1. 1 Sales Taxes © Allen C. Goodman, 2014

2. http://taxfoundation.org/article/facts-figures-2014-how-does-your-state-compare

3. 3

4. 4 Checked. MI IS the same as IL

5. 5

6. 6 http://taxfoundation.org/article/facts-figures-2014-how-does-your-state-compare

7. 7

8. 8 http://taxfoundation.org/article/sources-state-and-local-tax-revenues

9. 9

10. 10

11. Gas taxes 11 Note: The American Petroleum Institute (API) has developed a methodology for determining the average tax rate on a gallon of fuel. Rates may include any of the following: excise taxes, environmental fees, storage tank taxes, other fees or taxes, and general sales tax. In states where gasoline is subject to the general sales tax, or where the fuel tax is based on the average sale price, the average rate determined by API is sensitive to changes in the price of gasoline. States that fully or partially apply general sales taxes to gasoline: CA, CT, GA, IL, IN, MI, and NY.

12. 12 Sales Taxes are Excise Taxes Sales, or consumption, taxes provide largest source of revenue for state governments. General sales taxes are used in 46 states w/ rates varying from 1.7 to 9.45% In 2011, they generated about $971 per person in revenue. Close to $3,000 per household Michigan’s total (in 2011) was $969  rank = 21.

13. 13 Not Everything is Taxed In principle, one could argue that sales taxes might serve as consumption taxes, and hence encourage saving, but … Not everything is taxed. Food in grocery stores is not taxed in numerous states (including Michigan). Net effect  General sales taxes apply to 40 to 60% of personal consumption in aggregate.

14. 14 Origin and Destination Principles Origin – Tax based on location of sale. Destination – Tax based on location of consumption or consumer. State sales taxes are INTENDED to be destination taxes … but what about Internet purchases? There are lots of holes in the collection of these taxes.

15. 15 Selected Sales Taxes Items such as cigarettes or gasoline, Cigarette taxes vary from $0.17 per pack in Missouri to $4.35 per pack in New York. Gasoline taxes vary from $0.08 per gallon in Alaska (no surprise) to $0.5247 per gallon in California. Michigan’s tax = $0.391.

16. 16

17. 17 Optimal Sales Tax Analysis Suppose we have goods A and B and we need to collect revenue R from taxes t A and t B. Should the taxes be equal? Good A $ Good B Price B 11 DADA DBDB

18. 18 Optimal Sales Tax Analysis If they are equal we get indicated revenues. We get reduced quantity demanded for each. We also get indicated DW losses. Good A $ Good B Price B 11 DADA DBDB RARA RBRB DW B 1+t DW A DW B

19. 19 Optimal Sales Tax Analysis We could be more efficient if we could raise same revenue with less DW loss. How can we do that? Raise tax on A so price ↑ by 1%. This leads revenue to ↑ by a lot, and quantity to decrease by a little so DW ↑ by a little. Reduce tax on B (more than 1% - why?) to make revenue constant and it decreases DW B by more than DW A increased. Good A $ Good B Price B 11 DADA DBDB RARA RBRB DW B CS loss ↑ CS loss ↓ Rb’Rb’ 1+t +  t A 1+t -  t B

20. 20 Optimal Sales Tax Analysis Idea, here, is that you tax most heavily those things that have the least elastic demand, because it changes quantity the least. Called the Ramsey Rule. Taxes should be inversely proportional to their price elasticities of demand. Good A $ Good B Price B 11 DADA DBDB RARA RBRB DW B Rb’Rb’ CS loss ↑ CS loss ↓ 1+t

21. 21 Should we tax this way? There are some ethical and distributional issues here. If demand for insulin is very inelastic, do we slap a big sales tax on insulin. May hit the poor. On the other hand, it provides a rationale for taxing addictive substances.

22. 22 Border Effects We talked about this a little bit before. What happens if Michigan taxes cigarettes a lot, and Ohio a little? What happens if Michigan taxes items a lot and the Internet doesn’t collect any taxes at all?

23. 23 Taxes Complicating our earlier analysis Let’s look at cigarettes. You may have somewhat inelastic LR supplies. Why? $$ Qq MIOH P0P0 P0P0 Q1Q1 Q2Q2 DODO DMDM P M + t q1q1 SMSM S' M P1P1 +PS -CS D' O DW

24. 24 Taxes Complicating our earlier analysis You have a DW loss in MI. You have an efficiency gain in OH, which does not offset the loss in MI. Also, additional costs and inconvenience to Ohio buyers. $$ Qq MIOH P0P0 P0P0 Q1Q1 Q2Q2 DODO DMDM P M + t q1q1 SMSM S’ M P1P1 -CS D’ O DW +PS

25. 25 Pechman’s Analysis – Table 15.5

26. 26 Pechman’s Analysis – Table 15.5

27. 27 Simple Ramsey Proof – 1 Two goods Q 1 = a 1 – b 1 P 1 Q 2 = a 2 – b 2 P 2 Normalize prices P 1, P 2 at 1 Institute tax rates t 1 and t 2. Revenue = R 1 = [a 1 – b 1 (1+t 1 )] t 1 Revenue = R 2 = [a 2 – b 2 (1+t 2 )] t 2 Deadweight Loss = D 1 = ½ *  Q  P = ½ * b 1 t 1 * t 1 = b 1 t 1 2 /2 Deadweight Loss = D 2 = b 2 t 2 2 /2

28. 28 Minimize sum of DW subject to constant tax revenue. Min L = ½ b 1 t 1 2 + ½ b 2 t 2 2 + λ { - [a 1 – b 1 (1+t 1 )] t 1 -[a 2 – b 2 (1+t 2 )] t 2 } Simple Ramsey Proof – 2 Simplifying, Further simplifying,

29. 29 Simple Ramsey Proof – 3 Because Multiplying by And finally … If P 1 = P 2 = 1, then If demand elasticity of G 1 > G 2, we have a higher tax on G 2 than on G 1.