Sales Tax on Services Would Not Lessen Tax's Regressiveness Library: BIZ Keywords: TAX EARNINGS REGRESSIVE ECONOMICS POLICY RESEARCH INCOME SERVICES Description: Sales taxes are widely regarded by economists as regressive in that lower-income families generally pay a higher percentage of their income in sales taxes than high-income families.
Sales Tax on Services Would Not Lessen Tax's Regressiveness
Sales taxes are widely regarded by economists as regressive in that lower-income families generally pay a higher percentage of their income in sales taxes than high-income families.
Based on the assumption that purchases of services increase with increased income, some have argued that the regressivity would be lessened by widening the sales tax to apply to a variety of services. But a study by University of Nebraska-Lincoln senior Bree Dority O'Callahagan challenges that premise.
Writing in the May issue of Business in Nebraska, the newsletter of UNL's Bureau of Business Research, Dority O'Callahagan said she found little change in the percentage impact of Nebraska's sales tax on low- vs. high-income families when sales tax was added to selected services.
An undergraduate research assistant in the bureau, Dority O'Callahagan used figures from the U.S. Bureau of Labor Statistics to show that sales taxes paid as a percent of income in 1999-2000 regressed from 3.7 percent for Nebraska families earning from $5,000 to $9,999 per year to 1.3 percent for families earning $70,000 or more.
The senior economics major from Kearney then examined the data to see how purchasing patterns for selected goods and services change with increased income.
"The common belief is that demands for services increase as incomes rise, but the data tell a different story," she wrote.
"Both low- and high-income households consumed approximately the same percent of services relative to their incomes. It was, however, the demand for different types of services that changed at the various income levels. In relative terms, low-income families may have required more household rental equipment, but less garden and lawn care services, while the reverse may have been true for high-income families. The net result is balanced, and the proportion of income spent on total services is nearly constant across the income distribution."
When Dority O'Callahagan added a hypothetical 5 percent sales tax on selected services (excluding personal and medical services), the percent of income paid in sales taxes increased to 2.3 percent for high-income families and 6.5 percent for low-income families -- almost exactly the same ratio as there is without the tax on services.
"Broadening the tax base to include services is unlikely to impact the high-income families who, supposedly, spend relatively less of their income on taxable goods and more on nontaxable services," Dority O'Callahagan concluded. "Taxing services would not balance the tax burden."
She also cited figures from the National Telecommunications and Information Administration that indicate that Nebraska's sales tax could become even more regressive with increased Internet purchases.
Approximately 19 percent of U.S. households with annual incomes ranging between $10,000 and $15,000 have access to the Internet, compared to 85 percent of households with incomes of more than $75,000. Further, 49 percent of high-income Internet users purchase goods or services online, compared to 26 percent of low-income users. Meanwhile, the Internet Tax Freedom Act prohibits state and local governments from taxing Internet access and collecting sales taxes on Internet sales unless the retailer has a physical presence in the state or locality.
"If these Internet trends at the national level are similar in Nebraska, then high-income Nebraska households with greater access to the Internet would purchase more items via the Internet than those with low income," Dority O'Callahagan wrote. "As a result, low-income households would bear more of the sales tax burden, further increasing the regressivity of the Nebraska sales tax base.
"Perhaps before further changes in sales taxes are passed, reexamination of who will ultimately bear the burden should be considered."
Contacts: Charles Lamphear, Director, Bureau of Business Research, (402) 472-7928 (flamphear1 at unl.edu) or
Bree Dority O'Callahagan, Undergrad Research Assistant, BBR, (402) 472-8730 (bocallag at unlnotes.unl.edu)
The April issue of Business in Nebraska can be downloaded in Adobe Acrobat PDF format from the Bureau of Business Research Web site (www.bbr.unl.edu
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