In contemplating the viability of implementing a national retail sales tax, an examination of the experiences with state and local sales taxes offers valuable insights. While these taxes constitute a significant revenue source for most states and localities, their complexity and divergent practices suggest that establishing and managing a comprehensive national tax would present considerable challenges.
Originating as a measure of fiscal necessity during the Great Depression, the first sales tax in the United States was introduced in Mississippi in the 1930s. Since then, sales taxes have become prevalent across states and localities, with only a handful of exceptions. Presently, 45 states, along with the District of Columbia and numerous local jurisdictions, impose sales taxes. Notably, Alaska, Delaware, Montana, New Hampshire, and Oregon abstain from state-level sales taxes, although Alaska permits localities within the state to implement them. The range of state-level sales tax rates is vast, spanning from 2.9 percent in Colorado to 7.25 percent in California, excluding local rates. Additionally, the scope of goods and services subject to taxation varies significantly.
The experiences of individual states underscore the complexity and potential pitfalls of instituting a broad-based, high-rate federal retail sales tax. State practices often diverge from ideal standards, making the administration of a national tax challenging. A key concern lies in the differentiation between purchases made by producers and those made by consumers. A functional retail sales tax should exempt all business purchases; however, this objective is often not met by most state-level sales taxes. On average, estimates suggest that between 20 and 40 percent of state sales tax revenue is generated from business-to-business transactions. In certain states, this proportion can even rise to as high as 70 percent. The absence of a consistent exemption for producer purchases at the national level would result in cascading taxes and market distortions, posing a significant issue.
While a national retail sales tax would encompass the consumption of all goods and services, state sales taxes deviate from this model in various ways. While general sales taxes typically apply to most tangible goods, exceptions exist. For instance, 13 states solely tax food purchased for in-home consumption, and six of these states do so at a reduced rate compared to their general sales tax. Among these states, five offer income tax credits to alleviate the burden on low-income residents. Moreover, the taxation of services poses a formidable challenge for states as they navigate social, economic, and administrative complexities. While some states tax specific services, only Hawaii and New Mexico include almost all services in their tax bases. The enforcement of service-based sales taxes is particularly challenging due to difficulties in auditing their paper trail, leading to broad exemptions in many states.
A noteworthy consideration is the potential impact of product exemptions intended to enhance tax progressivity. While cash rebates for lower-income families offer a more straightforward administrative approach and minimize household behavior distortions, certain states favor exemptions for specific products perceived as "worthy. This practice, while appearing progressive, can cater to producer interests seeking exemptions, potentially complicating the administration of a national tax.
In contemplating the replacement of the federal income tax with a national retail sales tax, a broader tax base would be imperative to ensure viability. A narrower base, similar to the typical state-level approach, could necessitate an exorbitant tax rate to generate sufficient revenue. As such, the complexities and nuances encountered at the state and local levels underscore the intricate nature of instituting a national retail sales tax.