A Short History of Sales Tax in the United States
- May 4, 2015 | Ryan O'Donnell
The idea of sales tax goes back to ancient times. The governments of ancient Egypt, Rome and Greece all had general sales taxes. It was the Romans who brought the idea to Europe.
In the United States, Pennsylvania had a mercantile license tax introduced in 1821, although it was not a broad-based tax like we have today. It was a tax on the gross receipts of local businesses; limited to commerce within Pennsylvania.
Broad-based state sales taxes in their earliest form began in West Virginia at the beginning of the "Roaring Twenties". In 1930, Kentucky was the first state to pass a tax levied exclusively on retailers.
There are many reasons other states enacted their own general sales taxes.
Wyoming, for example, didn't enjoy much of that "Roaring Twenties" decade of lavish consumption.
Back then, Wyoming was dependent on a natural resource economy and the state's population entered their Great Depression much earlier than the rest of the country. Their sales tax was adopted only after several other forms of tax were carefully considered (such as income, property or mineral taxes)—and it was also supposed to be a temporary emergency measure.
Other states enacted their programs to fund various public projects (examples could range from water quality improvement, education, community center construction or road maintenance).
But it wasn't long before other state lawmakers decided to introduce their own legislation. By 1933, eleven more states had instituted sales tax initiatives.
Sales tax ballooned after that. Not less than seven years later, eighteen more states had joined the party... bringing the total number of states collecting sales tax to thirty. By 1969, most of the states have instituted general sales taxes.
The five states which do not collect a general sales tax are the "N.O.M.A.D. states": New Hampshire, Oregon, Montana, Alaska and Delaware.
Laws and Court Cases
The decision to collect sales tax is up to each state, with guidance from the U.S. Constitution. Specifically two clauses in the Constitution: the Due Process Clause of the 14th Amendment and the Commerce Clause from Article 1, Section 8 of the U.S. Constitution.
The Due Process Clause says no state shall "deprive any person of life, liberty, or property, without due process of law." With respect to state taxation, the Supreme Court has interpreted this to prohibit a state from taxing a corporation unless there is a "minimal connection" between the company and the state in which it operates.
The Commerce Clause, in part, allows Congress to "regulate commerce with foreign nations, and among the several States." The Supreme Court has ruled the Commerce Clause prohibits states from enacting laws that might unduly burden or inhibit the free flow of commerce between the states.
At times, there have been disagreements between state laws, federal laws and commerce practices… leading to important historical decisions.
Three of the more significant decisions took place in the U.S. Supreme Court. They are as follows:
Scripto, Inc. v. Carson
Location: U.S. Supreme Court
Many believe if a company operates only with third party contractors in a given state, it does not create nexus.
This is incorrect.
In 1960, the Scripto, Inc corporation was a Georgia based retailer with no offices in Florida, but with 10 independent contractors working in the state to sell the Scripto product (writing utensils). The contractors were paid on commission and physically present within the state of Florida.
The state of Florida attempted to assess Scripto for use tax on the sales the contractors had made. Scripto, challenged this assessment, arguing it had no facilities, employees, or office buildings in Florida, and thus did not have the necessary nexus with Florida to obligate it to collect use tax on Florida sales.
The U.S. Supreme Court decided that with respect to nexus, making a distinction between employees and independent contractors would open the door to planning for tax avoidance. So, independent contractors working on behalf of a company in whatever state are held to the same standards as actual employees. Justice Clark, writing for the court, called the difference between regular employees and contract workers "without constitutional significance."
The Scripto case is still of great importance having been cited in Borders Online, LLC v. State Board of Equalization (2005). In this case, the court held that Borders' return policy of allowing for the return of online purchased goods to an affiliated brick-and-mortar Borders retailer was sufficient to establish nexus, because it was adopted as part of larger plan to expand its California market.
National Bellas Hess Inc. v. Illinois Dept. of Revenue
Location: U.S. Supreme Court
The U.S. Supreme Court decision in National Bellas Hess Inc. v. Illinois Dept. of Revenue set the stage for our current debate on Internet sales taxes.
The court's majority ruling found, "the many variations in rates of tax, in allowable exemptions, and in administrative and record-keeping requirements could entangle [the company]'s interstate business in a virtual welter of complicated obligations to local jurisdictions."
Unfortunately, the Court did not anticipate the consequences of the Internet being invented...floppy disks had only just been invented!
Due to this decision, out-of-state retailers have not been obligated to collect sales taxes because states don't want to "violate the Due Process Clause of the Fourteenth Amendment and create an unconstitutional burden on interstate commerce" according to the Supreme Court.
If you're doing it all on paper, yes. But with the Internet, computers and Avalara's TrustFile helping you file taxes, it's no trouble at all.
Quill Corporation v. North Dakota
Location: U.S. Supreme Court
In this 1992 case, Quill Corporation sold office equipment and supplies via direct mail, and argued they did not have to collect and remit sales tax to the State of North Dakota because they had no significant presence therein. Quill had a licensed computer software program that some of its North Dakota customers used for checking Quill's current inventories and placing orders directly, so the state tried forcing the issue on the grounds that Quill benefited from sales to ND residents.
Basically the state tax commission took the position that even though Quill Corp. was incorporated in Delaware and had no physical presence in North Dakota, they had to collect and remit sales tax to North Dakota.
Eventually the U.S. Supreme Court unanimously decided the lack of a physical nexus in a state IS sufficient grounds to exempt a corporation from having to pay sales and use taxes to a state. However, the court explicitly stated Congress can overrule this decision through specific legislation.
Opposition to Sales Tax
What about opposition to sales tax...what do opponents of sales taxes say?
Collecting and paying sales tax is part of the hum of daily life for most businesses selling goods in the United States. Even though U.S. sales taxes are less than 100 ye
ars old, most of us are used to them and it's hard to think of a time when business owners didn't have to collect and pass taxes back to the government.
Of course, for our customers there's no burden of added consumer filing or paperwork. It's just a line item on their receipts.
You see, property and income taxes have historically been the primary sources of state revenue. But you can only raise these taxes so far before people get upset.
New Hampshire, for instance, does not have a state income or state sales tax...but they DO have the nation's third highest property tax, and this fact forces the state to lean heavily on property taxes.
On the other hand, consider that NH has few other taxes, so the overall tax burden on its residents is low.
Opponents of sales taxes say:
- There are too many sales tax exemptions.
- Sales taxes are too complicated with different rates, rules and ways of collecting them.
- Sales tax presents the risk of double taxation with businesses being treated as consumers.
- Times have changed. These days the United States is much more focused on services than on producing raw goods like we were during the Industrial Revolution.
- Our economy has changed. How do you tax online purchases made to customers nationwide? This is in the works, with a lot of discussion.
We'll dig deeper into online sales taxes in a later article.
A Way Out
Many sales tax exclusions and exemptions are allowed in almost every state. Exemptions are granted for many reasons such as:
- Concerns about fairness, such as business-to-business transactions
- Administrative difficulties in collecting tax
- Concerns that other states don't tax the same good or service, and what would happen if the tax were imposed?
Generally they fall into three buckets:
- Exemptions based on the type of goods sold (essentials like food, clothing, and prescription medications are commonly not taxed)
- Exemptions based on who is making the purchase (federal government agencies, state government agencies, and certain non-profits like charitable or religious organizations)
- Exemptions based on purchases made for certain uses (agriculture, manufacturing, industrial processing, or goods which will ultimately be resold)
For specific exemption examples and what you need to claim exemptions, you'll want to consult your state's tax department or department of revenue website.