What is a Sales Tax?

A sales tax is like paying a toll at a toll booth…

Except instead of paying to use the road, you pay a fee to make a purchase. Often, road tolls are based on how far you drive. Sales taxes work similarly, as you purchase more goods, you pay higher fees.

When you purchase many goods and some services, you have to pay a tax to the government.

Taxes, in general, are involuntary fees levied by the government on various activities, such as sales, labor, and profits. Many national and local authorities charge an income tax, for example, meaning the government takes a portion of your paycheck.

With a general sales tax, the government places a surcharge on the goods or services you purchase.

Often, this fee is based on the value of products or services bought. For example, if you buy a $10 item and must pay a six percent sales tax, you’ll pay $10.60 in total. Buy a $100 item, and you’ll pay $106 total.

A general sales tax is a tax that is charged on most goods. Some goods, such as groceries, are generally excluded from general sales taxes. An excise tax is a sales tax charged on a specific item, such as tobacco.

In the United States, the federal government doesn’t charge a general sales tax. However, many state and local governments charge general sales taxes. Rates can vary from jurisdiction to jurisdiction.

While the federal government doesn’t charge a general sales tax, many state and local authorities do. State and local sales taxes typically average between 5% to 8%.

Some states, including Alaska, Delaware, Oregon, New Hampshire, and Montana, charge no sales tax. Other states, including Alabama, Arkansas, and Washington, have average sales taxes in excess of 9%.

Across the United States, some 11,000 local governments charge a sales tax. Often, these local sales taxes are tacked onto state sales taxes.

In Illinois, the statewide sales tax is 6.25%. Pick up goods in Chicago, however, and you’ll pay 10.25%. The city of Chicago tacks on an additional 1.25%, while Cook County adds another 1.75% and the Regional Transport Authority (RTA) adds another 1%.

Usually, sales taxes are collected at the point of purchase. A good might go from a manufacturer to a distributor, and finally to a brick and mortar retailer. However, only the retailer will collect a sales tax. The customer buying the products will pay for it. The retailer will pass the tax revenues on to the government.

Sales taxes are an essential source of revenue for many local and state governments. In 2016, state governments collected a total of $441 billion in sales taxes. This accounted for roughly 35%of own-source general state revenues.

Approximately two-thirds of that revenue comes from general sales taxes. Excise taxes on tobacco, alcohol, and other specific products account for about $150 billion in taxes.

Some local governments, such as city governments, also charge sales and excise taxes.

Roughly 11% of own-source local revenues came from sales taxes, totaling $85 billion. Selective sales taxes totaled $32 billion, or 3% of own-source revenues. In other words, many local and state governments depend on sales taxes for revenues. Without sales taxes, governments might have to cut vital public services.

Sales taxes are considered regressive taxes. This means poorer people usually spend a higher proportion of their income on sales taxes than wealthy people. With progressive taxation, on the other hand, wealthy individuals typically spend a more substantial portion of their income than the less fortunate.

Let’s illustrate why sales taxes are regressive. Say John makes $50,000 a year and buys a $1,000 television, which is subject to a 10% sales tax. He’ll pay $100 in sales taxes, which is equal to 0.2% of his annual income ($100 / $50,000 x 100).

Jane, on the other hand, earns $500,000 per year. Being wealthier, she can afford a more expensive television. She spends $3,000 on a television and $300 on sales tax. While Jane pays more in sales taxes, it amounts to just 0.06% of her income ($300 / $500,000 x 100).

Many governments try to mitigate the regressive nature of sales taxes by not taxing some essential goods.

For instance, quite a few states exclude groceries because authorities don’t want to make buying food more of a burden. Michigan, Texas, and California, among others, exclude groceries.

Alabama, South Dakota, and Mississippi, however, charge the full sales tax on groceries. Some states, like Idaho, tax groceries but give families tax rebates. Besides groceries, medicine, medical devices, and clothing are often exempt from sales taxes. Exempted and taxed items vary from jurisdiction to jurisdiction. In some cases, states may exclude groceries, but local authorities may still levy a tax.

Groceries are frequently excluded because people need to buy food to survive. Medicine and other excluded items are seen as essential as well.

Many states still tax food purchased at restaurants, however. Some states also tax hot food from grocery stores. Eating at a restaurant or buying hot food is seen by some as a “luxury.” People could buy groceries and prepare food themselves, usually at a lower price.

Electronics, books, automobile parts, and various other products are regularly subject to sales taxes. Arguably, many of these items are still essential — if not quite as basic as groceries.

Sales taxes and Value Added Taxes (VAT) taxes are similar, in that both tax the cost of a good or service — But there are important differences.

First off, whereas sales taxes are ubiquitous in the United States, VATs are common in Europe and elsewhere.

With a sales tax, only the seller at the last point — where the product is sold to the end consumer — collects the general sales tax. In practice, this usually means a retailer charges a consumer the sales tax.

With a Value Added Tax, the tax is charged by sellers at every step of the supply chain. Let’s say a manufacturer sells a gizmo to a distributor. The manufacturer will collect the VAT and give it to the government. Next, the distributor sells to a retailer, which then sells the gizmo to a consumer. Both the distributor and retailer will collect the VAT and give it to the government. However, at each step of the way, the seller only pays the VAT on the value they add.

The easiest way to explain this is with an example.

Let’s say fictional company Acme Gizmos operates in a jurisdiction with a 10% VAT and buys the raw inputs to make a gizmo for $10. With the VAT, Acme Gizmos will pay $11 for the raw materials. Next, Acme Gizmos sells its gizmos to a retailer for $20.

With the VAT added in, the retailer pays $22 ($20, plus 10% of $20).

Now here’s where it gets a bit complex. Acme Gizmos would receive $2 in value-added taxes, but it can subtract the previous VAT paid. This means the company would only send $1 in additional taxes to the government.

When the retailer charges the consumer its value-added tax, it too will be able to subtract the VAT previously paid. In this way, the VAT still falls onto the shoulders of the end consumer in the supply chain.

An excise tax is a tax placed on specific products or services. Often, excise taxes are included in the retail price. Merchants usually pay excise taxes to the wholesaler and then mark up the products when they sell them to consumers.

In the United States, the federal government places an excise tax of 18.4 cents on every gallon of gasoline sold. Ultimately, consumers end up paying an extra 18.4 cents per gallon of gas.

Retailers pass the revenues to the federal government, which then uses the money to maintain roads and infrastructure. The more you drive, the more you’ll wear down the roads, and the more you’ll pay in fuel taxes.

Governments often charge a “sin tax,” which is an excise tax on a product that is harmful to society. In 2018, the federal government imposed $1.01 in excise taxes per pack of cigarettes. Many state governments — and some city governments — also charge a sin tax on cigarettes.

Besides raising revenues through sin taxes, the government also wants to discourage the consumption of harmful products. According to market economics, as prices rise, consumption generally falls.

Excise taxes are considered a type of sales tax. Excise taxes differ from general sales taxes because they apply only to specific products. Further, excise taxes are often included in the price of the product rather than being tacked on as a fee at checkout.

The Tax Cuts and Jobs Act changed the deduction for sales and property taxes, and local and state income taxes. Under current tax rules, you can deduct either local and state income taxes or what you spent on sales taxes from your federal income tax return.

You must choose whether to deduct state and local income taxes or sales taxes. No matter your choice, you can also include property taxes in the deduction. State and local taxes are often called SALT, and this deduction is referred to as the SALT deduction.

The SALT deduction will lower your federal income tax bill, helping you save money. However, you can deduct a maximum of $10,000.

To deduct sales taxes, you need to keep your sales receipts. When it’s time to file, you’ll add up the total amount you paid in sales taxes and then deduct that amount from your federal taxes, up to a maximum of $10,000.

For most taxpayers, deducing your local and state income taxes is both easier and saves more money. However, if a taxpayer lives in a state that doesn’t charge an income tax, deducting sales taxes may help them to save money.