The pros and cons of local sales taxes
Tomorrow, voters in a number of Minnesota localities will go to the polls to decide whether or not their locality can impose or increase its sales tax. Is this a good idea?
Let us start by addressing a normative question, fairness: are sales taxes fair? Well, that depends on your definition of “fair”; it’s a normative question, after all.
You can make an argument that sales taxes are fair in that they apply to all equally, unlike, say, the income tax, which levies very different burdens on different individuals. As I’ve noted before, the lowest-earning 20% of Minnesota’s households pay no state income tax, so a sales tax is one way of getting these folks to contribute.
For many, that isn’t “fair” at all; many people argue that taxes should be based on the ability of the taxpayer to pay. In this sense, sales taxes are unfair — they are “regressive” — in that they impose a higher burden on people with lower incomes. If you pay a sales tax of 5% on a $100 purchase, the $5 dollars is a larger share of a lower income than of a higher one.
This leads us to the next consideration: simplicity. A sales tax is pretty straightforward. Unlike the income tax with its multiple brackets, everyone faces the same rate.
In the interests of fairness, however, this simplicity is often compromised. Minnesota exempts many items from the sales tax, such as food, narrowing the tax’s base, with the intention of removing that regressive tax burden on people with lower incomes. Sometimes, higher rates of sales tax are imposed on “luxury” items such as yachts, which are only purchased by people with higher incomes. All this comes at some cost in terms of simplicity, but not much.
A final points relates to efficiency. Taxes levied on income from labor or investment incentivize you to work or invest less. This lowers the overall amount of production in an economy. Sales taxes do not have this effect. Instead, they incentivize you to purchase less (excise taxes on alcohol, for example, are levied with just this aim in mind). If the sales tax rate is uniform across all goods and services, production is not distorted. It can be, however, if, in the name of fairness, various different rates are imposed on different products.
All in all, sales taxes are not the worst way for a government to raise revenue. What must also be considered, however, in the individual case, is 1) how high are the other taxes the government levies? and 2) how high are taxes elsewhere? Especially in the case of smaller jurisdictions, such as those who are voting tomorrow, it is relatively easy for someone to shop somewhere with a lower — or no — tax, which they will be increasingly tempted to do if those taxes keep on getting higher. The real winners in tomorrow’s sales tax votes might be the neighbors.