What Is a Sales Tax?
A sales tax is a consumption tax imposed by the government on the sale of goods and services. A conventional sales tax is levied at the point of sale, collected by the retailer, and passed on to the government.
A business may be liable for sales taxes in a given jurisdiction if it has a presence there, which can be a brick-and-mortar location, an employee, or an affiliate, depending on the laws in that jurisdiction.
- A sales tax is a consumption tax on the sale of goods and services.
- A sales tax is usually charged as a percentage of the retail cost at the point of purchase.
- Local and municipal governments may charge their own sales tax, which is added to the state sales tax.
- Four U.S. states do not have any sales taxes, while a fifth—Alaska—has no statewide sales tax.
- Outside the United States, many countries impose a value-added tax rather than a sales tax.
Understanding Sales Tax
Conventional or retail sales taxes are only charged to the end user of a good or service. Because the majority of goods in modern economies pass through a number of stages of manufacturing, often handled by different entities, a significant amount of documentation is necessary to prove who is ultimately liable for sales tax.
Suppose a sheep farmer sells wool to a company that manufactures yarn. To avoid paying the sales tax, the yarn maker must obtain a resale certificate from the government saying that they are not the end user. The yarn maker then sells the product to a garment maker, who must also obtain a resale certificate. Finally, the garment maker sells fuzzy socks to a retail store, which will charge the customer sales tax as part of the price.
Different jurisdictions charge different sales taxes, and states, counties, and municipalities may levy their own sales taxes. Sales taxes are closely related to use taxes, which apply to items from outside their jurisdiction.
These are generally set at the same rate as sales taxes but are difficult to enforce, except when applied to large purchases of tangible goods. An example would be a Georgia resident who purchases a car in Florida; they would be required to pay the local sales tax as though they had bought it at home.
A nexus is generally defined as a physical presence, but this "presence" is not limited to having an office or a warehouse. Whether a business owes sales taxes to a particular government depends on the way that government defines a nexus.
Having an employee in a state can constitute a nexus, as can having an affiliate, such as a partner website that directs traffic to your business' page in exchange for a share of profits. This scenario is an example of the tensions between ecommerce and sales taxes. For example, New York has passed "Amazon laws" requiring internet retailers such as Amazon.com Inc. (AMZN) to pay sales taxes despite their lack of physical presence in the state.
There are four U.S. states with no sales taxes: Delaware, New Hampshire, Montana, and Oregon. Alaska also has no statewide sales tax but allows city and county governments to charge a local sales tax.
In general, sales taxes take a percentage of the price of goods sold. A state might have a 4% sales tax, a county 2%, and a city 1.5%, so that residents of that city pay 7.5% in total.
Certain items are often exempt, such as food. Others are exempt below a certain threshold, such as clothing purchases of less than $200.
Conversely, some products carry special taxes, known as excise taxes. "Sin taxes" are a form of excise tax, such as the local excise tax of $1.50 New York City charges per pack of 20 cigarettes on top of the State excise tax of $4.35 per pack of 20 cigarettes.
Sales Tax vs. VAT
A Sales Tax is different from a Value-Added Tax in that the sales tax is only collected once. A VAT is collected throughout the production process.
The U.S. is one of the few developed countries where conventional sales taxes are still used. Outside of the U.S., many countries have adopted value-added tax (VAT) schemes. These charge a percentage of the value added at every level of production of a good.
In the example above, the yarn maker would pay a percentage of the difference between what they charge for yarn and what they pay for wool. Similarly, the garment maker would pay the same percentage on the difference between what they charge for socks and what they pay for yarn. This is a tax on each company's gross margins, rather than on the end user.
The main objective of the VAT is to eliminate tax on tax (i.e., double taxation) which cascades from the manufacturing level to the consumption level.
The U.S. system with no VAT implies that tax is paid on the value of goods and margin at every stage of the production process. This would translate to a higher amount of total taxes paid, which is carried down to the end consumer in the form of higher costs for goods and services.
What Is the Sales Tax in California?
California has a statewide sales tax of 7.25%. In addition, some municipalities may impose local sales taxes.
What States Have the Lowest Sales Tax?
The states with the lowest average sales taxes are Hawai'i (4.44%), Wyoming (5.36%), and Alaska (1.76%). In addition, four states (Delaware, New Hampshire, Oregon, and Montana) do not allow any sales tax to be charged at all.
What States Have the Highest Sales Tax?
Louisiana has the highest sales tax, with a statewide average tax of 9.55% according to the AARP. This includes both state and (average) local taxes. Tennessee, Arkansas, and Washington also have high average sales taxes of above 9%.
The Bottom Line
A sales tax is a percentage-based tax on finished products at the point of sale. Sales taxes are common in the United States, where each level of government may charge an additional percentage of gross sales. They are less common outside the U.S., where many countries use a value-added tax instead.