CAN CUTTING SALES TAXES INCREASE SPENDING? EVIDENCE FROM OHIO BEN PASSTY JENNIFER 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 Year Sales Tax Revenues 2000$ 490,742, $ 495,933, $ 505,259, $ 526,814,210 Average for 5 Percent Rate$ 504,687, $ 674,072, $ 666,903,210 Average for 6 Percent Rate$ 670,487, $ 634,120, $ 646,201, $ 630,348, $ 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

Results AR(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

Results Impact 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

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