Broad Base, Low Rates: Every US State Fails on Good Sales Tax Principles

In a previous post, I contrasted the income and property taxes, but I left out the other important tax: the retail sales tax. So let’s rectify that omission.

The retail sales tax is like the “Little Engine that Could,” delivering a steady stream of revenue to governments, while mostly staying out of the passionate debates surrounding the income and sales taxes. About 23% of state and local tax revenue comes from general sales taxes in the US, roughly equal to income taxes, and if you include selective sales taxes it’s slightly larger than the property tax share.

But there’s a problem with sales tax. The sales tax “base,” basically the extent of economic activity that the base covers, has been shrinking. A lot. As Jared Walczak has recently written, in just the past 20 years the “breadth” of the sales tax (how much of the potential base it covers) has fallen from about 50% to 30%.

As Walczak also notes, there are seven or so broadly agreed on principles of sales taxes, but I would say there are two primary ones (the first two on his list):

  1. An ideal sales tax is imposed on all final consumption, both goods and services.
  2. An ideal sales tax exempts all intermediate transactions (business inputs) to avoid tax pyramiding.

But US states violate these two principles in various ways, leading to (oddly enough) a tax base that is simultaneously too narrow and too wide. Why is this?

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