Legislators have been considering raising new — and necessary — revenue by expanding the sales tax base to include more goods and services instead of increasing the sales tax rate. This would be a good way to raise revenue if it is done in ways that make the tax more equitable. Still a broader sales tax would fall more heavily on low-income families. Legislators could limit the burden on those least able to bear it by coupling the sales tax expansion with a new, refundable sales tax credit.
The inequity of the sales tax
The original budget framework increased the state’s sales tax rate from 7 percent to 8.25 percent (and from 8 percent to 9.25 percent in Philadelphia). This proposal was opposed by many legislators. Some opposed any tax increase. Others worried that businesses near our borders with other states would lose sales.
A third group was rightly concerned that the sales tax places too much of a burden on those with low incomes. According to the Institute on Taxation and Economic Policy, the lowest-income 20 percent of Pennsylvania families pay an average of 5.8 percent of their income in sales tax. The top 20 percent, by contrast, pay less than 2.3 percent of their income in sales tax. And families in the top 1 percent pay only 0.6 percent of their incomes in sales tax.
A recent Pennsylvania Budget and Policy Center (PBPC) report demonstrated that an increase in the personal income tax raises revenue in a far more equitable way than an increase in the sales tax.
Advantages of broadening the sales tax
Instead of raising the sales tax, legislators considered broadening the base of the tax to goods and services presently not subject to the tax. There are better and worse ways to get more revenue from the sales tax. If we broaden the tax in the right way, and, in addition, add sales tax forgiveness for those with low incomes, the sales tax could be made more equitable than it is today.
Both liberal and conservative policy analysts have, for three reasons, supported broadening sales taxes to include a wider range of goods and services.
First, a broader sales tax raises more revenue without raising rates, which is attractive both economically and politically.
Second, a broader sales tax is fairer to different types of businesses than a tax on some businesses rather than others, when there is no obvious rationale for the difference.
And third, sales taxes applied to some businesses rather than others encourages greater consumption of untaxed goods and services than those that are taxed. This is a source of minor economic inefficiency.
A broader sales tax and inequity
Despite these advantages, broadening the sales tax by itself does not fix the inherent unfairness in the sales taxes. But, as PBPC has pointed out before, there are more- and less-equitable ways of broadening the sales tax.
A sales tax that excludes goods and services that are necessities, such as food, clothing, and health care, is more equitable, because low-income families spend a higher portion of their income on these goods and services than high-income families. Thankfully, Pennsylvania legislators do not seem to be considering including these items in the sales tax base.
A sales tax that excludes goods and services that are luxuries is less equitable. Lower-income families pay sales tax on laundry detergent and tax preparation software, but higher-income families don’t pay sales tax on dry cleaners and accountants. Many luxury services are exempt from sales tax: swimming pool maintenance and cleaning, health club memberships, spa and massage services.
Deomcratic legislators appear ready to subject a variety of forms of entertainment, amusement, and recreation to the sales tax. PBPC has shown that these services are taxed in most other states and that these taxes fall more on those with higher incomes. Data from 2007 shows that the top 20 percent of earners purchase more than half of all entertainment admissions. The bottom 20 percent of earners purchase only 4 percent of entertainment admissions.
Expansion of the sales taxes to entertainment, amusement, and recreation makes it a more equitable way to raise revenue. But it is important that symphonies, museums, and ski slopes are included as well as bowling allies, amusement parks, and campgrounds.
Sales tax expansion can be done in an equitable or inequitable way. And it is critical that exclusions from the sales be determined by considerations of equity, not by which enterprises have the best lobbyists or other connections to legislators.
Refundable sales tax credit
Broadening the base of the sales tax in the right way still doesn’t overcome the inherent inequity of this kind of tax. But we can make the sales tax fairer by offering a refundable tax credit for low- and moderate-income families. The sales tax credit would be based on the typical consumption patterns of families at different income levels — no one would have to save receipts to claim it. Families that do not have to file an income tax return would submit a separate form to receive their rebate.
A modest sales tax credit could offset the increase in sales taxes paid by low-income families as a result of broadening the sales tax base. A slightly larger tax credit would not only do that, but it would reduce the burden of the existing sales tax on low- and moderate-income families, taking an important step towards making Pennsylvania’s tax system fairer.
Broadening the sales tax base in the right way and adding a refundable sales tax credit would give Pennsylvania’s low- and middle-income families something for which to be grateful this holiday season.
Marc Stier is the director of the Pennsylvania Budget and Policy Center.