CAN CUTTING SALES TAXES INCREASE SPENDING? EVIDENCE

FROM OHIO

BEN PASSTYJENNIFER PITZER

AUBER OCT. 9, 2011

Background and Motivation

State budget deficit How would increasing the state sales

and use tax 1 percentage point affect Ohio consumers?– State-Level analysis

Are consumers near state borders more likely to substitute out of state goods?

Ohio’s Sales and Use Tax

Ohio’s state sales and use tax has changed twice in the last decade– Temporary increase to 6% in 2004– Decrease to 5.5% in 2006

Changes in total spending and resulting tax revenues were disappointing after 2006

Data

Ohio Department of Taxation Data– Tax rates–Monthly tax revenues– By county– From 2000 through 2009

Data involve using tax rates and collections to calculate spending

Average Monthly Tax Revenues

YearSales Tax Revenues

2000 $ 490,742,3302001 $ 495,933,4802002 $ 505,259,2602003 $ 526,814,210

Average for 5 Percent Rate $ 504,687,3202004 $ 674,072,2502005 $ 666,903,210

Average for 6 Percent Rate $ 670,487,7302006 $ 634,120,1602007 $ 646,201,0702008 $ 630,348,9602009 $ 588,015,410

Average for 5.5 Percent Rate $ 624,671,400

Analyses

Aggregate monthly consumer spending– Account for changes over time– Seasonality– Changes to tax state level tax rate• 2 dummies for each increase

– 5 to 5.5%– 5.5% to 6%

Empirical Framework

We infer spending changes when collections and tax rates fail to vary proportionally– Cessation of spending– Transfer of Spending out of the taxation

zone Sources of Identification– Variation over time at OH state level– Variation across Ohio counties as a

panel

ResultsAR(3) models for Tax Revenue

($millions)

Forecasting Results

The incremental changes from 5% to 5.5% are clearly different than those from 5.5% to 6%

Possible expectations– Nonlinear relationship between Taxes

and Revenue (confounded by spending behavior)

– Omitted variable bias

ResultsImpact of the Recession (removing

2009; DV is tax revenue in $millions)

Another Source of Identification

Counties also levy sales and use taxes

Factors that could drive changes in county tax rates– Size– Bordering other states– Responding to state policy

(endogeneity)

Panel Results (Rev/Person)

Results

County Taxes can affect revenue, which means they must also impact spending

These are much smaller levels (around 1%), but they often increase 0.5% or more at a time (same as Ohio)

Could these rates be affecting our state-level results?

County Populations and Tax Rates

Border versus Interior Counties

Border versus Interior Counties

What about the Nine Largest Counties?

Comparative Tax Progression

Effective Tax Rates

Counties Raise Sales Taxes When

They do not fear losing sales to a rival state (because there isn’t one nearby), and

Their rates are low to start with, and The state is lowering rates

Conclusions

Local policy changes can obscure analysis done purely at the state level– One third of people in Ohio perceived

little change when the state cut its taxes in January 2006

– Interior counties were more likely to increase their tax rates

How to Increase Spending

Cutting sales taxes can increase spending…

If you find a way to prevent lower-level governments from engaging in a money grab by raising their own taxes