Rental Cars Shouldn’t Face Another Layer of Tax

In recent years, lawmakers in several states have considered proposals to impose sales taxes on vehicles purchased by rental car companies for their fleets. While most proposals failed, Maryland adopted a new 3.5 percent 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. on rental car companies’ registration of new vehicle purchases. Proponents see these bills as leveling the playing field, since individuals pay 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.  on their vehicle purchases. But exemptions for rental car companies’ fleets exist for a reason. These exemptions are not special treatment nor a loophole, and they do not provide a tax break. Well-designed sales taxes fall on final personal consumption only—not intermediate goods—thereby avoiding tax pyramidingTax pyramiding occurs when the same final good or service is taxed multiple times along the production process. This yields vastly different effective tax rates depending on the length of the supply chain and disproportionately harms low-margin firms. Gross receipts taxes are a prime example of tax pyramiding in action. and preventing the sales tax from becoming a tax on the in-state production of goods or services. Imposing sales taxes on rental car companies’ fleet purchases, in addition to the sales and rental car excise taxes imposed when those cars are rented, yields double taxationDouble taxation is when taxes are paid twice on the same dollar of income, regardless of whether that’s corporate or individual income..

Cars are the equipment of rental car companies, just as assembly-line equipment and forklifts are the machinery of manufacturers, and earth-moving equipment is the machinery of construction companies. Sales tax is collected on each vehicle rental transaction, typically in addition to special excise taxes and fees. The sales tax is imposed on final consumption (renting a car), not on the input (purchasing the car for the rental car fleet).

Proposals in Hawaii, Maine, Massachusetts, New York, and Washington would have extended sales taxes to rental car companies’ fleet purchases, but while these legislative proposals sought to tax rental car companies’ inputs, they implicitly recognized that the sales tax should exempt some vehicles. These proposals did not touch the exemptions that most states offer to “rolling stock,” the heavy trucks used for interstate shipping. Carriers do not pay sales tax on an 18-wheeler because it is understood that those vehicles do not represent final consumption. Shipping goods by truck is a cost of providing the final good, which can itself be taxed when sold. The truck used to ship the goods is not taxable itself.

The same logic applies to rental car fleets. Companies do not buy fleets of rental vehicles for personal consumption but rather for their core business activity: renting out vehicles. The consumption is renting the vehicle, and it usually involves several layers of tax, including the sales tax, a special rental car 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., or both.

The 3.5 percent vehicle excise tax on short-term rental vehicles was adopted as part of Maryland’s 2025 budget. This year, a bipartisan group of legislators sought to repeal the new tax, though with the state facing a large budget shortfall, repeal did not advance. Since 2025, New York’s S3399, Maine’s LD 1602, Massachusetts’ H.3160, Washington’s HB 1986, and multiple Hawaii bills, including HB 2575, also would have imposed sales taxes on rental car fleets. None of these proposals have advanced far to date, with measures being held in committee or receiving negative recommendations. In Hawaii, which has a gross-receipts-like sales tax, rental car fleet purchases are already taxed at a wholesale rate of 0.5 percent. (Ordinary sales taxes do not tax wholesale transactions, reflecting the unusual nature of Hawaii’s hybrid tax.) House Bill 2575 would have raised the rate on rental car companies’ fleet purchases to the full 4.5 percent rate that applies to most retail transactions in the state.

Notably, Hawaii already has plenty of rental car taxes. Car rentals themselves are subject to the 4.5 percent General Excise Tax (Hawaii’s hybrid sales-gross receipts taxGross receipts taxes are applied to a company’s gross sales, without deductions for a firm’s business expenses, like compensation, costs of goods sold, and overhead costs. Unlike a sales tax, a gross receipts tax is assessed on businesses and applies to transactions at every stage of the production process, leading to tax pyramiding.), plus a $7.50-per-day rental motor vehicle surcharge tax. Vehicles picked up at an airport are also subject to additional fees to fund the airport district, including an 11.11 percent airport concession recovery fee and a $4.50-per-day customer facility charge. And while Hawaii’s rental car taxes are higher than average, there’s nothing at all unusual about the taxes themselves. Car rentals are taxed in all 50 states, even those without a sales tax. On a five-day, $50-a-day rental, average statewide effective rates range from 2.0 percent in Delaware (one of five states without a statewide sales tax) to 22.5 percent in Minnesota. If the goal of the sales tax is to tax consumption, nothing is left out of the base.

Economists generally agree on three basic principles of sales taxation:

1. An ideal sales tax is imposed on all final (personal) consumption, both goods and services.
2. An ideal sales tax exempts all intermediate transactions (business inputs) to avoid tax pyramiding and to avoid transforming it from a consumption taxA consumption tax is typically levied on the purchase of goods or services and is paid directly or indirectly by the consumer in the form of retail sales taxes, excise taxes, tariffs, value-added taxes (VAT), or income taxes where all savings are tax-deductible. to a tax on production or investment.
3. Sales taxes should be destination-based, meaning the tax is owed in the state and jurisdiction where the good or service is consumed.

No sales tax perfectly lives up to these principles, with all states making policy choices to exempt some final consumption and likewise taxing some business inputs. But states overwhelmingly exempt business machinery and equipment, as they recognize that machinery and equipment are the quintessential cases of goods used for production. Similarly, retailers do not pay sales tax on goods purchased wholesale for later sale to consumers.  

Proponents of taxing rental car purchases tend to characterize their proposals as “closing a loophole,” but there is no loophole to close. If rental car companies paid sales tax on their vehicles, the result would be higher car rental prices for consumers and an older fleet, creating economic distortions. Because all rental car companies would face the tax, much of the additional cost would show up in rental rates, a classic example of tax pyramiding, where the tax is embedded during one or more stages of production before being imposed again on final consumption (renting the car).

Whether taxing business-to-business transactions primarily leads to pyramiding (with higher final consumer costs) or a reduced return on investment largely depends on the interstate market. In general, in states with destination-based sales taxes, when in-state companies are taxed on inputs but their out-of-state rivals are not, then in-state companies can be placed at a competitive disadvantage since their out-of-state rivals can sell into the state without bearing the same costs. Consumers’ costs rise less (though still some, because the supply curve shifts), but in-state companies are harmed. If, however, all companies competing in the market bear similar costs, much more—though likewise not all—of the added cost is passed along to consumers.

With rental cars, markets are inherently local. If a tire manufacturer in a given state must pay taxes on its rubber extruders and molding machinery, and its out-of-state competitors receive equipment exemptions, it may have difficulty competing on price against rivals with lower input costs, since out-of-state companies can sell their tires in-state as well. But car rentals are location-specific: a person landing at the airport must rent from a rental car agency that has a location there. If all car rental companies in the state are subject to the tax, much more of the added cost will be passed on to consumers.

To the extent that the rental car companies also bear some of the burden, however, the result will be an older, somewhat lower-quality fleet, since the return on car rentals will be lower. Supply and demand curves will meet at a new price that is higher for consumers but still yields lower profits for rental companies, and changes in demand at these higher prices will make it less attractive to spend more (under higher sales taxes) to supply newer vehicles. At higher base prices, demand for newer and nicer vehicles will be lower, so the fleet will be refreshed less frequently. On the margin, the tax would encourage vehicles to be held longer and for many vehicles to be of cheaper makes and models than they would otherwise be.

Taxing the purchase of rental cars also incentivizes the purchase and titling of cars in neighboring states. When the sales tax is applied to the purchase of a vehicle, it is imposed where the vehicle is titled. A Marylander purchasing a car in Virginia still pays Maryland tax since their address is in Maryland and they will title the car there. But rental cars do not work that way. Cars are routinely driven across state lines. Fleets are intermingled, fully legally. Anyone who has ever picked up a rental car knows how many different states’ plates are on the cars in the lot. Imposing a tax on rental car fleets could create an incentive for rental car companies to title more of their vehicles out-of-state, and this, in turn, could reduce the amount of revenue that would otherwise be generated from taxing these intermediate transactions in the first place.

Some proponents of these bills have argued that, while other business equipment should remain exempt, rental cars are somehow different because rental vehicles can be depreciated for corporate income taxA corporate income tax (CIT) is levied by federal and state governments on business profits. Many companies are not subject to the CIT because they are taxed as pass-through businesses, with income reportable under the individual income tax. purposes, whereas personally owned vehicles cannot. This argument confuses two concepts and actually makes the case against taxing these purchases.

Corporations pay corporate income tax on their net income (profits). Taxing net income entails beginning with all revenue and deducting business costs, such as compensation, the cost of goods sold, and capital investments. Once all business costs are deducted, what remains is net income, which is subject to corporate income tax. This means, of course, that rental car companies deduct the cost of acquiring their fleet when determining profit.

Some proponents of sales tax on these purchases seem to believe that the businesses are already receiving a “benefit” because they can deduct the costs of these vehicles for corporate income tax purposes, but that is not a tax benefit. Corporate income taxes are on profits, and purchasing cars is an expense, not profit. The profit comes from renting them out (net of expenses), not buying them.

The fact that rental cars are deductible business expenses for federal and state corporate income tax purposes underscores the reason they should be exempt from sales tax. It demonstrates that they are clearly business inputs, just like manufacturing machinery, farm equipment, office equipment, and, of course, 18-wheelers. 

It isn’t an accident that purchasing rental car fleet vehicles is exempt from the sales tax almost everywhere. Such purchases were never intended to be in the sales 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., and their inclusion would only add a hidden layer of tax to rentals, in addition to the sales and car rental excise taxes already imposed. Rental cars shouldn’t face yet another layer of tax.

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