A Proposal to Eliminate Sales and Use Taxes

Hal R. Varian, Dean
School of Information Management and Systems
UC Berkeley
Berkeley, CA 94720
November 12, 1999
December 11, 1999 (revised)


I propose eliminating all state and local sales taxes and replacing
them with a revenue-equivalent state income or consumption tax.

1.  Compliance costs.  We spend a significant amount of effort to
calculate an Adjusted Gross Income for purposes of Federal and State
taxation.  Why should we also spend additional resources to monitor
consumption at the level of individual purchases?  It makes more sense
to replace state sales taxes with a tax on reported income.  Since 80%
of the states already have a state income tax, typically based on the
Federal AGI, the compliance costs would be very small.  Even states
without an existing income tax would have minimal compliance costs
since a Federal AGI is computed for almost everyone.

2.  Consumption tax. If it is felt to be particularly desirable to tax
consumption, rather than income, then states could offer taxpayers a
deduction for their measured savings.  Since consumption expenditure
is, by definition, income minus savings, this would be essentially
equivalent to a very broad-based sales tax. 

3.  Tax base.  If an income tax supplement is used to make up for lost
sales tax revenue, it would be appropriate to have a cap, in order to make
the incidence of the tax supplement similar to that of current sales
taxes.  This cap would differ from state to state, depending on
revenue needs.  In 1987 state sales taxes were about $600 per capita,
so a cap of around $1500 would probably be the right order of magnitude. 

4.  Tax location.  State sales taxes have been popular because they
tax purchasers rather than residents.  However, most proposals for
taxing online sales base tax liability on place of residence, which is
also the determining factor for state income tax liability.  Hence
there would be little difference in incidence between most proposed
sales tax reforms and a state income tax.

5.  Special jurisdictions.  Cities and regions that levy add-on sales
taxes could just as easily use an add-on income tax, which would have 
similar incidence.

6.  Business-to-business taxation.  Business-to-business transactions
in intermediate goods would not be taxed under this system.  The
treatment of state and local corporate income tax would be subject to
negotiation, but most likely there would be an increase in such rates
to make up for the lost revenue from state use taxes.

7.  Implementation.  There is no reason for the Federal Government to 
impose the elimination of state sales taxes; indeed, they are
prohibited by the Constitution from doing so.  The Federal Government
should simply do nothing.  If online purchases become large enough to
significantly impact state revenues, states would be led to adopt such
a plan on their own.  If online purchases never reach such a
threshold, there is no real problem to solve.

8. Research.  It would be valuable to try to estimate what form of 
revenue-neutral income taxation would have similar incidence to
existing sales and use taxes.


The proposal to replace state sales tax with a capped supplement to
state income tax satisfies all the requirements set forth by the
committee with respect to simplification, neutrality, unchanged
burden, reporting requirements, revenue base, discrimination,
international neutrality, and privacy.  Indeed most of these issues
are rendered moot by this proposal.

The current state sales tax system is costly, inefficient, and
inappropriate for the information age.  The current debates over
ecommerce taxation offer a good opportunity to replace the sales tax
with a more sensible system of state and local taxation.