Local Sales Taxes
Local sales taxes are taxes on consumption of goods that are instituted by local governments such as municipalities, counties, and special districts.
Local sales taxes are sales taxes that are adopted, often after a referendum vote, by local governments. Thirty-eight states have local governments with local sales taxes in place. The laws that govern these local sales taxes vary tremendously state by state. In some states only counties are permitted to adopt local sales taxes; in others, only municipalities; and in some, counties, municipalities, and special districts. There are many possible and actual combinations of jurisdictions. Beyond those basic differences, there are also large differences in the state laws that regulate how these local sales taxes will function, what they will tax, and what rates are permissible.
Local sales taxes are now the second largest source of own source revenue for local governments in the United States, and their popularity and local government reliance on them are only growing. While they are nothing new, the first local sales tax was introduced in New York City in 1934 during the Great Depression. They did not become widespread until the 1970s, and even then only 25 states permitted them. While they have been a vital source of revenue for many local governments for many years, the literature surrounding local sales taxes has largely emerged in the last two decades, though there are notable exceptions. Today many aspects of local sales taxes have been studied including whether they are used to supplement or reduce property taxes, how volatile the revenue generated by local sales taxes is, the revenue-raising capacity of jurisdictions with regard to local sales taxes, and the factors that influence the adoption of local sales taxes.
State local sales tax laws by jurisdictional eligibility and discretionary authority
Areas of Research
The research on local sales taxes is a growing field of inquiry that spans many disciplines, research questions, and approaches. The majority of the research in this area is done via single-state analyses; this is likely due in part to the diverse and complicated nature of the laws governing local sales taxes. In addition to the majority of research being done at the state level, the majority of the research also examines county local sales taxes rather than municipal or some combination of jurisdictions. A third theme among the existing literature is that of those single-state analyses, the majority of them are conducted in the state of Georgia or Oklahoma. This last point is especially problematic given the differences in how local sales taxes are structured; although it is true for Georgia counties, it may not mean anything for West Virginia municipalities or special districts. Despite these limitations there is a great deal of valuable research and insights about local sales taxes that can be taken from this literature. This chapter will cover four of the more prominent and robust lines of literature and briefly discuss some of the other analyses of note.
First things first, what prompts some local governments to adopt local sales taxes almost immediately and others to never adopt? This is a topic that was first examined in the context of counties in Georgia in three separate analyses and examined from multiple perspectives including the effect that property taxes had on adoption, whether the effects of neighbors’ local sales tax adoption have an effect, and the ability to shift the local sales tax burden to nonresidents (Pajari 1984; Zhao 2005; Sjoquist et al. 2007). These analyses are followed up with additional state contexts and perspectives. For example, Luna et al. (2007) examine the final local sales tax adoption in Tennessee counties – this is novel because it is the first to recognize that many local governments will adopt more than one local sales tax. Another example is that of Burge and Rogers (2016) who examine the adoption of local sales taxes in Oklahoma from the perspective of leader-follower dynamics. A final example with this line of research is Afonso (2018) who examines Texas municipal local sales tax adoptions with a repeating events model and is the first to model multiple local sales tax adoptions. In general this line of research finds that being able to export burdens to nonresidents and the adoption of local sales taxes by neighbors and peers are important factors when understanding the adoption path of local governments.
A second important line of research within the local sales tax area is the relationship between local sales taxes and property taxes. This is not surprising since property taxes are the largest source of own source revenue for local governments and local sales taxes are the second largest. The first analysis to tackle this question utilized Georgia counties once again (Jung 2001). Similarly, there was a follow-up study also examining this relationship in Georgia counties (Zhao and Jung 2008). However the second, fourth, and fifth analyses used national samples (Sjoquist et al. 2005; Afonso 2014, 2015). The second used a national sample of large cities, and the fourth and fifth used a sample of counties from 35 states. The results are largely consistent with each other. When answering the question, do local governments use local sales tax revenue to increase total own source revenue or to offset and lower property tax revenue, the consensus is both. The analyses examining the national datasets find that there are two distinct types of local government behavior, and Afonso (2014, 2015) suggests that an important factor that can be used to differentiate these types is the adopted local sales tax rate.
A third line of research involves the volatility of revenue receipts once local governments become more dependent on local sales taxes. This literature is closely related to other literature of revenue portfolio diversity that does not directly compare dependence on property taxes to dependence on local sales taxes. For the studies that have directly studied the relationship between greater dependence on local sales taxes as opposed to property taxes (Afonso 2013, 2017b; Hou and Seligman 2010), the evidence finds that revenue receipts become more volatile. An important implication of this finding is that local governments will need to address this uncertainty due to the requirement that they balance their budgets. A primary strategy to do this would be to increase the size of their fund balance (or rainy day fund).
The fourth and final line of research to be discussed here is on sales tax competition. This line of research examines issues of cross border shopping, rate setting, and spatial competition (Agrawal 2015; Burge and Rogers 2011; Wong 1996; Luna 2004). A large concern regarding local sales taxes is whether having a higher local sales tax rate in your jurisdiction will encourage consumers to do their shopping in other communities; this is often referred to as tax leakage. As a result there is also examination of whether neighboring jurisdictions’ local sales tax rates will impact home local sales tax rates. There is the possibility of policy mimicking where you are more likely to adopt local sales taxes because neighbors and/or peers have done so or tax competition where you will choose to remain just below neighbor’s rates. The evidence supports that spatial competition does affect both local sales tax rates and tax leakage.
In many respects, local sales taxes are still in their toddlerhood. While, strictly speaking, they have existed since the 1930s, they did not become widely available until the 1970s, and their adoption and prevalence came subsequently. This is very unlike the property tax. Local sales taxes have grown in popularity, and many have speculated why. One possible reason is that it is not that people prefer local sales taxes to property taxes, but simply that property taxes are too restricted by tax and expenditure limitations and are essentially “tapped out.” Another possible reason is that they are genuinely more popular and that citizens prefer local sales taxes to property taxes. There are numerous potential reasons this may be true; perhaps the largest three are that (1) sales tax burden may be shared by both residents and nonresidents (tourists, commuters, students) in a way that the property tax cannot be, (2) people do not realize their full local sales tax burden in the same way as the property tax since it is spread out throughout the year on many purchases, and (3) if residents would have a larger tax burden under a higher property tax rate, then they will prefer local sales taxes.
These reasons also shed some light on some of the concerns regarding sales taxes. First, since people often do not realize their full sales tax burden, they often underestimate it. This is an aspect of a broader concept referred to as fiscal illusion. Second, people want to minimize their tax burdens, and that is rational and expected. However, the sales tax (local or otherwise) is regressive. Regressive simply means that low-income people will pay a larger share of their total income than wealthy people will. It does not mean that the low-income people are paying more in actual dollars, just that it is a higher percentage of total income. Many states often try to make sales taxes less regressive by omitting food and prescription drugs from the tax base.
Another aspect of local sales taxes that has been largely unexplored but is critical in understanding both why they have spread and why they are popular among voters is that the revenue is often earmarked for specific purposes. This means that when citizens vote to adopt local sales taxes, the jurisdiction is not just claiming they are going to use the revenue generated for specific functions/programs/projects – they are legally required to. Earmarks are a common feature of local sales taxes, and many types of earmarks exist. Not surprisingly there are local sales taxes that may be earmarked for popular areas of expenditure like education and transportation, but there are also earmarks for property tax reduction, economic development, and in some states they can be earmarked for projects that the jurisdiction specifies (Afonso 2017a). When citizens know how the revenue is going to be used, and they support that area of expenditure, they are more likely to support the tax.
Local sales taxes are interesting, complex, and a critical source of revenue for many states’ local governments. While there is still a lot more research needed to understand the effect that they may have on government and citizens alike and how they may interact with the economy, other sources of income, and politics, there is a solid foundation of research today. As consumers, and in some case producers, of information, it is essential to understand local sales taxes and to always consider the institutional and legal framework that the local sales taxes are nestled within.
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