A state expenditure tax: An alternative to income and sales taxes

Sehoon Park, Purdue University

Abstract

The issues with state income and sales taxes suggest that an efficient state tax system may require a sales tax that is more broadly based and an income tax that is more stable. A tax on expenditure, which would substitute for both the state sales tax and the state income tax, meets these requirements. There will be no transitional problem to the extent that an expenditure tax substitutes for the state sales tax because the state sales tax is a direct expenditure tax. However like the federal tax, there will be transitional problems if the tax base is shifted to an expenditure base from the income base, but to a lesser degree because the state income tax rate is on average one-eighth of the federal income tax rate. Therefore, they may be ignored entirely. This study concludes that a tax on expenditure with a flat-rate, designed to generate the same tax revenue as under the current state income and sales taxes, would result in a tax system that is both more efficient and more equitable. A considerable fraction of the efficiency gains due to a tax switch results from the elimination of taxation on returns to savings under the current state income tax. The efficiency gains also could be caused by the fact that under the expenditure tax, taxpayers are taxed evenly on their expenditure in each period. Equity improvement results from the inclusion of the progressive federal income tax payment into an expenditure tax base, expanding sales tax base progressively. The identical treatment of all consumption also would improve the equity of the tax system. The relative economic efficiency gains of moving to an expenditure tax depend on both individual's lifetime income paths and consumption preferences across periods. People who save the most would experience the largest efficiency gain, while individuals who save the least would have the smallest efficiency gain.

Degree

Ph.D.

Advisors

McNamara, Purdue University.

Subject Area

Finance|Agricultural economics

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