I had been avoiding posting about Oregon's revenue system for quite a while now because I have a real job and spending time digging into the evidence on tax systems was not a high priority. However, the opinion piece in the Oregonian by Scott Bruun finally prompted me to make a first foray into the debate and I considered a kind of commitment device to finally get my hands dirty. So I decided to start a discussion and over the next month or so I could start to see what the evidence was. After all I have only three readers and they are all pretty patient. Then comes Jeff, who throws gasoline on my nice slow burning fire, and here I am, spending half the night looking at income/sales tax revenue elasticities! Thank you and curse you Jeff Alworth!
So first lesson: a blog is a public forum and so you had better be prepared to engage the public.
But, now that I have looked at a number of studies and have updated my knowledge from my policy student days (gosh, can it really be 15 years ago already?) I am left with two conclusions about the variability of sales taxes.
Second lesson: sales tax revenue is not significantly less volatile than income taxes in the short run and may, in fact, be more volatile.
In a number of studies, short run volatility is actually greater for sales than income tax revenue. Its volatility can change depending on the exemptions and other specifics of the tax, and for some states it is quite stable while in others it is quite volatile, but overall the evidence is simply not there to support the lower volatility claim. What this means is that is the case of short-run income shocks the state is potentially as bad off or worse off with a sales tax.
There is, however strong and consistent evidence that the long-run income elasticity from sales taxes is lower than income. This is not questioned anywhere in the literature, but the interpretations differ. The evidence cited in a previous post show a a fairly significant difference between long-run elasticities for sales and income taxes. This is argued to be largely reflective of the growth rates of the two taxes as incomes in general grow and does not tell us that much about stability. (Which, by the way, is one reason fiscal conservatives don't like income taxes as they grow too fast in their view) In other words, it is argued that this is mostly an indication of a trend and not about variability around that trend. But I am not entirely convinced: it does inform us about, for example, the effects of an extended recession - suppose a three year span of low state income (sound familiar?) - a sales tax should fall less severely in that case.
Third lesson: a sales tax might mitigate the downturn in government revenue during an extended downturn in the economy.
So what does this tell us? Well, it probably says that volatility itself should not be a determining factor in choosing a sales tax. How likely are short-run fluctuations v. long-run downturns and how much each matter seem to be pertinent questions. Oregon has been severely hurt by extended slowdowns of the economy but has also struggled with more short-term economic variation as well.
Forth lesson: with whatever revenue source you have, excepting somewhat property taxes, there is going to be significant volatility.
Whether income or sales are more or less volatile in the short- and long-runs, the essential fact is that they are both volatile and mechanisms for smoothing, rainy-day funds if you will, are necessary if the government really wants to reduce volatility significantly. Sales taxes will not do it. A rainy day fund requires restraint when revenues are high and a reserve to draw on when times are good.
So finally what I am left with is a belief that diversification of revenue sources may help somewhat but that volatility is simply not a particularly compelling case for sales taxes.
20 comments:
I will post specifically on the issue next. But I feel we are going around in circles:
I claim that it is not hard in theory to devise EICs for exapmle that make the tax system progressive, even if there is a sales tax. I agree and have from the start that a sales tax without such credits is regressive.
I believe you are saying that in practice it is unlikely such credits will be made significant enough to correct the regressivity of the sales tax due to political reasons and thus a sales tax should be opposed from the outset. You may well be right about that, Oregon's income tax system would have to be made much more progressive and that may end up being too hard.
The Washington state example is exactly what you would expect and what the research all the way back to the fifties told us: a sales tax alone, even with exemptions, is regressive. It has to be coupled with credits to make it (or more accurately the tax system in general) progressive.
I am beginning to think (as the post hopefully makes clear) - and you may be way ahead of me on this front - that whatever political will there is to change the system should concentrate on a permanent rainy day fund rather than sales taxes. I am still slightly in favor of diversification if possible with the addition of a sales tax, but only with the requisite income tax credits. But this could change as I do more research. I do find the federal deductions argument compelling, so I have to think about that some more too.
I do not have a dog in this hunt, by the way. I want to see the best way to achieve stability.
OK, one last try:
Suppose you have an economy with three households, each have incomes as follows:
1 - $1000
2 - $2000
3 - $3000
Suppose, for the sake of argument, that household one spends 40% of their income on taxable items, 2 spends 25% and 3 spends 10% and that the sales tax is 5%.
In this case sales tax revenue from each household makes up 2% of 1's income, 1.25% of 2's and .5% of 3's. So it is regressive on this metric.
Now suppose income taxes are levied as follows: 5% for 1, 7% for 2 and 9% for 3. (This can be either through straight marginal rates or by using credits - doesn't matter) Then total tax spending (for both taxes) by each household as a percentage of income is now: 7% for 1, 8.25% for 2 and 9.5% for 3. Voila, progressive overall tax structure (again using this basic metric).
OK, I am giving up now. I created an extreme case to make a point. Adjusting the percentages in the direction you suggest would only mean I have to make income taxes less progressive to correct - in other words makes my point even more easily. You are resorting to fighing the hypothesis.
As I have said now several times, only when combined with income tax credits (or a more prgressive income tax structure) can a sales tax be made progressive (or if you wish - part of an overall progressive structure). I have just shown you how and I think I have made my point.
Darrel,
I do understand your point and I addressed the semantic problem before in the commentary you and I are having and have agreed that you must couple a sales tax with credits - exemptions are not enough. But to say it is not possible to have a progressive tax system that includes a sales tax is wrong.
Thank you and curse you Jeff Alworth!
No problem. Call me the Gas Man.
Now, onto the general discussion, I have just a comment or two. It's interesting to pore through the discussion in one read, rather than a point-by-point. I tend to be able to keep the issues straighter this way.
Darrel, you point is that in no case would a sales tax add stability to funding streams, and it would almost certainly add regressivity. You add, unneccessarily, that I am a pawn for ideologues who pine for a sales tax. We'll leave that aside for now, but it's flatly wrong--I have invariably argued against a sales tax until seeing these posts.
To your argument, though, I see no evidence of a theoretical barrier. Patrick offers a progressive structure in two or three comments that would create progressivity. Your dispute is with the practical applicability of the system
However, it's important to note that in a 2003 report by the legislature--I haven't done the research on more recent data--when they looked at all taxes and fees paid by taxpayers, Oregon had an almost perfectly flat tax structure. As I recall, everyone paid about 10%, give or take a percentage.
Since increasing progressivity and reducing instability are the goals, we must consider the current system a failure in both metrics. Yet Patrick's policy fix "might mitigate the downturn in government revenue during an extended downturn in the economy" and would improve progressivity.
What alternative structure would you offer?
For the sake of argument, an example of a progressive sales tax in actual use is proabbly the luxury tax signed by Bush I in 1990. "The tax added 10 percent to the cost of recreational boats priced at more than $100,000, furs that cost more than $5,000 and new cars that sold for more than $30,000." (Quote from Mark Albright in the St. Petersburg Times) Most of it is gone now and I have not seen an economic analysis of this tax, but I suspect it would be considered progressive by most metrics.
Darrel,
Which is, of course, completely beside the point. Once again, you change the subject when you get an answer that you can't argue against. You asked for an example of a progrssive sales tax, I give you one, and so you move on to overall revenue collection and job losses as if one thing had anything to do with the other. I now see that you are not interested in having a substantive discussion about one topic, but are more interested in scoring points and having the last word (I have no doubt you will respond to this) - but I don't find our exchanges productive and am choosing not to participate further.
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