A Final Treatise on Sales Taxes

In previous posts I have examined a number of aspects of sales taxes and looked for evidence that would shed light on the actual experience of sales taxes and different tax mixes. Unfortunately, the empirical evidence is scant and not terribly informative. This is not too much of a surprise as it is a very challenging research problem, you have to control for all of the things other than taxes that might affect state revenues, investment, employment, etc. and doing so is virtually impossible. It is frustrating, however, but as an economist I have a fall back: economic theory which can give some insight into expected affects of tax structure changes. I am now in a position to summarize what I have learned and what I now think about sales a sales tax for Oregon and why.

Before that, however, I have a few loose ends to fill in. The first is what George Zodrow of Rice University (who very generously sent me a copy of his book, “State Sales and Income Taxes: An Economic Analysis”) calls the "exportability" of a tax system: how well a state can export its revenue burden to residents of other states. Income taxes, as I said before have the nice feature of being deductible on federal tax returns (sales taxes have been added too in the past as a temporary measure, but you have to choose one or the other, so if we are talking about adding a sales tax along with income taxes, we loose a bit of the exportability). Deducting income taxes on federal returns shifts the burden a bit to residents of other states. But a lingering question is whether sales taxes can be good in the exportability criterion from the fact that non-residents spend money in Oregon.

I think Zodrow says it best:

The sales tax on consumer goods can be exported to the extent that such goods are purchased by out-of-state residents – primarily tourists and business visitors. This is not likely to be an important source of revenue for most states. In any case, if opportunities for tax exporting in this area are deemed to be significant, they can be exploited through the use of special taxes on hotel/motel occupancy, car rentals, and, to a much lesser extent on entertainment and admission to amusements.

To this I would add that a gas tax is also a big area in which we exploit these opportunities to export our taxes. Dean Runyan Associates does the Oregon State Travel Impacts studies for the state and I looked at their estimates. First, they report that many locales charge an occupancy tax for hotel/motel rooms – though these are local taxes, not state. They also report that food and retail spending together make up less than 40% of visitor spending. But in 2006 they estimate a total in excess of $7 billion spent in Oregon by out of state visitors – so perhaps there is room for some more specific taxes if not a sales tax in general, though we must be mindful that we are very dependant on tourism in this state and we would not want to impact it too much.

This brings me to another point, if sales taxes are enacted; will it hurt the tourism and retail sectors hard? I feel pretty strongly that they would not. I think the price elasticities would be low due to the fact that we would probably have a sales tax on the low end in the national spectrum, so we would not be abnormally expensive.

On the other hand, abnormally high tax incidences do worry me for the very same reason. So Oregon’s income tax rate, essentially the highest in the nation, worries me a lot. I have tried to
find evidence of the impacts and I have seen estimates of lower investment, job losses and increased expense for employers who have to compensate for the tax difference but overall impact on the economy is, in my mind, difficult to assess and I remain unconvinced by the evidence. But I am pretty strongly influenced by economic theory, however, which suggests that this should matter in investment and employment decisions.

Volatility is, as I said at length before, not reason enough to support a sales tax, as not much is necessarily gained by such a tax. The only real answer to volatility is either a rainy day fund, or (as was pointed out to me by Fred Thompson) allowing the government to engage in deficit spending during bad periods. The latter strategy has the appeal of not over saving which is inefficient. Equity is a concern, but income taxes have been shown to be a poor way to achieve redistributive goals (and may in fact be impossible because labor markets adjust). It is through ex-post transfers that equity gains are made in general, but we would have to be ready to devote a good portion of any sales tax to such an end if we are to avoid making our tax system more regressive.

So in the end, where do I stand? Well I would like to see a sales tax to lower the income tax incidence in Oregon. I would support it only if there were adequate exemptions and transfers that could assure we do not add regressively into the tax system. I would also like to see some type of permanent rainy day fund or the allowing of deficit spending. I think we could stand to gain much as a state in terms of investment and job creation from the lowering of the income tax and that boom and bust cycles in state spending are very inefficient. Any exportability we get from a sales tax will be countered by the loss in exportability from the lower income tax, and I don’t expect much in terms of volatility reduction except perhaps in extended downturns. I do think that, all else equal, diversification of revenue streams is a decent goal, but, more importantly, I think we should avoid being an outlier in any one tax dimension in the US.