Federal Limitations on State Taxation

All states vary by the specific laws they set on taxation, such as whether to impose retail sales tax or how to distribute tax payer money. However, all states must operate under specific restrictions and limitations from the government as set forth by the Constitution. The Commerce Clause of the Constitution prohibits tax on trade among states, and gives the federal government the power to regulate all interstate trade.

Before this clause allowed free trade among states, individual states had the right to tax goods as they crossed state lines making it difficult for businesses to profit from interstate trade. State taxation is also affected directly by the federal government. The Federation of Tax Administrators provides several laws that put a restriction on states to tax any businesses that may operate in several different states at once.

One issue that has proved controversial is the right of states to place taxes on services provided by the internet or any revenue that may be related to internet businesses. The Internet Tax Non-discrimination Act places a restriction on states to tax internet access or electronic commerce.

These limitations on state taxation by the Constitution are designed to promote free trade between states. State taxes will be abolished by the government if they are found to discriminate against interstate trade. For example, in several court cases have made it illegal to make tax exempt certain products that are manufactured in state. The Constitution mandates that state taxes not be "facially discriminatory", which means they cannot obviously favor instate business over out of state businesses.

States are free to choose the rate at which they tax income, by person or business, as well as tax on retail sales. States use this revenue to operate school systems and local governments, along with the income that is provided for them by the local government.

States are allowed to tax residents as long as these taxes do not conflict with the limitations set forth by the Constitution and the federal government. Local taxation, such as property tax, is also regulated by the state and is used to provide services for state residents. States are permitted to regulate taxes on corporations, and these tax laws vary from state to state. In order to attract new business, some states require low corporate income tax.

NEXT: How Congress Can Interpret the Commerce Clause