Larry DeBoer
Professor of
Agricultural Economics
Purdue University

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Sales Tax Maybes

Early in January, the state announced that revenues had fallen short of projections -- again. Later in the month, revenue forecasts were again revised downward. The state's budget is in bad, bad shape.

When the forecast was revised, it knocked $322 million out of expected revenue. This cut the sales tax forecast $352 million. The net change in all the other taxes was positive.

What's wrong with the sales tax? Why has its growth fallen so far short of predictions in the recent recession and slow recovery?

Maybe it's the kind of recession that we had. It was mostly a recession in manufacturing. From February 2001 to July 2003, U.S. businesses shed 2.7 million jobs. About 2.4 million of those were jobs in manufacturing. Indiana is a manufacturing state. One out of every five of our jobs is in a factory. For the United States, it's one out of nine. So, when a manufacturing slump drags down the national economy, it really hurts here.

Many people are not working, or working less than they'd like, so they tighten their belts and spend less. Sales tax revenues fall short.

Maybe it's not just recession. Globalization and technology are changing the economy. If a factory closes temporarily during a recession, then re-opens when the economy recovers, there are jobs to be filled. If a factory closes for good, because its machines are obsolete or its products can be produced cheaper somewhere else, jobs are lost. New jobs will be created, but only after a company builds a new plant or an entrepreneur gets a new idea. That takes more time. More people are without jobs longer. They spend less, and sales taxes grow slowly.

Maybe it's the things we tax. I mean things. Most goods are taxable; most services are not. Cars and clothing, appliances and fuel are taxed. Untaxed are travel agents, haircuts and movie tickets, as well as medical care and legal advice.

Over the years, taxpayers have spent less and less on taxed goods and more and more on untaxed services. According to national data, the things that Indiana taxes made up about 35 percent of all consumer spending in 1970. It's 29 percent today. Less of our spending is taxed.

It's not so much that we're buying fewer goods and more services. Mostly, it's that the prices of goods are rising slower, and the prices of services are rising faster. The sales tax is a percentage of price.

Maybe it's the Internet -- everyone's favorite explanation for everything. More and more taxable goods are sold online. The state has trouble collecting taxes on these goods. The state can require a retailer to collect and pay sales taxes if they have facilities in Indiana. Most online vendors do not.

Perhaps online consumers don't know this, but if the seller doesn't pay the sales tax, the buyer owes it. The sales tax is a "sales-and-use" tax, meaning taxes are owed on goods bought elsewhere if they are used in Indiana. The state tries to collect these taxes with the income tax returns. If you use the IT-40 tax form, check out line 17: "use tax due on out-of-state purchases." About three million taxpayers file returns each year. Only 30,000 pay any use tax. No one believes that only 1 percent of Indiana taxpayers buy online.

The problem will only get worse as online sales keep growing. Two professors from Tennessee, William Fox and Donald Bruce, figure that Indiana lost $114 million in taxes on Internet sales in 2001 and will lose $389 million in 2006. You can read their study on the Internet (tax free!) at http://cber.bus.utk.edu. Click on "e-commerce."

What's wrong with the sales tax? Maybe it's the recession or technology and globalization. Maybe it's growing spending on services or Internet sales. Maybe it's all four, and some other reasons besides. Here's the irony. A year and a half ago, we decided to reduce property taxes by a billion dollars. We funded that relief with a sales tax hike. That made Indiana's governments more dependent than ever on sales taxes. Maybe we've got a problem.




Writer: Larry DeBoer
Editor: Olivia Maddox