Sales Tax

A sales tax is a tax on the sale of goods and services, normally charged as a percentage of the price and collected by the seller, who passes the money to the government. In its classic form, a retail sales tax is levied once, at the final sale to the consumer. In wider usage the term also covers value-added tax (VAT) and goods and services tax (GST), which tax each stage of production but are designed to end up as a charge on final consumption.

Like other taxes on spending, sales taxes are indirect taxes: the shop or platform hands over the money, but the cost is largely borne by buyers through higher prices, an issue studied under tax incidence. They are a major item in the government budget of US states, for nearly every country that uses VAT or GST, and for many developing economies where collecting income tax is harder.

A sales tax works like a small extra charge printed at the bottom of a receipt. The shop adds it to the price, collects it with the payment and later sends what it gathered to the tax office. The buyer pays it, but the shop does the paperwork.

Because everyone pays the same rate when they buy the same item, the tax is simple to understand. The catch is that people with smaller incomes spend most of what they earn, so the tax takes a bigger slice of their budget than it takes from people who save much of their income.

For a tax added on top of the shelf price (the US convention), the calculation is:

Here $P$ is the pre-tax price and $t$ is the tax rate as a decimal. A $200 purchase at an 8% rate costs $200 \times 1.08 = 216$, of which $16 is tax.

Where prices are shown including tax, as is normal for VAT in Europe and the UK, the tax inside a price is:

At a 20% rate, a £120 item contains $120 \times 0.2 \div 1.2 = 20$, so £20 of tax.

A retail sales tax is charged only at the final sale. Businesses buying inputs show an exemption certificate, so the tax is not stacked at each stage. If exemptions are poorly policed, though, business purchases can be taxed and the tax "cascades", raising prices more than intended.

A VAT or GST is charged at every stage, but each business deducts the tax it paid on its inputs from the tax it charges on its sales. Each firm therefore pays tax only on the value added at its stage, and the full tax ends up in the final consumer price. This credit chain creates a paper trail that makes evasion harder, which is one reason the IMF has long recommended VAT to developing countries. More than 170 countries now use VAT or GST, but the United States does not.

• United States. Sales tax is set by states and localities, not the federal government. Forty-five states and the District of Columbia levy a statewide sales tax; Alaska, Delaware, Montana, New Hampshire and Oregon do not, although some Alaskan localities do. Combined state and local rates approach 10% in places. The Supreme Court's 2018 decision in South Dakota v. Wayfair allowed states to require remote sellers with enough sales into the state to collect tax, reshaping e-commerce compliance.
• European Union. All EU states use VAT, with standard rates that must be at least 15%; most are 19% to 27%.
• United Kingdom. VAT has a standard rate of 20%, with reduced and zero rates for items such as children's clothing and most food.
• India. GST replaced a patchwork of central and state levies in 2017. A reform effective 22 September 2025 collapsed most rates into two main slabs of 5% and 18%, with a 40% rate for luxury and "sin" goods.
• Pakistan. The federal sales tax on goods has a standard rate of 18%, while provinces tax most services under their own laws.
• Gulf states. The UAE introduced VAT at 5% in 2018, and Saudi Arabia, which started at 5% the same year, raised its rate to 15% in July 2020.

Economists often prefer broad consumption taxes to income taxes because they do not tax saving or investment directly, and so distort decisions less. A broad base with one rate keeps tax neutrality, while long lists of exemptions add complexity and lobbying.

The main criticism is that sales taxes are a regressive tax relative to current income, since lower-income households spend a larger share of what they earn. Governments respond by exempting food, medicine and other essentials, or by paying rebates; critics on the other side note that exemptions are poorly targeted because richer households also buy those goods. Sales taxes also raise prices once when introduced or increased, which shows up in the consumer price index, and they encourage cross-border shopping where neighbouring rates differ. Large cash-based informal economies can weaken collection, particularly in low-income countries. Excise duties on items such as tobacco, alcohol and fuel are a related tool, often justified as a Pigouvian tax on harmful consumption.

• OECD: Consumption Tax Trends 2024
• European Commission: VAT