Several recent reports and news articles have argued that rental car companies are using special carve-outs in the tax code to gain a competitive advantage over their online competitors. Critics have gone on to claim these companies are the recipients of more than $4.1 billion in taxpayer-funded subsidies. However, this analysis completely misses the mark. While decried as a taxpayer-funded subsidy, the tax treatment of purchases by rental car companies is sound tax policy that should be celebrated - not condemned.
It is true that rental companies largely avoid paying sales tax on the new cars they purchase. On the surface, it may appear that they are getting a sweet deal, but these transactions are considered to be business-to-business, which aren’t typically taxed. In general, sales tax should be broadly applied to all final consumer transactions, but not applied to business-to-business transactions.
In most instances, the levying of sales tax occurs when businesses sell goods or services to consumers or households. Since business-to-business transactions are generally used as inputs, and not for final consumption, they should not be considered taxable. Take, for example, fresh bread that may be sold at your local grocery store. First, a farmer purchases seeds to grow, that wheat is sold to a miller, a bakery buys flour from the miller, and a supermarket buys that bread from the bakery. If a sales tax would have been imposed on each individual transaction, it would result in a phenomenon called tax pyramiding, where the same transaction is taxed multiple times.
To recoup costs that occur from tax pyramiding, the final seller (in this case, the grocery store) would have to significantly raise the final sale price that consumers end up paying at the checkout counter. Layers of taxation are incredibly inefficient, which is why states have tried to avoid such a tax structure by exempting most business-to-business transactions from sales taxes. Ending this crucial provision in the tax code would subject every business input purchase to sales tax - a potentially economically damaging activity.
In the case of rental car companies, the purchase of cars is similar to this simple bread example, as it is considered an input in order to operate their business. “Big rental” is not abusing a tax loophole or being subsidized by the government, they are utilizing an important provision of the tax code that actually protects taxpayers from excessive sales tax burdens.