The impact of expenditure category exemption on the incidence of a retail sales tax
Judd, Frederick Alonzo, IV
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Questions of equity and concerns over an escalating deficit have forced the Montana State Legislature to seek alternative and/or additional ways to raise revenue. One such proposal to raise revenue is a sales tax. Opposition toward a sales tax is based largely on the feeling that it is a regressive tax, and therefore distributes the burden unfairly. The purpose of this study is to determine the impact of expenditure category exemption on the incidence of a retail sales tax. The overall progressivity/regressivity of a retail sales tax is calculated, both with exemptions and without exemptions from the base of the tax. The model used in this study is an expenditure function that is quadratic in family size and permanent income. Tobit regression analysis is used to derive maximum likelihood estimates for 41 expenditure categories. From these tobit estimates, expenditure shares <proportion of expenditures relative to permanent income) and the tax base share (proportion of total expenditures on those items included in the base relative to permanent income) are calculated at different levels of permanent income. Exempting those goods and services that are a larger proportion of expenditures relative to permanent lncome for households in lower permanent income brackets (such as food purchased in grocery and convience stores and utilities) increases (decreases) the progressivity (regressivity) of a sales tax. A broad-based sales tax is regressive for households earning less than $5000 in permanent income. From approximately $5000 to $25,000 a broadly-based sales tax is progressive. For those households earning $25,000 or more, the tax is slightly regressive to progressive. Exempting certain expenditure categories (Food at Home, Utilities, Telephone, Water and Other Public Services, Prescription Drugs and Education) from the base makes the tax progressive for households whose permanent income is $25,000 or less. From $25,000 to $60,000 the tax is slightly regressive. For households whose permanent income is greater than $60,000, the sales tax is fairly proportional.