The degree of tax pyramiding varies from state to state depending on the types of sales tax exemptions they provide to businesses. For example, California exempts purchases for resale. So, when the California grocery store buys food, it doesn't pay sales tax. Yet, it has paid sales tax on all of the equipment and other tangible personal property used in the store (supplies for example). Some states have reduced pyramiding by providing sales tax exemptions for certain types of equipment purchased by businesses, such as that used in manufacturing. Typically the rationale for such exemptions is to entice businesses to locate their manufacturing operations in the state.
The remedy for tax pyramiding is to not have businesses pay sales tax. If they don't pay the tax, then it won't be factored into pricing. There are two big obstacles to fixing pyramiding though:
- Pyramiding has been around since the beginning of the sales tax and it generates revenue for the state (likely at least 20% of the state sales tax comes from businesses). How do you replace that revenue?
- Many people (including lawmakers) think that businesses have too many tax breaks and are not paying their fair share and would not support legislation to make all business purchases exempt from sales tax.
Despite these obstacles, there are reasons to remove pyramiding from the sales tax system and ways to deal with the obstacles. First, there are other reforms needed to the sales tax system, such as base broadening (along with rate reduction; see my Report #2a at the link below). Revenue generated from that change can cover the revenue generated from pyramiding and be a more equitable and transparent way to generate sales tax revenue. Removal of pyramiding would likely generate increased business activity in the state because the price of doing business here would drop - other tax revenues should go up from the change. Also, taxpayer education would help. Individuals need to see the hidden cost of pyramiding (which they pay; businesses pass most costs onto customers). It would be more clear to individuals how much sales tax they are paying if the sales tax shown on the sales slip is the total amount and that will only happen if pyramiding is removed from the sales tax system.
The pyramiding flaw is a U.S. one. All industrialized countries other than the U.S. use a value-added tax to tax consumption (rather than a sales tax). A VAT that does not allow for exemptions and special rates does not impose a VAT on businesses purchases.
For more information on the problems created by pyramiding, why it should be eliminated and ways to do so, see Report #2c at:
What do you think?