Sales Tax: From SALT to Federal Sales Taxes, Use Taxes and the VAT

Though sales tax is a well-established concept in 45 US states, it turns out that the idea in the US is not yet even 100 years old. Some sources claim that the concept began in West Virginia in 1921, while others point to Kentucky in 1930.1,2 By 1933, at least 11 states had adopted a sales tax of some form, and to date in 2017, only five states haven’t adopted sales tax yet: Oregon, Alaska, Delaware, Montana, and New Hampshire.3 Thirty-eight states (including Alaska) are allowed to levy separate sales taxes for particular goods as well, such as tobacco, alcohol, and gasoline.

Sales tax yields are essential to keep government functioning at a state level, much more so than at the federal level. According to The Tax Policy Center:

  • States collected $412 billion, or 35 percent of own-source general revenue, from sales taxes in 2014
  • Nearly two-thirds of that ($272 billion) came from general sales tax
  • One-third ($140 billion) came from selective excise taxes on tobacco, alcohol, etc.
  • Local governments collected $105 billion from sales taxes in 2014, with $75 billion coming from general sales taxes and $30 billion coming from selective excise taxes.4

The sale of goods through the internet has complicated the sales tax debate, as goods sold interstate via the web are beholden to different laws and regulations. Some states have enacted legislation that demands online sellers collect sales tax from states even if they have no physical presence in said state. The federal government has proposed legislation before, such as the Marketplace Fairness Act of 2013, that would affect online retailers, but currently there are no federal laws governing online sales tax.5

Internet Sales and Use Taxes

When online retailers sell outside of their state of residence, they are not required by federal law to pay sales tax, but instead are encouraged to charge and pay what is called “use tax”. Use tax is defined by Investopedia.com as, “A sales tax on purchases made outside one’s state of residence on taxable items that will be used, stored or consumed in one’s state of residence and on which no tax was collected in the state of purchase.”6

This is much like a border adjustment tax (BAT), also known as a destination-based cash flow tax, or DBCFT, which deals with international imports and exports.7 This is a value-added tax that says exported goods are exempt from taxation, while imported goods for use in the US are taxed.

In regards to use taxes, it falls onto the consumer to calculate and pay both state and local sales taxes. This means if the state-of-residence would have taxed the purchase where the product will be used and stored, but the online retailer’s state doesn’t tax the purchase, it’s still on the buyer to pay taxes. Residents who don’t may be subject to interest and penalties, so retailers should calculate these costs into interstate sales or display a disclaimer on their website to help keep their customers from running afoul of tax law. Nolo offers a helpful 50-state guide to internet sales tax for online retailers wondering about internet sales taxes for the state and local levels.8

Value Added Tax and Sales Tax Alternatives

When we compare state and local taxation (SALT) to federal tax laws, things can begin to get complicated. It’s been proposed that, by repealing the 16th amendment and, in effect, income tax, we could instead charge citizens a flat 10 to 25 percent tax on all retail purchases. In other countries, a national tax like this is called a “value-added” or VAT.9

The benefits of a VAT would be simplification of tax reporting and collection, making differing state internet retail laws obsolete. A VAT of five percent could also sufficiently support corporate income tax cuts from 35 percent to 15 percent and still raise GDP by 5.5 percent and $3.1 trillion in federal revenue, according to the Tax Foundation.10 Assuming no changes to the economy, their model actually estimates that a 1.46 percent VAT would provide “enough revenue, on a dynamic basis, to replace the corporate income tax in full, increasing long-term GDP by 6.5 percent and not losing any federal revenue in the long run.”

States that have abandoned state income taxes in favor of sales taxes appear to be meeting their revenue-generating needs, indicating that replacing sales taxes with income taxes in other states should work. However, as income tax made up roughly 41 percent of total state collections in 2014, while 30 percent were derived from sales and use taxes, states would likely have to increase sales tax rates as well as number of taxed items to make up that 41 percent income tax deficit.11

Tax Reform and the Road Ahead

For as long as taxes have been around, people have been debating and adjusting them. Changing societal and political landscapes raise continuing questions about how effective, fair, and even confusing the current system is. Those in favor of national and flat taxes like proposed VATs argue for simplicity in an increasingly complex world where sales can be made from anywhere at practically any time. Those against flat taxes generally argue that they put an unnecessary burden on low-income earners and the impoverished, who don’t have to worry about income tax as much as they do about SALT.

Another complication with both state and local taxation is the growing popularity of blockchain-based cryptocurrencies (i.e. Bitcoin, Ethereum, etc.). While not widely accepted as methods of payment, they are gaining in popularity as well as market cap.

In terms of tax reform, as the Government Accountability Office states, “ultimately, the nation will have to decide what it wants from the federal government, that is, what level of spending do we want on programs, tax preferences, and other government services and how we will pay for that spending.”12

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Students enrolled in Villanova University’s Graduate Tax Program who are pursuing a Master of Taxation (MT) degree, or a Master of Laws (LLM) in Taxation degree engage in discussions on these topics, including the future of sales and uses taxes, as well as tax reform. The desired outcome is to develop and drive thoughtful, rational and equitable approaches to tax reform, and ultimately change. It’s the only thing that’s constant, after all.

Sources:

1http://www.investopedia.com/articles/tax/10/history-taxes.asp

2http://money.howstuffworks.com/personal-finance/personal-income-taxes/state-sales-taxes2.htm

3https://en.wikipedia.org/wiki/Sales_taxes_in_the_United_States

4http://www.taxpolicycenter.org/briefing-book/how-do-state-and-local-sales-taxes-work

5https://en.wikipedia.org/wiki/Marketplace_Fairness_Act

6http://www.investopedia.com/terms/u/use-tax.asp

7http://www.investopedia.com/terms/b/border-adjustment-tax.asp

8https://www.nolo.com/legal-encyclopedia/50-state-guide-internet-sales-tax-laws.html

9http://money.howstuffworks.com/personal-finance/personal-income-taxes/income-tax6.htm

10https://taxfoundation.org/value-added-tax-revenue-neutral-alternative-corporate-income-tax-0/

11https://www2.deloitte.com/content/dam/Deloitte/us/Documents/Tax/us-tax-current-trends-in-state-taxation-consumption-tax-versus-income-tax-010915.pdf

12http://www.gao.gov/assets/210/202725.pdf

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