Broadening the Sales Tax Base in Nebraska is the Right Idea

August 12, 2010

Nebraska state Senator Rich Pahls is at it again. He is planning to introduce legislation that would apply the sales tax to a yet-to-be-define list of currently untaxed items, while using the additional revenue to reduce the sales tax rate or other taxes. Pahls introduced legislation last year that would have eliminated all sales tax exemptions. It went nowhere.

Broadening the sales tax base and lowering the rate is a good idea and a move in the direction of sound tax policy. Services should be taxed. Groceries should be taxed. All end-user consumption should be taxed. There is no reason that entire sectors of the economy and swaths of consumption should go untaxed while others are singled out for taxation. Broadening the tax base allows the government to raise the same amount of revenue with a lower tax rate, which reduces distortions in the economy. Taxing all consumption at the same low rate keeps lawmakers from picking winners and losers in the market and ensures you will be taxed equally no matter what you choose to purchase. And on average everyone still pays the same amount of tax. In addition, a broadened tax base will likely help stabilize sales tax revenues, something you would think lawmakers would be concerned about considering the slump in tax revenues over the last few years.

That being said, while broadening the sales tax base is generally good, lawmakers need to be careful not to tax business to business transactions. These sales are not consumption and taxing them leads to double taxation and is economically damaging. Only end-user purchases qualify as consumption in the economic sense, and they are the only purchases that should be taxed under a general sales tax. Unfortunately, it is not clear that Pahls makes this distinction (expecially considering that last year he proposed to end all sales tax exemptions, even those for business inputs).

Unfortunately, this type of reform is seen as radical and a political non-starter. One reason is that people have concerns that changes such as applying the sales tax to groceries might unfairly or disproportionately impact the poor. Even Sen. Pahls seems reluctant to embrace this “emotional” reform.

First, remember that broadening the tax base allows us to lower the rate, so that everyone, poor and rich alike, will be paying a lower tax rate on their non-grocery purchases, offsetting some of the increased tax paid on groceries. Still, lower income people spend a disproportionate amount of their income on necessities like food, and they may very well come out behind even after accounting for the lower rate. Then I would recommend implementing or expanding food assistance programs (which provide free food, not just tax-free food) targeted at those who truly need it. The bottom line is that most of us can afford to pay sales tax on our grocery purchases. Exempting groceries for everyone is a very costly and indirect way of providing assistance to the poor.

One more quick note. First, Pahls has also proposed adding a sales tax holiday. Maybe this is an effort to win support for his broaden-the-base, lower-the-rate proposal, but it is a bad idea. Sales tax holidays are political gimmicks and have no place in a well-designed sales tax system.

Note: this post was edited slightly after the original posting.


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