10.8 Sales Tax Evaluation
The evaluation of sales taxes can be approached using three main criteria: efficiency, equity, and adequacy.
In terms of efficiency, it is important to assess which economic decisions will be changed or distorted by the tax and the magnitude of these distortions. One major issue is the distortion of relative prices, where the availability of substitutes for taxed goods can lead producers and consumers to favor low- or no-tax items. In cases of negative externalities, taxes can restore efficiency by internalizing the external costs. For general sales taxes, the tax incidence on consumers or producers depends on the elasticity of supply and demand. When it comes to excise taxes, the burden on consumers is greater when there are few substitutes for the taxed item, whereas the burden shifts toward producers if there are readily available substitutes.
Regarding equity, general sales taxes tend to be regressive because low-income households spend a larger portion of their income on consumption items. This means they bear a relatively higher burden, though exemptions for necessities like food or energy can help address this issue. For excise taxes, there are also concerns about vertical equity, as low-income households spend a higher percentage of their income on goods like energy, cigarettes, and alcohol. However, some excise taxes, such as gasoline taxes, may be justified under the benefits principle, where users of certain public goods, such as roads, are taxed in proportion to their use.
In terms of adequacy, general sales taxes can generate significant revenue, but the effectiveness of this is often undermined by exemptions, which reduce the overall tax base and limit revenue-raising capacity at reasonable rates. For excise taxes, the ability to raise revenue also depends on the availability of substitutes and the overall demand for the taxed goods.
For further details on who bears the burden of federal excise taxes, the Tax Policy Center provides valuable insights.