The Prospects for General Sales Taxation in American State and Local Government Finance: Challenges for a Fiscal Workhorse Unready for the New Millennium
Mikesell, John L., Journal of Public Budgeting, Accounting & Financial Management
ABSTRACT. The retail sales tax has provided a strong foundation for American state government finance since its beginnings in the Great Depression. However, its position as a productive, reliable, and administrable revenue source is now under challenge from three forces. First, it continues as a tax primarily on purchases of tangible personal property, despite the shift in consumption toward services. Second, the physical presence rule for taxation of sales by remote vendors creates an intolerable imbalance between local and remote sellers. And third, legislatures keep gnawing away at the base with politically attractive but fiscally unjustifiable exemptions. In total, the position of the sales tax as a viable and defensible revenue alternative is at risk.
The general sales tax served as the foundation for fiscal autonomy of American state and local governments for more than half the twentieth century. From its beginnings as a means of desperation finance for state governments in the Great Depression, it became the largest single source of state tax revenue by 1947, a rank it retained for fifty years by consistently contributing about one-third of tax revenue to state budgets. It provided a strong foundation for enhanced state government in the post WWII era and still continues as a strong second to personal income taxes in aggregate state finances (Mikesell, 2000). While five states (Alaska, Delaware, Montana, New Hampshire, and Oregon) levy no state sales tax, across the nation the sales tax consistently has yielded about one-third of state tax revenue. At the local level, it yields considerably more revenue than any other non-property tax, although the tax on real property is the unchallenged local revenue leader. Of course, the sales tax is an extremely important revenue source for local government in some urban areas, notably New York City, Washington, and Chicago. Replacing any considerable share of the revenue from such an important fiscal contributor would be no simple task.
Table 1 offers an overview of the role of the retail sales tax in state government finances and of the structural variations in these taxes across the states. Among the forty-five states levying the tax, states collect from 18.8 percent of their total tax revenue from the tax (New York) to 60.8 percent (Texas). Eleven raise more than 40 percent of their total tax collections from the tax; the median is 33.6 percent. It is a source of considerable fiscal significance to most of the states. To raise this revenue, states levy statutory rates ranging from 2.9 percent (Colorado) to 7 percent (Mississippi and Rhode Island). Sixteen states apply rates of 6 percent or higher, but 5 percent is the median.
The structure of the taxes is not the same across the states. When the implicit sales tax base is measured against the size of the state economy for each state, the differences are striking.1 Table 1 shows base breadth, measured by implicit sales tax base as percent of state personal income, to range from 115.4 percent in Hawaii to 26.5 percent in Illinois; the median is 46.6 percent. That comparison means that the same statutory rate will yield dramatically different amounts of revenue from the economy according to the legislative structure of the tax base; those states with few exemptions from the sales tax will raise considerably more revenue from a given tax rate than will those with narrower base structures. The structures and resulting bases differ considerably among the states, but - regardless of how structured - the tax yields revenue that would be difficult to replace.
The status of the sales tax as a reliable, administrable, and equitable revenue producer for state and local governments is being challenged by technology, economic change, and political forces. There are three primary challenges.2 First, the sales taxes continue their traditional structuring as taxes limited to the purchase (or sale) of tangible personal property. …