Retail Sales Taxes

Most states and localities generate a significant portion of their revenue from the taxation of retail sales. However, Alaska, Delaware, Montana, New Hampshire, and Oregon have no state sales tax. Sales taxes are attractive because they are relatively easy to administer. In addition, they provide a stable revenue source, typically fluctuating less than an income tax.

However, sales taxes are also problematic. They are regressive, meaning that people with lower incomes pay a higher percentage of their income for the tax than do those with higher incomes. There are ways states can address the regressivity of the sales tax. 

First, they can lower or eliminate the sales tax on certain necessities that make up a larger share of consumption for households with lower incomes, such as groceries. This approach, though, has some disadvantages. It is not well targeted and can create administrative challenges for businesses and tax administrators.

Second, states can provide a refundable credit to qualified individuals to help offset sales taxes. While better targeted than exemptions, this approach can create administrative challenges for taxpayers, as they will need to fill out a form or file an income tax return to receive the credit.

Third, they can tax services or expand the services that are taxed. People with higher incomes are more likely than people with lower incomes to pay for services. Thus, taxing services broadens the tax base and reduces the regressivity of the sales tax. Most states impose sales taxes on some services. However, each state taxes a different set of services.

For years, e-commerce negatively affected state and local sales tax revenue. Many out-of-state retailers failed to collect, and their customers failed to pay, retail sales taxes for online or mail-order sales. A 2018 U.S. Supreme Court decision (South Dakota v. Wayfair) reversed this trend by allowing states to collect sales tax from online sales even if the seller lacked a physical presence in the state. In the years since, state sales tax revenue from online sales has increased considerably. However, in most states, the tax only applies to remote sellers that meet certain transaction or sales thresholds.

Another type of sales tax is the gross receipts tax. As of 2024, only seven states had a state-level gross receipt tax. A gross receipts tax is levied on the seller rather than the consumer. It applies to all business sales, regardless of whether the item is sold for consumption or intermediate use. The tax does not allow deductions for the cost of producing the item, previous taxes on the item, or other costs. As a result, the base is simple to measure, and the tax is easy to administer. However, multiple layers of tax are levied as a product goes through production and distribution. This is known as pyramiding. The extent of the pyramiding depends on how many times intermediate components are sold before being incorporated in the final product and the extent to which the tax is passed on to the buyer at each stage. Consequently, the tax is not transparent to the consumer. It also is likely to distort the behavior of consumers and businesses.