Tax Exporting and the Business Share of Sales Tax Levies

Abstract

In 2010, state and local sales taxes on non‐labor input purchases made by businesses constituted 42 percent of state and local sales tax revenue, on average. Taxing firms could enable state and local governments to export portions of their tax burdens. The average tax rates that subnational governments choose to levy on business purchases are potentially influenced by the exportability of those taxes as well as on the exportability of alternative taxes. If a state's capacity to export the burdens of alternative taxes is limited, then governments may rely more heavily on business sales taxes. This study examines the relationship between tax exporting and the average sales tax rate that state and local governments choose to levy on business purchases using state‐level panel data from 2003 to 2010. I find that the average sales tax rate is largely determined by a state's ability to export taxes to national taxpayers through the deductibility provisions provided by the federal tax code. The offset provided to firms by the deductibility of state and local business taxes is positively related to the average sales tax rate on business purchases. The deductibility offset available to households that itemize places downward pressure on average sales tax rates. The results suggest that federal tax policies that increase the deductibility offset for firms or reduce the offset for itemizers could prompt subnational governments to increase sales tax levies on business purchases which would increase business tax deductions at the federal level and offset revenue gains from federal tax reform.