What is Sales Tax?

A sales tax is a consumption tax paid to a government on the sale of certain goods and services. Usually, the vendor collects the sales tax from the consumer as the purchase is made. In most countries, this is called VAT or GST, which is a different form of consumption tax. In some countries, the listed prices for goods and services are the before-tax value, and a sales tax is only applied during the purchase. In other countries, the listed prices are the final after-tax values, which include the sales tax.

U.S. Sales Tax

In the United States, sales tax at the federal level does not exist. At the state level, all (including District of Columbia, Puerto Rico, and Guam) but five states do not have statewide sales tax: Alaska, Delaware, Montana, New Hampshire, and Oregon. States that impose a sales tax have different rates, and even within states, local or city sales taxes can come into play. Unlike VAT (which is not imposed in the U.S.), sales tax is only enforced on retail purchases; most transactions of goods or services between businesses are not subject to sales tax.

The sales tax rate ranges from 0% to 16% depending on the state and the type of good or service. In Texas, prescription medicine and food seeds are exempt from taxation. Vermont has a 6% general sales tax, but an additional 10% tax is added to purchases of alcoholic drinks that are immediately consumed. Rules and regulations regarding sales tax vary widely from state to state.

On average, the impact of sales tax on Americans is about 2 percent of their personal income. Sales tax provides nearly one-third of state government revenue and is second only to the income tax in terms of importance as a source of revenue. Reliance on the sales tax varies widely by state. Sales taxes are much more important in the south and west than they are in New England and the industrial Midwest. Florida, Washington, Tennessee, and Texas all generate more than 50 percent of their tax revenue from the sales tax, and several of these states raise nearly 60 percent of their tax revenue from the sales tax. New York, on the other hand, only raises about 20 percent of its revenues from the sales tax.

U.S. State Sales Tax Rates

U.S. History of Sales Tax

When the U.S. was still a British colony in the 18th century, the English King imposed a sales tax on various items on the American colonists, even though they had no representation in the British government. This taxation without representation resulted in the Boston Tea Party and eventually led to the American Revolution. The U.S. never established a federal sales tax, and state-level sales taxes have a complex history. Sales tax didn't take off until the Great Depression, when states needed ways to raise revenue. Mississippi was the first to adopt a sales tax in 1930.

How to Deduct Sales Tax in the U.S.?

Taxpayers must choose between the standard deduction or itemizing deductions. Sales tax can only be deducted if itemizing. Meticulous record-keeping is required, such as saving receipts for a year. Less than 2% of Americans claim sales tax as a deduction each year.

After choosing standard or itemized deductions, taxpayers decide whether to claim state/local income taxes or sales taxes, but not both. For large purchases like a car, wedding, or major appliances, it may be advantageous to deduct sales tax instead of income tax.

Value-Added Tax (VAT)

VAT is commonly used outside the U.S. in over 160 countries. It is an indirect tax imposed at different stages of production whenever value is added. All participants in the supply chain—wholesalers, distributors, manufacturers, and retailers—usually pay VAT, not just the end consumer. VAT can be calculated as the sales price minus costs of materials or parts already taxed.

VAT has advantages like reducing tax evasion and incentivizing cost control in the supply chain. However, VAT can be regressive, taking proportionally more from low-income individuals. Cascading VAT can negatively impact new or marginal businesses.

Goods and Services Tax (GST)

GST is similar to VAT and applied to goods and services at multiple points in the supply chain. Countries that implement GST or VAT include Spain, Greece, India, Canada, Singapore, and Malaysia.