Researchers explore economic impacts of expanding sales tax to include services
Revenues generated by the state's sales taxes make up the lion's share of the Utah's general fund.
In fact, sales taxes accounted for 87.6 percent of the state's general fund in 2003.
The monies are used to fund general government activities and higher education.
In Utah, the sales tax base is mainly derived from the sales of tangible goods, while most services are exempted.
The exemption of services was originally not a conscious policy decision when the state's sales tax was enacted in 1933, explained a recent research brief released by Utah Foundation.
Instead, the exemption was basically a result of services representing only a small fraction of total consumer spending at the time.
However, the Utah and United States economies have changed significantly during the last 30 years.
Calculations based on the National Income and Products Accounts table on U.S. personal expenditures show that, since 1980, household service expenditures have climbed from 48.2 percent of personal consumption to 59.4 percent.
Within the same period, expenditures on tangible goods have fallen from 51.8 percent to 40.6 percent of household expenditures.
The trend of personal consumption toward services is likely to continue, noted the independent public policy organization.
The situation, in turn, will further erode the current sales tax base in Utah, noted the foundation.
According to University of Tennessee economists Donald Bruce and William Fox, Utah's sales tax base is not keeping pace with the state's economy.
The researchers estimated Utah's long run sales tax elasticity to be 0.873. The figure means that, for every 1 percent growth in personal income, sales tax revenue expands by 0.873 percent.
In addition, the University of Tennessee economists determined that Utah's short run sales tax elasticity was quite volatile.
During economic expansions, the short run elasticity was 1.780, meaning that the tax base expands faster than the economy.
However, during economic downturns the short run elasticity was -1.544, indicating that the tax base was contracting more than the economy.
The negative elasticity stems from the fact that personal income is almost always increasing, and that when personal income growth falls below expectations, revenue growth is negative. While this trend is acceptable when revenues exceed expectations, the state can often be unprepared for revenue shortfalls due to the lack of stability of revenues
Most states, including Utah, have partly broadened sales tax base to include some services. But only Hawaii, New Mexico and South Dakota tax services comprehensively. The Federation of Tax Administrators estimates that most local governments tax less than one-third of service categories. According to the federation's 1997 survey, Utah levied sales taxes on 22 of the 40 identified services purchased predominantly by households.
One of the major arguments for expanding the sales tax to include services is the revenue potential from the extension. A study by Michael Mazerov of the U.S. Center on Budget and Policy Priorities calculates the revenue potential of expanding the sales tax to household services to be an increase of 23 percent of current revenues. However, the calculations do not account for the fact that Utah already taxes some household services.
In addition to increasing revenues or reducing the rate, expanding the sales tax would prevent a continued erosion of the state's revenue base by capturing the shift of consumption to services.
While only a limited comparison, the University of Tennessee study found that the states that tax services comprehensively had higher long run tax elasticities than Utah. A comparison of state sales tax revenues as a percent of personal income seems to corroborate the finding. The trend lines indicate that Utah's sales tax revenues as a percent of personal income are declining relatively quickly.
New Mexico and South Dakota experience slightly upward facing trend lines, while Hawaii has experienced a slight decline, which may be attributed to Hawaii's long running economic recession in the 1990s.
According to Kirk Stark in an article for State Tax Notes Magazine, including services in the sales tax could have the effect of stabilizing tax revenue. The claim is based on the assumption that services are less prone to the cyclical nature of the economy, therefore mitigating the revenue shortfalls during economic downturns. Utah is particularly vulnerable during economic downturns and a comparison of short term elasticities indicates that states that tax services comprehensively are less prone to revenue shortfalls.
In principle, the association pointed out that the sales tax is intended to be an assessment on household consumption. However, as the number of services being offered in the state's economy has increased, so has the variability in the amount of sales tax that households pay within similar levels of consumption. Households that prefer to spend disposable income on goods can end up paying a greater amount of taxes than families choosing to devote a similar amount of disposable income to services. Also the number of services that can act as close substitutes for tangible goods has been steadily increasing and, if prices are similar, consumers will avoid the tax by opting for the service. Therefore, broadening the base to include services will distribute the tax burden more fairly, regardless of consumption preferences.
The sales tax is generally regressive in relation to taxpayers' income. Lower wage earning households tend to consume a larger percentage of incomes. Lower wage earning households also consume more goods and less services than higher income households.
Proponents of extending the sales tax maintain that broadening the base will allow for a reduction of the overall rate and thereby reduce the amount of sales tax paid on necessary item like food. However, the research conducted on the topic does not seem to indicate that extending sales taxes to services significantly reduces regressivity.
A 1990 study by Minnesota economists found that consumption of services like water, sewer and personal care comprised a higher percentage of expenditures for people with low incomes. Nevertheless, the study and other research projects determined that expanding the base is unlikely to make the sales tax more regressive, concluded the independent public policy organization.