STABILITY OF THE STATE SALES TAX INCOME ELASTICITY

Abstract

Revenue stability for a tax source is defined here as the situation where the income elasticity of revenues is countercyclical; that is, the elasticity rises in a recession and declines in an expansion. A sales tax revenue function is conceptualized in a manner such that the income elasticity is endogenous and a function of the position in the business cycle, the interest rate, and the inflation rate. Short-run income elasticities are then measured based on the economic conditions existing over the past eight years. A varying elasticity model is employed to estimate the revenue function for ten categories of sales. The short-run efosticities shift dramatically over the years, with those for durable goods falling in recessions and rising in expansions, and those for nondurable goods rising in recessions and falling in expansions. The aggregate sales tax elasticity moves in a procyclical fashion, evidencing that the sales tax is unstable. A varying elasticity model is demonstrated to provide improved forecasts over the historical period compared with a constant elasticity model.