News

Is the Sales Tax a Healthy Alternative to Income Tax Collection for States?

By  | 

You don’t need to be told that taxes place a burden on your wallet. One look at your paycheck deductions or the extra sales tax siphoned off at the bottom of your receipts will give you a pretty good idea. But did you know that taxes also place an economic burden on more than just your wallet?

No matter the type, it’s a fact that taxation inhibits economic growth, and it’s up to states to strike a delicate balance between collecting the tax revenue they need while ensuring their economic prosperity.

Sales tax has historically been viewed as the least harmful taxation method to local economic growth. Let’s take a look at why sales tax holds less of a burden, and if it can realistically replace income taxes as a viable revenue-generating source for states.

Why Sales Tax Is Less of an Economic Burden

Sales tax impacts economic growth less because it is a broad-based flat tax, meaning everyone who makes a purchase has to pay the same amount. Traditionally, sales tax is also lower in rate than other taxes assessed, according to The Wealth of States (p. 88).

It’s important to remember, though, that sales tax does come with its own economic burdens, such as differences in rates that can cause shoppers to either shop online or cross state lines. However, these burdens are less than other taxes being assessed. For example, a high income tax rate disincentivizes paid labor, and according to a study reported in Wealth of States (pp. 82–84), states with high property taxes also exhibit underperformance in several key economic growth indicators, including population, net domestic in-migration, nonfarm payroll employment, personal income, and gross state product.

As of 2014, the highest average combined state-local sales tax rates were found in Tennessee (9.45 percent), Arkansas (9.19 percent), Louisiana (8.89 percent), Washington (8.88 percent), and Oklahoma (8.72 percent). Averaged together, states with the highest sales taxes outperformed states with the lowest sales tax burden in the same key economic indicators as listed above (pp. 85–86).

Is a Tax on Sales a Viable Replacement to Taxing Income?

As of Q4 2014, the average total revenue collected by states from sales tax and income tax combined stood at 30 percent and 41 percent, respectively. In order to make up that extra 41 percent of revenue, states will need to do two things:

  • Increase the Sales Tax Rate: Except for the seven states that already do not collect income taxes — Alaska, Florida, Nevada, South Dakota, Texas, Washington, and Wyoming — states changing their system will likely need to raise their current sales tax rate to fill the revenue gap.
  • Increase the Sales Tax Base: States may need to increase the number of taxed items to meet their revenue needs through sales tax alone.

Given that seven states already meet their revenue-generating needs without collecting a state income tax, replacing it with a sales tax appears to be a viable option. If your state is considering abandoning income tax for sales tax collection, you should take measures to understand exactly how this will affect you; it may even result in discounted federal income taxes for you and your family.

[cf]skyword_tracking_tag[/cf]

Amanda L. Grossman is the creator and owner of FrugalConfessions.com -- live a VIP life on an average paycheck -- where she shows hard-working people how to end anemic savings account syndrome and pay off debt years earlier than your creditors want you to without getting a second job or eating ramen noodle dinners. Amanda's area of expertise is in personal finance, and she has authored several personal finance articles for the Houston Chronicle, is a featured blogger at the Houston Chronicle, and has staff written for ReadyforZero.com Blog and RelayRides.com Blog (several of which have been syndicated to LifeHacker, Business Insider, and Yahoo Finance). She has a knack for taking seemingly complex, and irrelevant financial topics and making them accessible and meaningful to the average person. She, her husband, and their two cats (Lyla Bear and Danny Boy) live in a fixer-upper in Houston TX.