The first sales tax was not imposed until 1921, and the first general sales tax was adopted in 1930 — more than a century and a half after the country's founding. However, once the first state tapped into this revenue source, others rapidly followed suit.
Today, just five states don't have a statewide sales tax — and jurisdictions within some of those states do impose sales tax.
This article will explain the history of sales tax, including some major changes that happened along the way.
The first states to charge sales tax
West Virginia was the first state to collect sales tax. In 1921, the state imposed taxes on the sale of a small number of products, including coal, oil, natural gas, timber, and electric lights and power.
While the types of taxable items in West Virginia would eventually expand, Mississippi was the first state to impose a generalized, widespread sales tax on most items. The Mississippi Business and Occupation (Sales) Tax Act took effect on March 1, 1934, codifying provisions of a law that had gone into effect in 1930.
Since Mississippi's law was broader than West Virginia's, some argue that Mississippi was the first state to charge consumers tax at the point of purchase. Regardless of which side of this argument you take, though, you can say that states started imposing sales tax about a century ago.
The expansion of sales tax regulations
Although states didn’t begin collecting tax until the 20th century, the idea took hold quickly — and the Great Depression played a big role.
In the 1930s, cash-strapped states began experiencing major revenue shortages, as both property and income tax collection dropped dramatically due to conditions related to the Depression. Charging sales tax likely seemed like a great way for states to refill their coffers.
Kentucky's sales tax was first implemented in 1934, at a flat rate of 3%. The tax was charged on general retail gross receipts, which made Kentucky the first state to impose the tax exclusively on retailers. The tax was unpopular and was repealed in 1936, making Kentucky the first state to repeal its sales tax (it came back eventually, but not until 1960).
By the end of the 1930s, a total of 22 states had sales tax rules in place. Six more states and Washington, D.C., enacted sales taxes in the 1940s, and another five followed suit in the 1950s. The number continued to expand until 1969, when Vermont put a statewide tax in place.
Since that time, no additional states have moved to tax retail sales. Alaska, Delaware, Montana, New Hampshire, and Oregon are the only five that don't impose a statewide sales tax.
Nexus definitions arise
The first mail-order catalog in the U.S. dates back to 1744, when Benjamin Franklin released a trade catalog to sell books. But while Americans have long had the ability to buy products via mail, sales tax was typically charged only on items purchased locally.
That's because a state could require a retailer to collect sales tax only if it had a physical presence there (this presence was deemed physical nexus).
This rule was challenged in the 1980s, though. North Dakota tried to impose a use tax, effective after July 1, 1987, on the Quill company, which sold office equipment and stationery to the state's residents, via mail order. North Dakota's law was challenged, and the case made it to the Supreme Court, which issued its ruling in 1992, in Quill v. North Dakota.
The Supreme Court held that because Quill had "purposefully directed its activities at North Dakota residents," the Due Process Clause in the U.S. Constitution didn't prevent the state from imposing its use tax on Quill.
However, North Dakota's imposition of this tax was found to be an undue burden on interstate commerce, and therefore a violation of the Commerce Clause found in Article I, Section 8 of the Constitution.
The decision meant that physical nexus continued to be a determining criterion in whether a state could require a business to collect and pay sales tax. Physical nexus could typically be established with a storefront, a warehouse, or even local employees — but some part of the company's operations had to be centered locally.
Wayfair changes the game
When the Quill case was decided, online commerce was in its infancy — but it would soon grow. In the mid-1990s, Amazon and eBay began operating, and they quickly became two of the first big online marketplaces. And in 1998, PayPal began providing a secure way for everyday buyers to pay for online purchases.
Global e-commerce had already reached $150 billion in sales by 1990, and despite the burst of the dot-com bubble in 2000, the percentage of sales made online has continued to grow exponentially. In 2024, e-commerce accounted for more than $1 trillion in sales in the U.S. alone.
States were initially prevented from taxing these online sales by the Quill ruling, but the Supreme Court changed the game in 2018. The court heard a case called South Dakota v. Wayfair and overruled past decisions mandating that physical nexus needed to be established before a state could require a seller to collect sales tax.
Under new rules resulting from the Wayfair ruling, states could still use physical nexus as a criterion for determining an obligation to collect sales tax. But a new criterion was added: economic nexus. Under these new rules, if a company did enough business with a state’s residents, the state could make the business collect and pay sales tax.
In the wake of the Wayfair decision, states rushed to pass new laws requiring online sellers to start collecting and paying taxes. In fact, some already had laws in place in anticipation of this type of change.
By January 2023, every state that levies sales tax had put economic nexus rules in place, with most requiring either a certain amount in annual sales (such as $100,000, $250,000, or $500,000) or a certain number of transactions in a year, such as 200. Unfortunately, the rules vary from state to state, which has created a major headache for businesses.
Marketplace facilitator laws
In a bid to capture every bit of revenue, states also began passing regulations called marketplace facilitator laws. These rules require online marketplaces like Amazon and Etsy to collect sales tax on every transaction on their platform.
By imposing this requirement, states ensured that they could capture the tax revenue they might otherwise miss when small sellers complete just a few transactions or earn a small amount in total sales on larger platforms.
All states that charge sales tax now have these laws in place as well.
Sales tax on SaaS and digital goods
The Internet didn't just usher in a new way to buy goods that states had to learn to regulate -- it also ushered in new types of goods: Digital ones.
Today, many people buy digital goods they never physically hold, and pay fees for software as a service that is never physically downloaded, much less physically delivered. States have had to grapple with determining how to tax these new types of products.
Historically, many states treated software as taxable if it came with something tangible, like a CD for installation (e.g. Alabama). Then, as technology evolved, states began to tax software that people downloaded, treating it as though it were a physical product. However, the rise of cloud computing and SaaS now means many digital products are never downloaded at all.
States have taken divergent approaches to this issue, with some imposing tax because buyers have "constructive possession" of cloud services and classifying SaaS as taxable cloud computing, while others categorize SaaS offerings as non-taxable data processing or information services.
However, the laws are still evolving, and revenue-hungry states across the U.S. are likely to continue finding new and creative ways to categorize digital goods as taxable so they can capture those dollars being lost.
Sales tax collection today
Today, states rely on sales taxes to provide around 31.18% of tax revenue, on average. This is the case despite:
- Sales tax being regressive. Sales taxes hit lower-income people harder because they spend a greater share of their income on taxable items.
- Sales tax being an inconsistent revenue source. During tough economic times, many people limit their spending, resulting in revenue shortfalls.
Sales tax collection is also costly and complicated for retailers. One study done in the state of Washington, for example, found that the total cost of collecting and remitting sales tax is 6.47% of sales for small retailers, 3.35% for medium-sized retailers, and 0.97% for large retailers.
Since larger companies are better able to shoulder this burden, they may have an unfair competitive advantage.
The good news is, there are solutions out there for businesses of all sizes. Numeral provides comprehensive sales tax support, taking all tax compliance tasks off your plate. Numeral tracks nexus, registers your business to collect sales tax where necessary, collects the correct tax amount, files tax forms, remits payment, and even opens your mail from the state.
If you're ready to make compliance headaches history, reach out to Numeral today to find out more about how we can help.
