Key Takeaways
- When thinking about taxes, we often consider the tax rate—or what percentage of something is taxed. But there is another factor in considering taxes: the tax base.
- The tax base is what gets taxed: income, sales, property, etc.
- If a tax base is too narrow, a higher tax rate is needed to raise the same amount of revenue for government services. Conversely, a broad base that applies to more activities, income, goods, or services allows for a lower tax rate to generate the same amount of revenue.
- Narrow tax bases can cause people and businesses to make decisions for tax reasons that they might not make otherwise, like saving less money or hiring fewer workers. This can be harmful to the economy, individuals, and businesses alike.
- A great example of differing tax base design can be found in state sales taxes.
- A sales tax base includes everything we buy that is subject to a sales tax.
- When states exempt goods or services from the sales tax, they narrow the tax base.
- Goods and services that are commonly exempted or excluded from state sales tax bases include groceries, streaming services, and even haircuts, but each state approaches this differently.
- When a sales tax base is too narrow and the tax rate increases, each good or service purchased becomes more expensive.
- A broad base paired with a low tax rate is a stable and neutral way to raise revenue to fund government services
Transcript
How high are my taxes?
When people ask this question, they’re usually asking about the tax rate – or what percentage of something is taxed.
But there’s another piece of the puzzle, called the tax base, that’s just as important. The tax base is what gets taxed – like income, property, or the stuff you buy.
If the tax base is not designed properly, like when some things are taxed at a high rate while other things are not taxed at all, the tax code can cause people and businesses to make decisions for tax reasons that they might not make otherwise, like saving less money or hiring fewer workers.
Tax distortions like these hurt individuals, businesses, and the economy. Let’s take a closer look at how the tax base works using sales taxes.
The sales tax base contains all the stuff we buy that’s subject to a sales tax. The more consumer goods and services that are taxable, the broader the base.
But many states exempt things like groceries, streaming services, and even haircuts, which narrows the base.
If a state’s base is too narrow, it needs a higher tax rate to raise the same amount of revenue, making those purchases more expensive.
If a state broadens the sales tax base by eliminating exemptions, then it can lower the tax rate and still collect the revenue it needs.
A broad tax base coupled with a low rate is a neutral and stable way for the government to raise revenue, while minimizing harm to the economy.
