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SEIFFE:  Sales Tax Numerology

Wednesday, December 20, 2006

By Ralf Seiffe

Years ago, I remember going into the Glen Ellyn Toy and Card Shop with two quarters burning a hole in my pocket.  That fifty cents was the first installment on the allowance my parents had granted me as a baby-boomer, fourth grader entering the consumer society of the 1960’s.   I was after a plastic model of the new Corvette and I found one that was priced at 49 cents.  “Perfect!” I thought.  I have just enough money to secure my first car project.  Model and quarters in hand, I presented myself to Mrs. Greene, the cashier, who rang up the purchase.  “Fifty-one cents” she said.  Looking at the two quarters, then at her, I protested: “but it’s only 49 cents!”

“Sales tax” she replied and, for the lack of a penny, she voided the transaction and took the model back for restocking.  The store lost the sale and I learned the permanent lesson that taxes change behavior.

The recent report of the Commercial Club of Chicago disclosed that Illinois’ costs are “out of control” and, through a combination of over-promising its employees and subsidizing ever-more expensive interest groups, it has managed itself into a $108 billion accumulated deficit.  Among the remedies the report floated was the possibility of increasing the sales tax by raising the rate, expanding it to services or both.

Tax increase advocates argue that Illinois does not tax services now and that this is unfair because the proportion of the Illinois economy that is subject to sales taxes has fallen from  32% of the economy in 1965 to just 13% now.  From that, the taxers apparently want us to conclude that exempting services is part of the “structural” problem Illinois has in taxing itself.  I don’t buy that and neither should you.

First, is it your sense that 87% of what you buy is exempt from sales taxes?  It’s certainly not mine.  Nevertheless, let’s believe the report and question why goods have suffered while services have benefited.  Could it be that by not taxing services, we’ve gotten more of them?  Does that help us understand why Illinois has developed a vital and important professional services industry that sustains our economy as opposed to Detroit or Toledo which are living with the goods model?  Where would you rather live?  Would a tax on services help or stall growth of these well-paid jobs?

Next, let’s fire up a calculator and see if the taxers’ argument stands any scrutiny by returning to my childhood experience.  Then, the tax rate was a flat 4% which explains the two cents Mrs. Greene added to that 49 cent plastic model.  I have no idea what that toy would sell for today; its manufacturer recently razed their factory in Morton Grove.  So, as a surrogate, let’s substitute a real Corvette as our example.

In 1965, the list price of a new Corvette convertible was $4,106.  With a few options, the real sales price was probably $4,500.  When it sold in 1965, the state collected a sales tax of about $180.

Fast forward forty years and when you walk into a Chevrolet dealer for a new Corvette convertible, be prepared to spend about $58,000 for a moderately equipped model.  Based on the tax rate my wife just paid for a truck she bought, the governments involved would collect sales taxes of $5,075 on today’s Corvette transaction.

Punching these numbers into my trusty Hewlett-Packard 12C, I solved for the compound annual growth rate of the tax collections the state receives.  Based on this forty year period, the actual tax collection, on essentially the same transaction, grew at an astounding 8.7% rate.  Much of this is due to more governments getting a piece of the transaction but from the new Corvette owner’s point of view, does it matter who is collecting?

The Commercial Club’s report also notes that Illinois’ economy grows in the 4% range.  If we took the 1965 transaction’s $180 tax collection and applied the economy’s growth rate, the state’s collection would have grown to only $864 by 2005; the state has massively benefited from inflation.  So, what this calculation tells us is that Illinois and its other units of government have managed to grow their tax collections nearly six times the amount the growth rate in the economy would forecast.  This should scorch any notion that we should increase the sales tax rate.

The taxers will then bring up the change in the nature of the economy to justify expanding the tax base to include services.  The report’s claim that sales taxes effect only 13% of the economy doesn’t pass the sniff test but let’s take it at face value, anyway.   The report shows that in 1965, 32% of the state’s economy was subject to the sales tax.  Adjusting for the relative decline from 32% to 13%, one might be able to justify expanding the base. 

Returning to the example transaction, however, we find that expanding the base is not justified, either.  If the Corvette transaction should generate $864 to maintain the state’s “fair share” of the economy, perhaps the absolute collection should rise to reflect the decline in the sales tax base.  Adjusting by the reciprocal of 13/32’s—the difference between 1965 and 2005--maintaining the state’s same share of the economy would require a collection of  just $2,155, not the $5,075 government now collects.

© 2006 Ralf Seiffe

Ralf Seiffe advises business start-ups and product launches from Chicago, Illinois and is a political analyst and columnist for the Illinois Leader and Illinois Review.

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