Nebraska Sales Tax Modernization
Nebraska was one of the last states to adopt a sales tax, allowing the Cornhusker State to benefit from the decades of sales tax experience in other states. Nebraska policymakers can once again fuse their knowledge from decades of sales tax experience with the principles of sound taxation to update Nebraska’s sales tax for the 21st century.
Nebraska created its sales tax in the Nebraska Revenue Act of 1967. The transformational law reformed the tax code, decreasing Nebraska’s dependence on property taxation by creating a statewide sales tax and income tax. The 1967 sales tax adoption made Nebraska the second-to-last state to enact a sales tax. Only Vermont (1969) created a sales tax after Nebraska, while Oregon, Montana, New Hampshire, Delaware and Alaska never adopted a statewide sales tax.
Mississippi created the first state sales tax in 1930, followed by 23 more states that created a sales tax in the 1930s. Another five states created a sales tax in the 1940s, five more added a sales tax in the 1950s, and then 11 states (including Nebraska) created a sales tax in the 1960s.
Nebraska now has the opportunity to modernize its sales tax in order to make it more economically efficient and suited for the 21st century economy. Furthermore, sales tax reform will play a key role in Nebraska’s broader tax modernization.
Principles of sales taxation
For the practical purposes of this article, consumption taxation refers to the American retail sales tax as is currently law in Nebraska.
Consumption taxation is more pro-growth and economically neutral than income taxation. The retail sales tax is the American form of consumption taxation. In Europe, consumption taxation takes the form of a value-added tax (VAT), which is economically equivalent to the retail sales tax when they are structured correctly.
By taxing consumption rather than income, policymakers give workers the option to save and invest their discretionary earnings without being immediately subject to income taxation. Thus, consumption taxation is more neutral to economic decision-making than income taxation, and incentivizes savings and investment on the margin. By contrast, income taxes are deducted before a worker or investor is able to make an economic decision to invest or consume, which means income taxation is less economically-neutral and disincentivizes savings and investment on the margin.
All state sales taxes underperform on revenue generation because of their structures. Specifically, state sales taxes tend to be levied upon most retail goods consumption but not upon most retail services. This structure is less economically neutral than a tax that is levied upon both goods and services evenly. The goods-weighted sales tax structure is largely an accident of history. When sales taxes were first created, the American economy was largely goods-based, and taxing services would have been administratively challenging. Yet as the American economy has modernized, it has evolved towards relatively more retail service consumption and relatively less retail goods consumption.
Because retail service consumption is often left untaxed, the sales tax base has eroded over time. As a result, just like other states, Nebraska’s sales tax collects less revenue than it otherwise would if it was applied more evenly to the retail consumption base.
Furthermore, whatever you tax more of, you get less of. So a goods-weighted sales tax favors service consumption at the expense of goods consumption. Thus, the retail sales tax creates an economic bias that favors service consumption and disfavors consumption of the goods that fall within the sales tax base. A well-structured sales tax would have as few carveouts as possible, and different types of retail consumption should be treated as neutrally as possible.
In contrast, business input purchases should be exempted from sales taxation altogether. A well-structured sales tax should only apply to retail consumption and not wholesale and supply chain business purchases. Taxing business inputs at multiple stages of production causes tax pyramiding – which results in final consumption purchases that are subject to multiple, non-transparent layers of taxation due to taxation occurring throughout the supply chain. Such taxation raises the cost of retail consumption and artificially encourages business consolidation in order to reduce tax pyramiding.
Modernizing Nebraska’s sales tax
Nebraska’s sales tax is the most competitive component of its four major taxes, ranked 14th in Tax Foundation’s 2022 State Business Tax Index. Nebraska’s statewide sales tax is 5.5 percent. With local sales taxes added in, Nebraska’s average state plus local sales tax is 6.94%. That makes Nebraska’s sales tax the 29th highest in the country, meaning that it is lower than the median state.
Still, Nebraska’s sales tax can be improved. For example, LB 1264, proposed during Nebraska’s 2022 legislative session, would have expanded the sales tax to include more retail consumption. The sales tax should be expanded to non-business retail consumption such as motor vehicle maintenance, painting and maintenance services for real property, investment consulting, personal care, and medical, dental, accounting, real estate and legal services. It would have also expanded more broadly to include more retail goods consumption, such as some medical equipment, medicines and motor vehicle fuel. These broad consumption categories rightfully belong in the sales tax base and would generate revenue that could be used to reduce tax rates.
Still more components of retail consumption would still remain outside Nebraska’s sales tax base. Policymakers should thoroughly consider bringing as much consumption as possible under the sales tax in order to make the tax code as economically neutral as possible, and to generate revenue to modernize the rest of Nebraska’s tax code.
Tax Foundation evaluated LB 1264’s sales tax expansion and found the bill would have improved the competitive structure of Nebraska’s sales tax from 14th to 11th in the country. Indeed, a broad sales tax is more economically neutral and is thus a better sales tax structure, which is reflected in Tax Foundation’s rankings.
However, it cannot be ignored that simply expanding the sales tax base without any offsets would cause a net tax increase, even if it resulted in a better tax structure. Nebraska’s total tax burden is one of the highest in the region. Therefore, policymakers should use any new revenue from sales tax expansion to buy down tax rates, resulting in a more competitive tax code without a net tax increase. Such a reform would comply with the straightforward principle of sound taxation – to levy taxes upon broad bases with low rates.
Policymakers should use new sales tax revenue to buy down income tax rates and to modernize the most anachronistic components of the property tax. As recounted above, the sales tax is more pro-growth and neutral to economic decision-making than the income tax. So rather than using sales tax revenues to lower the sales tax rate, policymakers should deploy such revenues to lower the income tax rate and to reform the property tax. Indeed, Nebraska’s corporate income tax (24th), individual income tax (25th) and property tax (40th) are all far less competitive than Nebraska’s sales tax.
Restructuring Nebraska’s tax code will ensure that tax structures that made sense in a previous era are revised to make sense in the modern era. Sales tax reform is crucial to the broader mission of tax reform, as many of the critical reforms that can be made to the income tax and property tax depend upon Nebraska opting for a modern, broad retail sales tax base.
This is the second blog in a three blog series on tax modernization in Nebraska. The other posts in the series can be found here: