Sales Tax Exemptions and Reductions (and Use, Excise, and Utility Tax Exemptions and Reductions)
While property tax abatements are the most common type of tax break offered in the name of economic development, state and local governments may provide exemptions or reductions relating to other kinds of taxes as well. Among these are the following:
Sales taxes are retail transaction taxes on the sale or rental of goods, as well as certain services.
Use taxes are sales taxes collected when the buyer is inside the state, but the seller is outside the state. Use taxes may also be imposed on goods brought into a state for storage, use or consumption.
Excise taxes are sales taxes that apply to particular products such as cigarettes, gas, and alcohol. Unlike general sales taxes, excise taxes are usually applied on a per-unit basis instead of as a percentage of prices.
Many states allow cities and counties to impose special sales taxes and local sales taxes, on top of the general sales tax. Utility taxes, which may apply to electricity and telephone service, are a typical example of a special sales tax.
How sales tax exemptions work
There are two broad categories of sales tax exemptions. The first type, offered mainly to manufacturers, exempts companies from paying sales tax on purchases such as construction materials used in building, expanding, or rehabilitating facilities, or machinery for use inside the facilities. The second type of exemption, offered mainly to retail stores that open in areas targeted for economic development, allows companies to keep sales tax collected from their customers.
Tax exemptions and reductions are granted at both the state and local level. They can be either entitlement subsidies enacted by law and available to any company that meets program requirements, or discretionary subsidies negotiated individually in a deal between a company and public officials.
Many states have laws that grant tax exemptions to manufacturers for the purchase of construction materials and/or new equipment. States may also offer sales tax exemptions for targeted activities such as new pollution-abatement equipment or for targeted industries such as high-tech businesses.
Other activities for which businesses may be exempted from state sales tax include:
- Electricity used in manufacturing, processing, mining, and quarrying.
- Sales of property delivered out of state by seller or agent.
- Sale of an entire business relative to depreciable assets.
When sales tax exemptions are granted to retailers, the granting state or city agrees to refund to the company the sales tax collected on sales in their stores. A few states allow sales tax to be diverted along with (or instead of) property tax in districts using tax increment financing (TIF). In these cases, a company's sales tax is used to pay for infrastructure and other improvements. Depending on the structure of the TIF deal, the improvements may subsidize the retailer directly, or may benefit the area more generally.
Tax exemptions are sometimes bundled with a number of location-specific entitlement subsidies, such as those granted to qualifying businesses in many enterprise zones.
In addition to sales tax subsidies, some states allow retailers to keep a portion of the sales tax revenue they collect as a sort of service fee. For more on this practice, known in some states as a “vendor discount,” see the 2008 Good Jobs First report Skimming the Sales Tax.
Outcomes and accountability
Sales and excise taxes are important revenue sources for the states and for many cities and counties. Only five states (Alaska, Delaware, Montana, New Hampshire, and Oregon) don't have broad-based sales taxes.
Like tax credits and tax abatements, tax exemptions are paid for through forfeited tax revenues rather than funds allocated in state or city budgets. Tax spending often does not undergo the same level of scrutiny as direct economic development expenditures. In fact, many jurisdictions never tally the total money spent on tax exemptions, even though they can be a significant drain on state budgets.
The lack of information compiled and disclosed about tax exemptions makes them one of the less accountable subsidies. Some tax exemption programs are structured in ways that increase accountability somewhat by requiring companies to prove that they meet the program criteria before receiving the exemption. Other programs, particularly sales tax exemptions for retail stores, are often awarded before a project has proven its value as an economic development engine in a community. Critics of tax exemptions argue that they are often used to subsidize growth that would have occurred anyway.
One way to improve tax exemption programs is to include safeguards such as wage standards or clawbacks. Such safeguards ensure that projects produce real community benefits and protect taxpayers in the event that the company does not meet the terms of the agreement.
Researching sales tax exemptions
State revenue departments deal with regulation and most other matters related to state sales taxes. Some sales tax exemptions for businesses require an exemption certificate from the taxing authority.
Most state websites have detailed information on laws, regulations, and criteria that determine when and why a business sales tax may be exempted or reduced. Researching the descriptions of tax exemption programs will inform you about the requirements companies are expected to meet in exchange for the subsidy, as well as provide information on how the subsidy is calculated.
A few states are required to prepare “tax incidence” reports that provide details about the distributive effects of various taxes and the lost revenues (e.g., Texas, Maine, Oregon, Minnesota, etc.).
Although sales tax records are considered proprietary and cannot be obtained, you may be able to locate alternative estimates of the amount of sales tax exemptions. Possible sources include public officials, development deal documents, and media accounts.
For background on fairness and distributive justice issues related to sales and other taxes, visit the website of the Institute on Taxation and Economic Policy (ITEP) at www.itepnet.org.