ECONOMIC ANALYSIS: Sales tax increase helps cut government spending

April 7, 2008

Indiana's sales taxes rose a penny this week, to 7 percent. The increase was a necessary remedy to our property tax mess. But it's worth laying out its impact on our economy.

Sales tax is paid by Hoosier residents, visitors and businesses alike. By my estimates, Indiana households will pay $640 million in additional sales taxes, businesses $500 million more, and out-of-state visitors an extra $160 million.

The two effects economists might worry about with a tax hike are changes to consumption patterns and the location of economic activity. So where do we stand with the new tax rates?

Our extra penny makes Indiana's tax rates 1 cent higher than in Kentucky and Michigan. As a result, we might see some residents traveling to those states to avoid the additional sales tax. I suspect the extra penny will have no measurable effect, though.

The tax rates in neighboring Ohio and Illinois vary by county, with large local option sales taxes. By my last count, only five counties adjacent to Indiana had sales tax rates lower than our 7 cents, and these were all rural.

Again, I think we will see no measurable economic impact from the sales tax increase. In general, the savings are not enough to warrant a long trip out of state.

By my estimates, the average Indiana household will spend an additional $267 per year in sales taxes. That average household is headed by a 48-year-old, has 1.3 wage earners, 2.5 total persons and 1.9 cars. Clearly, in Indiana, no one is average.

The biggest expense for households will be in transportation costs as the sales tax hits gasoline and car parts-amounting to about $65 per household each year. Additional big-ticket costs include other fuels, restaurant meals, clothing, entertainment and home furnishings. Each of these will cost $15 to $25 more per year.

It is worth noting that this average Indiana household also will see a $507 reduction in property taxes.

Indiana's sales tax is structured to eliminate much of the regressivity of traditional taxes on consumption. Since sales tax does not apply to services, food or prescription medicines, it is not clear that the poor pay a higher percentage of their income in sales taxes than the average family. That, of course, will vary tremendously by household.

Sales taxes are part of the triumvirate of tax instruments, which also includes property and income taxes. Sales taxes are more stable over the boom and bust cycle than are income taxes, but less so than property taxes. This helps keep government spending down since instability in government finances breeds inefficiency.

In the end, the increase in sales tax is part of a package that cuts the expense of government. That's a rare treat.

Hicks is director of the Bureau of Business Research at Ball State University. His column appears weekly. He can be reached at
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