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One potential, additional source of stimulus for the U.S. economy would be for states to eliminate the sales tax, at least temporarily.
However, given the complexity of sales tax systems across the states, the tactic would have several upsides and downsides, from macroeconomic and fiscal standpoints.
From a macroeconomic standpoint, the upsides would include a decent (but certainly not spectacular) boost to the economy in those states that have relatively high sales tax rates, such as in New York, New Jersey, California, and Mississippi. Studies have shown that a cut in the sales tax has historically led to a modest increase in consumer spending -- at least among some workforce segments, during normal economic times.
One sector that almost always loves a sales tax "holiday"? Auto dealerships, particularly those in high tax states where vehicle sales are subject to the tax, almost always see an increase in car sales after the holiday starts, and no wonder. Remove a 6 percent sales tax from a $40,000 auto purchase and the buyer saves $2,400 -- a significant chunk of change just about everywhere. For the above reason, big-ticket appliance stores also would likely favor a sales tax holiday. Big-ticket item sales -- like washers and dryers, refrigerators and furniture -- have really been hurt by the housing sector's three-year recession.
However, as investors are aware, these are not normal times, and citizens are deviating from the norm. Across the nation, they've shown a tendency to save at least a portion if not all additional income received from tax cuts and tax rebates -- such as the federal tax rebates passed in early 2008. Citizens, concerned about the threat of layoffs, have increased their savings rate, so it's unlikely that the economy would see a like-for-like economic stimulus from a sales tax holiday, as it would during normal economic conditions.
Keynesian economists also generally favor the reduction or elimination of sales taxes because they are regressive, not progressive taxes. They pose a greater burden on the poor and workers because sales taxes take a greater percentage of the groups' disposable income than they do from upper income groups.
The second aspect of a sales tax elimination concerns its impact on state and local budgets. For many states, it is a major source of revenue, so any revenue elimination would create a hole in state budgets. Moreover, given that many states are already facing large budget deficits due to the recession, which has decreased revenue and increased social service costs (including unemployment insurance), cutting or eliminating the sales tax would make it even harder for many states to balance their budgets, at least short-term.
Economic Analysis: The bottom line on a potential sales tax reduction? Assuming historical consumer spending patterns, those states and localities that eliminate the sales tax would see at least a modest boost in commerce. However, given that citizens have increased their savings rate due to the economy's clouded future, the stimulus affect from any sales tax cut is unlikely to add as much to GDP as it does during normal economic times.
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