adopting states was Vermont, which enacted its sales tax law in 1969. Today, five states still have no general sales tax: Alaska, Delaware, Montana, New Hampshire, and Oregon.

  The federal government's most familiar selective taxes are the per-gallon tax on gasoline, which began at one cent per gallon in 1932, and the per-package tax on cigarettes, set at $1.01 per package since 2009. A newer addition came with the 2010 health care reform law, which imposed a 10 percent federal sales tax on indoor tanning services, effective the 1st of July 2010. Unlike earlier federal excise taxes, this one is collected directly from the consumer by the seller and calculated on the sale price rather than a measured quantity.

• 4. How the System Works

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  Conventional or retail sales tax applies only to the final sale of a good to its end-user. Businesses that buy goods specifically to resell them are not taxed on that purchase. To prove their intent, those purchasers obtain a resale certificate from the taxing authority and present it at the point of sale. Without such a certificate, a seller is required to charge tax on every transaction within the jurisdiction.

  Across the United States, 45 states impose a statewide sales tax, and 38 of those also allow local governments to add their own layer. That stacking of rates can push the total significantly higher than the state rate alone. Chicago illustrates the extreme: the combined sales tax rate there is 10.25 percent, made up of 6.25 percent from the state of Illinois, 1.25 percent from the city, 1.75 percent from Cook County, and 1 percent from the regional transportation authority. Diners in Chicago pay even more: the Metropolitan Pier and Exposition Authority adds 1 percent to food and beverage, bringing the dining-out tax to 11.25 percent. Baton Rouge, Louisiana comes in at 9.45 percent total, and Los Angeles at 9.5 percent.

  California's approach illustrates an important legal nuance. Under California law, the sales tax is technically imposed on the retailer for the privilege of selling tangible personal property at retail. The consumer who pays it at the register is, in legal terms, reimbursing the retailer under a contractual agreement, not paying the tax directly.

• 5. VAT and the Global Shift

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  Over 140 countries have now adopted value-added tax systems, and those systems account for approximately 20 percent of worldwide tax revenue. The spread of VAT has come largely at the expense of conventional sales taxes, which are increasingly being phased out or replaced. The United States is now one of the few nations still running a conventional sales tax model.

  The key mechanical difference between the two systems is where the tax falls. Under a gross receipts tax, every transaction in a supply chain is taxed, meaning the same underlying value can be taxed more than once. Critics call this the cascading or pyramiding effect. VAT avoids that problem by taxing only the value added at each stage of production and sale, subtracting what was already paid at the previous stage.

  Among countries that use VAT, the rates vary widely. Norway, Denmark, and Sweden each charge 25 percent. Hungary leads the world at 27 percent, though reduced rates apply to categories such as groceries, art, books, and newspapers. Canada uses a federal Goods and Services Tax at a rate of 5 percent, effective since the 1st of January 2008. Alberta, Yukon, the Northwest Territories, and Nunavut collect only that federal GST, while other Canadian provinces layer on a Provincial Sales Tax or use a blended Harmonized Sales Tax.

• 6. The E-Commerce Battleground

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  The Supreme Court defined the central legal problem for online sales in 1967 in National Bellas Hess v. Illinois. The court ruled that a vendor without a physical location, or nexus, within a state could not be required to collect that state's tax. The principle was confirmed again in 1992 in Quill Corp. v. North Dakota, when the court overturned an attempt to force a Delaware e-commerce vendor to collect North Dakota tax. That 1992 ruling also established that only the U.S. Congress has the authority to enact interstate taxes. Observers and commentators argued for a Congressional reversal, but without success.

  The financial stakes of non-collection grew as online commerce expanded. The Congressional Budget Office estimated that uncollected use taxes on remote sales in 2003 could be as high as $20.4 billion. By 2011, that projected figure had risen to $54.8 billion. Economists who studied the sensitivity of online shoppers to sales tax found differing results: some research estimated elasticity of online purchase probability at around 2.3, while other studies produced smaller figures of around 0.5. The lower estimate suggests that enforcing an online sales tax would have negligible effects on overall sales volume.

  The Internet Tax Freedom Act of 1998 created a commission to study the question of internet taxation. The commission issued no formal recommendations. In 2003, the Congressional Budget Office warned that a multiplicity of tax systems placed a particular burden on smaller firms. To address that problem, 44 state governments and the District of Columbia cooperated in the Streamlined Sales Tax Project, which began in March 2000. Their work eventually produced the Streamlined Sales and Use Tax Agreement in 2010, establishing common standards for simplified and uniform sales tax laws. As of December 2010-24 states had passed conforming legislation. Whether that agreement can actually reach remote sellers still depends on Congress acting under the authority established in the Quill decision.

• 7. Fairness, Growth, and Local Impact

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  Economists at the Organisation for Economic Co-operation and Development studied how different types of taxes affect economic growth in OECD member nations. Their finding placed sales taxes among the least harmful taxes for growth. That is one argument in their favor. The argument against them centers on who bears the burden.

  Because sales tax rates do not adjust based on a person's income or wealth, economists generally classify them as regressive. Investopedia defines a regressive tax as one that takes a larger percentage from low-income people than from high-income people, applied uniformly. One mitigation strategy is to exempt categories of goods that lower-income households spend proportionally more on, such as food, clothing, and medicines. Excluding rent from the taxable base is another approach.

  At the local level, the effects of higher sales taxes are visible in consumer behavior. A study conducted in Minnesota and Wisconsin, after sales tax was raised on cigarettes, found that the effects on sales did not appear immediately. Changes showed up roughly six months after the tax increase took effect. Research from Georgia found that cities could use higher sales taxes to relieve property tax burdens, but only when property tax rates were actually lowered afterward. The underlying dynamic is straightforward: if local sales taxes climb high enough, consumers simply travel to neighboring areas to make their purchases, and the taxing jurisdiction loses the revenue it was trying to capture.