Goods Versus Services: A Call for Sales Tax Neutrality

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In the inaugural issue of Marginal Impact last June, I criticized state and local sales taxes for taxing a significant number of business purchases. Even as I said that sales taxes were overbroad along that dimension, I also observed that they were overly narrow along another dimension, because they exempted a significant fraction of consumer spending. I elaborate on that point in this article and an upcoming article.

The typical state sales tax has two major features that prevent it from being a broad-based tax on consumer spending. First, the typical sales tax exempts, or provides preferential rates for, groceries and other necessities. Second, the typical sales tax applies primarily to sales of goods and exempts many types of consumer services. The two features may overlap for some items; for example, housing and healthcare may be exempt from sales tax because they are necessities or because they are services or for both reasons. Nevertheless, the two policies require separate analysis.

The exemption of necessities from sales tax is intended to serve the legitimate goal of easing the tax burden on low-income households. As I will explain in an upcoming article, this policy turns out to be an ineffective and undesirable way to promote that goal. Nevertheless, the policy clearly has a coherent motivation. In contrast, the failure to tax consumer services, which is the topic of this article, has no defensible policy basis, despite its venerable pedigree in the history of sales taxation. The disparate treatment of goods and services has been uniformly condemned by tax policy scholars because it creates economic inefficiency and complexity.

Alan Viard is a resident scholar at AEI.

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