A Survey of Sales Tax Exemptions in the States: Understanding Sales Taxes and Sales Tax Exemptions

We analyze the choice politicians face when seeking votes from groups that lobby for sales tax rate decreases or from groups that lobby for certain tax exemptions, given the constraint that each politician wants to raise a certain amount of revenue. Using the application of sales taxes and sales tax exemptions we develop a model predicting a positive relationship between the number of sales tax exemptions and the sales tax rate. We find support for this hypothesis. A one-unit increase in the number of exemptions is associated with an increase between 0.10 and 0.25 percent in the sales tax rate. Our results provide one explanation of why estimates of revenue increases generated by a sales tax increase are often too optimistic.

Politicians face conflicting demands from diverse constituent interests. When maximizing their vote share in elections, they attempt to balance these demands. A good example of these conflicting demands concerns taxes. Some constituents want taxes raised on certain groups, while those groups on whom taxes are levied exert pressure to have their taxes lowered. For instance, some groups want high corporate taxes, while corporations prefer low taxes. However, politicians have tools to satisfy both groups: that is, they can support increases in tax rates while also supporting exemptions or loopholes that effectively lower tax rates.

This paper analyzes the practice of balancing sales taxes and sales tax exemptions, given the constraint that politicians want to raise a certain amount of revenue. We study the equilibrium relationship between the sales tax rate and the number of sales tax exemptions in a state. This study is motivated by the theory that those whose taxes are being raised have an incentive to lobby for tax exemptions. Thus, as tax rates rise, so could lobbying activities, and so  could tax exemptions.

Sales tax revenue can be an important component of a state’s total revenues. Its share of the total revenue ranges from zero for states that do not levy a sales tax to 44 percent for states like Washington that rely heavily on sales taxes. For each state, the sales tax revenue is determined by the sales tax rate, the level of economic activity, and the prices of the goods transacted. While sales tax rates are more or less uniform among states, the goods and services exempted from taxation and the administration of sales taxes vary greatly from state to state.

For this study, we compiled an inventory of all sales tax exemptions for all the states that levy a sales tax, together with an extensive background on how the states implement sales tax exemptions. This inventory is the starting point for a quantitative analysis of the impact of sales tax exemptions on sales tax rates and revenues across states. We show that there is a positive and statistically significant relationship between sales tax rates and sales tax exemptions, which is consistent with our theoretical model.

The next section introduces the conceptual framework for analyzing the relationship between sales tax rates and sales tax exemptions. The third section provides background on the variety of sales tax rates as well as the types of sales tax exemptions across states. The fourth section describes the methodology we used to collect and classify the sales tax exemptions data. The fifth section presents the data analysis, and we conclude in the final section.

Continue reading

To speak with a scholar or learn more on this topic, visit our contact page.