Tuesday, June 24, 2008

For the Love of the Sales Tax

In general, Utah’s legislature loves the sales tax. The reasons are fairly simple to understand. First, the sales tax is a tax on consumption and is therefore inherently regressive. In other words, the higher your income, the less of a percentage of that income goes to consumption, and therefore, to sales tax. Utah’s political leaders have generally had the idea that the way you gain economic growth, is by taxing the poor and exempting the wealthy, therefore freeing up money from the wealthy that can be invested in Utah’s economy. The obvious flaw in this logic is that investment capital is highly mobile. Savings from reduced tax burdens on the wealthy can just as easily flow out of the country to fund Chinese manufacturing as they can to home-grown businesses. Investment capital may also go to fund government bonds, used to cover the deficits created by reduced taxes on the wealthy. So I’ve made my point, back to the sales tax.

The sales tax from a political perspective is popular with lawmakers for the same reason fees are. It is because you pay a lot of them out, but you do so piecemeal and therefore don’t really internalize exactly what your tax burden is. People don’t adequately quantify how much they pay in taxes and fees that are taxed piecemeal, whereas they see quite clearly what their property tax and income tax burden is for the year.

Now there are some good things about the sales tax and consumption taxes. If your state or locality that assesses a sales tax is dependent upon the tourism industry, the sales tax is a great way of harvesting into this industry to pay for roads, infrastructure, parks and other things that reinvest back into tourism or to your citizen’s quality of life. It is no coincidence that states, such as Hawaii, which rely heavily on tourism, also use the sales tax as a major funding source. Even states with a modest tourism industry will often put extra taxes on hotels and other forms of lodging. Utah is one such state that imposes that kind of tax.
In Utah, the sales tax is a “staturory tax” which means exemptions to the sales tax can be passed through a simple bill through the legislative process, signed by the Governor. As a result, exemptions are constantly being bandied about for whatever interest group approaches the legislature. In Utah, the “manufacturers” exemption is one of the big exemptions which alleviates investment in business plant and equipment from facing a sales tax. There are a bunch of other exemptions, that every once in a while, a brave reformer will seek to repeal, but will usually find that the political will behind the repeal isn’t as great as the donations that come to those who support the exemption. As usual, farmers don’t pay any sales tax on farm equipment. As mentioned before, farmers don’t pay taxes, they receive them.
That being said, the Utah Legislature in a surprise move, did eliminate 50% of the sales tax on food (not food bought in a restaurant) which makes the sales tax less regressive than it had previously been. Though still slightly regressive, half of the most regressive aspect of the sales tax was statutorially eliminated by the legislature.

There are a couple of hazards from relying too much on the sales tax. First of all, consumption can be highly variable, and as a result, dependence upon the sales tax can create budgetary problems for governments which depend upon them. The sales tax is generally not deductible on your federal income tax as is the property tax and state income tax. Over-reliance upon the sales tax therefore increases the tax burden of Utahns to the federal government. Utah’s moving away from property tax on vehicles to fees on vehicles had pretty much the same effect, a decrease or increase in state burden (depending on whether you own a Mercedes or a Hyundai), and an increase in federal income tax (assuming you itemize deductions on a schedule A). When I address Utah’s income tax, I will address this further and in greater detail.

The sales tax, and particularly a local jurisdiction's dependence upon it, gives retailers a very strong bargaining chip when dealing with local government. That Walmart you may not want in your neighborhood, brings with it tax revenue that may be critical for your city. The location of that Home Depot, plus or minus 1/4 of a mile may determine where those tax revenues go. Reliance on the sales tax by local entities can skew the relationship commercial developers have with local government in ways that are unhealthy and imbalanced. Something to think about in the trade-off between development and having quiet neighborhoods.


Jeremy said...

Seriously...thank you for your tax posts! This is the kind of important stuff that often gets passed over.

Obi wan liberali said...

Thanks Jeremy. I studied tax policy in college as part of my economics degree. I've always been fascinated by Utah's tax policy issues.