Bryan Caplan  

Why Do Sales Taxes Exist?

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Mankiw's post on AMT reform reminds me of yet another simple challenge to the rational, selfish voter model: Since we can deduct state & local income and property taxes on our federal income tax, but not state & local sales taxes, why do sales taxes still exist?

After all, a state could abolish its sales tax, increase the income tax enough to equal the lost revenue, keep spending levels the same, and let the federal government write refund checks equal to roughly 1/3 of the tax increase.

You could say this is too simple, because sales taxes weigh more heavily on the poor. But (a) this is exaggerated, because a lot of states exempt necessities from the sales tax, and (b) you could compensate for the problem by cutting income taxes in a progressive way.

Anyone care to meet my challenge? Why would rational, selfish voters keep sales taxes at the state & local level, when the feds only allow deduction of income and property taxes?


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CATEGORIES: Tax Reform
Twitter: Bryan Caplan @bryan_caplan



COMMENTS (24 to date)
Brad Hutchings writes:

They are fairer and more enforceable. If the free market can't for whatever reason, provide some particular good (highways, water infrastructure, parks, etc.) I would much rather see a dedicated sales tax (which everyone pays) vs. a property or income tax add-on which just a few pay. A couple examples... gas taxes earmarked to highways, special local sales taxes earmarked to roads.

"Measure M" is a popular example in The OC. Honestly, I wouldn't mind if everything in city and county government were funded with a special sales tax earmark that comes to vote from time to time. Maybe even state too. On top of the general budget, it probably ends up freeing up road money for other things, but government budgets are just screwed up. But when you drive over poorly maintained roads for awhile, you can see where support for a dedicated sales tax comes from.

Rob writes:

Perhaps sales taxes remain in order to collect revenue from out of town visitors.

ErikR writes:

Don't you have to itemize deductions to deduct state income tax on your 1040?

What percentage of taxpayers itemize?

Daniel Lurker writes:

http://www.irs.gov/newsroom/article/0,,id=133209,00.html

Oddly, for two years there was a choice taxpayers faced between deducting income and sales taxes. Any insight into that puzzle? The IRS notes that residents of Alaska, Florida, Nevada, S Dakota, Texas, Washington and Wyoming were the main beneficiaries, since those states have sales, but not income taxes.

Jody writes:

What Daniel said: the discussion is moot now as sales taxes are now deductible. So the discussion should be one of why didn't they agitate for a change in the past?

mike writes:

Deductibility reduces the cost of income and property taxes to those who itemize. It does not reduce their cost to zero. Just because something has a higher price does not mean that none will be purchased. Pretty simple economics here. If income and property taxes were given full credits and not deductions, it would be a different matter, of course.

Mike writes:

Daniel,

The IRS link indicates that you have the option of deducing either sales or income/prop taxes - so it is not exactly what Brian is mentioning.

My answer to his inquiry - status quo - since things have always been that way, no one really cares enough to see them changed, even if it is in their best interest. I guess that's irrational however, so maybe I didn;t answer the question.

theCoach writes:

easy answers to easy questions - voters are not selfish and rational in the economic sense.

John Thacker writes:

Oddly, for two years there was a choice taxpayers faced between deducting income and sales taxes. Any insight into that puzzle? The IRS notes that residents of Alaska, Florida, Nevada, S Dakota, Texas, Washington and Wyoming were the main beneficiaries, since those states have sales, but not income taxes.

Insight? Well, the obvious one that those states are heavily represented by Republicans, and Republicans had a majority. Hence, since the allowing deductions of state sales taxes was both fair and self-interested, it's not surprising that it passed.

Just as it's not totally surprising that after years of saying that households making $100,000 or more per year are "rich," suddenly the Democrats have decided that they're middle class and deserve relief from the AMT.

However, Professor Caplan, not only is the sales tax more efficient, but many of the states which have sales tax but no income tax are precisely those that do NOT exempt necessities from the sales tax. (The exemption for sales tax on clothing, for example, is something that I associate with high-tax states.)

Also, self-interested voters may believe that income taxes are much more likely to be raised in future years than sales taxes.

Don Robertson writes:

The basic misconception is that tax structures are in any way rational. They are, but not from the perspective of those who pay taxes.

All taxing entities are run like public schools, i.e., they spend every penny they get or they get penalized in the next fiscal year by a deduction in their budget. All taxing entities are the same in this respect.

The assertion here is that because sales taxes are not tax deductible on the federal form, we should assume that the federal government has some surplus tax revenue in some lock box some where, but of course that's non-existent, because it got spent.

And, from the perspective of the state, sales taxes are merely revenue, which of course must be spent, for if they ran a surplus, some reformer would come along and want to take it away, say by repealing the sales tax. But don't worry, it got spent, so there's no need of any jack-booted tax reformers.

The rich/poor scenario has but a minimal effect upon tax policy, and lord knows the states aren't looking at the federal government's take and saying, "Ya know, we could save our citizens a pile..." Oh sure, historically there have been some gives and some takes based upon this rich/poor equation, and even at how the differences between state taxes and federal taxes fleece the taxpayer more-better and less-better, but in the end, government spends it all anyway, always increasing tax revenues with every popular proposal, like screwing all those annoying smokers.

In Canada they put into place a national sales tax, the GST. It was voted in very popularly on the premise it would remove the necessity for all the Provincial sales taxes and lower property taxes at the same time. Perennially, similar national sales tax proposals based upon the same premise arise in this country, but, beware and learn from the lesson of the neighbor to the north. The GST didn't eliminate the Provincial sales taxes or lower property taxes. Ottowa simply spent it all in spades.

The "fat" tax is being bandied about, but, if I had my way, we'd see a tattoo tax in the stratosphere. I'm an old guy, but I still like to look, as if it's one of my inalienable rights, but damn! I've seen enough tattoos on what I'm looking at to last me three lifetimes. I can't go to the beach anymore without slipping into utter catatonic despair.

Maybe we should levy a tax upon immigrants enough to pay off the national debt? Let's see. 10 trillion divided by 10 million... That's only a million bucks a piece.

Now, that's a do-able tax proposal! There has to be ten million people in the world who would pay a million bucks to live here so they can look at all our teenaged daughters!

Nah. Bad idea. The federal government would just spend it, and it would simply amount to a vast increase in dirty old men leering at our daughters.

That's the rational behind tax policy, or at least as cogently as I can explain it.

Don Robertson, The American Philosopher
Limestone, Maine

An Illustrated Philosophy Primer for Young Readers
Precious Life - Empirical Knowledge
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http://www.geocities.com/donaldwrobertson/index.html
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RogerM writes:

Income taxes go to the state, while sales taxes go to cities and counties. Sales taxes are the only incomes for most cities/counties. States don't care much about city/county government, and cities/counties don't trust state legislatures to share their funds. Besides, if enough states went with an income tax, the feds would eliminate the deduction.

Jake writes:

I agree with theCoach, to an extent. Individuals, recognizing their vote probably will not have a significant effect on the outcome, are more apt to vote for what they truly feel is "just" instead of what they feel will benefit themselves. Obviously, there are significant exceptions.

fiona writes:

RogerM. In Florida, where there is no state income tax, sales taxes largely go to the state, with additional portions levied by the local governments going to them. Local government is financed by property taxes. I believe that in Florida's case, the theory is that all those tourists are paying. Food (very narrowly defined) is exempted.

Re: the AMT - Anne Althouse had a post in which she reminded us that state income taxes from "blue" states are typically very high and are not exempt from AMT calculations, so the Democrats change of heart makes perfect sense in view of their constituency.

mobile writes:

Sales taxes tax consumption. Income taxes tax work and investment. Even if the sales taxes are not deductible from federal tax returns, a sales tax could still be a better way of generating revenue.

Bill Conerly writes:

Back in old days, all state & local taxes were deductible. Fed govt needed more money, so they looked at limiting deductibility. Head of Senate Revenue Committee at the time was Bob Packwood of Oregon (my state). Oregon did not have a sales tax, so Bob said, let's make the sales tax non-deductible. This was pure constituent interest on his part. Why didn't states change their tax system in response? Fear of the unknown. Everyone seems to fear that the total size of revenues will move adversely (liberals fearing a reduction, conservatives fearing an increase), and many seem to fear an adverse change in distribution. So it's fear of change keeping us as we are.

Miracle Max writes:

Following thecoach, since the model of rationality is pinched, unreal, and laughable to begin with, it should not be surprising that behavior does not conform to it. Mystery solved.

Usually, you can deduct sales taxes on your state income tax, but it's the pre-deduction liability that gets deducted from your Federal income tax.

Which means if I've paid X amount in sales taxes and have Y amount in state income tax liability, I only pay Y - X to the state, but I get to deduct Y in its entirety from my Federal income tax... so even though I don't have a line item on my Federal taxes to specify my state sales tax deduction, I still get to deduct it because it's included in my state income tax deduction.

R.J. Lehmann writes:

The option to deduct state and local sales taxes instead of income taxes was a part of Bill Frist's "trifecta" bill earlier this year that looked to bundle estate tax repeal with a minimum wage hike and various other tax provisions, all coming out of the pension bill negotiations. Estate tax repeal is dead, but a bunch of the other smaller tax provisions could see enactment during the rump session.

And yes, the option of greatest interest to states like Florida and Texas, where there is a sales tax but no income tax. And Florida would seem to provide the ultimate justification for why a rational voter may want a sales tax -- if it's a place where the number of tourists are great enough that a significant portion of the tax is borne by people who don't actually live there.

kenshi writes:

As for why sales taxes still persist to the present, I think there are two basic factors at work:

1) Unique legal situations: A state income tax is strictly unconstitutional in Washington state, despite numerous attempts to amend the state constitution to allow it. Washington, therefore, still has a high sales tax and high business & occupations excise tax, but no state income tax.

2) The Goldilocks Principle: Once a tax or regulation has been allowed, there is a tremendous vested interest on the part of government to keep and expand it regardless of whether or not it makes sense to do so. In fact, I can't think of a single example of government willingly surrendering a source of tax revenue prior to being forced to do so via technological obsolescence or general revolt of some sort. Once any sort of tax is approved, it's almost impossible to get rid of.

Bob Knaus writes:

The majority of taxpayers take the standard deduction, rather than itemizing. That's because the standard deduction is worth more, for most.

If you add standard-deduction taxpaying voters and non-taxpaying voters, you come up with quite a large majority for whom the state tax scheme has no federal tax consequences. Thus, the variety of state tax schemes.

Dr. T writes:

State sales taxes can be deducted from federal income taxes. In a state such as Tennessee (no income tax, 9.25% sales tax), the deductions can be quite substantial.

The problem you referred to occurs in states with both income tax and sales tax such as New York. It would make more sense to switch to all income tax or all sales tax and decrease the federal income tax burdens of state residents. I have lived in three states with both taxes, and the idea of dropping one to lower the federal income taxes of residents never came up in polital discussions.

Scott Wood writes:

Offhand, I would oppose switching to an income tax because income taxes seem to be easier to raise.

smili writes:

with a sales tax revenue increases with economic spending. incentives are in place within the tax code to preserve and promote a good economic environment.

property or asset taxes are less responsive to economic conditions.

from a rational perspective, I like a tax that encourages saving (perhaps owning a home). and while spending is not to be discouraged, I like that a sales tax rewards those who save (or those who do not spend).

dr writes:

I don't believe most states allow a deduction of sales taxes from their income tax. And it is certainly the case that in many if not most states the sales tax is primarily or entirely a state revenue source.

I believe the answer as to why the sales tax remains is threefold. As mentioned above, government inertia (well, let's not limit it to government--institutional inertia) plays a large role. And exporting the tax burden is a plus in everyone's mind; that's more effectively accomplished in most states, I would guess, with the sales tax.

Lastly, and maybe more significantly, the sales tax is the most invisible tax of the three major taxes--sales, income and property. Everyone knows their property tax bill. And once a year, everyone sits down and calculates to the dollar the income tax they paid the prior year--even if you don't have to write a check for the full $10,000, you are aware it's been paid over the course of the year. But the sales tax--quick, how much in sales tax did you pay last year? Most people don't have a clue, and most people aren't really even aware of it when they're out shopping.

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