As the holidays approach, many Americans are looking forward to spending time with family and friends. This will be a busy season of travel, and many people will rent a car to get to their destination. Americans may be surprised to see just how much they are taxed for renting a car.
Rental cars receive additional sales or excise taxAn excise tax is a tax imposed on a specific good or activity. Excise taxes are commonly levied on cigarettes, alcoholic beverages, soda, gasoline, insurance premiums, amusement activities, and betting, and typically make up a relatively small and volatile portion of state and local and, to a lesser extent, federal tax collections. treatment in all 50 states. Most other excise taxes arise from governments trying to discourage consumption of something they see as undesirable (sin taxes), or trying to calibrate the cost of something to account for estimated externalities (Pigouvian taxes), or levying a charge on a particular service to fund that service (user fees). Taxes on car rentals don’t fit any of these traditional economic justifications for an excise taxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities.. Instead, car rental taxes are often pitched as an attempt to export the tax burden to nonresidents.
Car rental taxes can vary significantly across states, both in rate and structure. States and municipalities levy both ad valorem sales taxes and fixed-rate ad quantum taxes (per rental day or per transaction), along with an assortment of other fees. To compare car rental taxes across states, we use a 5-day, $50 per day (or $250 total) charge sample rental agreement.
We estimate a statewide average rental car fee. Our estimates include state sales taxes (standard and rental-car-specific), population-weighted and local sales taxes (standard and rental-car-specific), and ad quantum excise taxes and fees applicable to car rentals. Our estimates don’t include airport-specific fees. Airport fees are negotiated separately at each airport and are often used to fund airport operations, along with commercial indoor and lot property rents.
Minnesota levies the highest average tax on car rentals at 22.5 percent. The next highest taxes are levied in Colorado (21.5 percent), New York (20.5 percent), and Arkansas (19.5 percent). These tax burdens are substantially greater than the lowest average tax on car rentals, which is only 2.0 percent levied in Delaware. Delaware is followed by Alabama (3.2 percent), Montana (4.0 percent), and Oregon (4.6 percent).
How does your state—or the state you are visiting—compare?
Some states levy their standard sales tax on car rentals, while others have set a separate, usually higher, rate that applies to car rentals. Outside of these sales taxes, Minnesota levies the highest specific excise tax on rentals, with both a 9.2 percent motor vehicle rental tax and a 5 percent motor vehicle rental fee. Delaware, which does not levy a broad sales taxA sales tax is levied on retail sales of goods and services and, ideally, should apply to all final consumption with few exemptions. Many governments exempt goods like groceries; base broadening, such as including groceries, could keep rates lower. A sales tax should exempt business-to-business transactions which, when taxed, cause tax pyramiding. , levies the lowest ad valorem tax at 1.99 percent. Hawaii levies the largest ad quantum tax of $7 per day of rental, while Massachusetts levies $2.60 per rental from a police training fee and parking violation surcharge.
Oregon does not levy a statewide tax on car rentals, but the 12 to 17 percent local levies average out to a 4.6 percent tax across the state’s population. This is only the second highest average local rate, however, as the 3 to 7 percent taxes levied by localities in Utah cover more of the population, averaging 5.67 percent across the state.
There are additional variations and nuances in vehicle rental taxes. Many jurisdictions exempt necessary replacement rentals. Some jurisdictions levy a different rate on passenger cars than they do on trucks, and some charge different rates on long-term rentals (usually defined as rentals of more than 30 days). Some state or local rates only apply at airports or hotels. Arkansas levies a 4.5 percent tax on rentals for the purpose of residential moving or shipping.
These various taxes combine to create a significant tax burden on car rentals in most states. In most cases, this burden is in addition to the user fees for transportation that those drivers must pay in the form of gas taxes or other levies. Drivers of rental vehicles must still fuel their vehicles with taxed fuel and pay applicable road fees and tolls. Owners of those vehicles must still pay the taxes and fees from buying, registering, and owning those vehicles.
This means that the excise taxes on rental cars tend to double tax drivers of rental cars or at least over-tax rental drivers compared to local drivers.
In some cases, this could be the result of poor transportation tax structure rather than a case of double taxationDouble taxation is when taxes are paid twice on the same dollar of income, regardless of whether that’s corporate or individual income.. Many states fail to fully fund their roads with road user fees, necessitating large transfers from general funds to fill those gaps. Nonresidents who are renting cars would presumably not be paying the state income tax and other taxes funding those transfers, so an excise tax on rental cars would be a way to capture their road use.
This policy band-aid on underlying road funding gaps creates more problems while failing to solve the larger one. Road funding should come from those who use the roads, regardless of who is driving, via principled and efficient user fees, not charging those who want to visit extra to make up for policy failures elsewhere.
Some jurisdictions do not allocate any of the rental car taxes to their transportation systems, instead treating them as general funds. In most states that do this, however, the tax rate on car rentals is higher than the general sales tax rate, often amounting to a significant premium.
While exorbitant fees on rental cars may be easier to sell to the state’s voters, who are less likely to need to rent a car in-state, a substantial portion of the rental car market is still comprised of local residents, meaning the tax baseThe tax base is the total amount of income, property, assets, consumption, transactions, or other economic activity subject to taxation by a tax authority. A narrow tax base is non-neutral and inefficient. A broad tax base reduces tax administration costs and allows more revenue to be raised at lower rates. isn’t entirely exported to nonresidents. In any case, trying to export the tax burden to nonresidents is likely to suppress tourism and other economic activity.
Large excise taxes on rental cars are obviously nonneutral, treating similar transactions differently to intentionally shift the burden to nonresidents. They also undermine the transparency of the tax system, both by surprising visitors with unexpected exorbitant fees and hiding some of the true cost of government services from residents. Rental car taxes also increase the complexity of the system, adding to administrative and compliance costs for in-state businesses.
Rather than levying additional taxes on rental cars, whether to equalize for general fund transfers to transportation or simply to force more of the tax burden onto nonresidents, states should enact principled, neutral transportation tax policy that is unlikely to discourage visitors, tourists, and other economic activity.
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