THE RETAIL SALES TAX: AN ECONOMIC STUDY by KENYON E. POOLE A study prepared for The Ontario Committee on Taxation THE RETAIL SALES TAX: AN ECONOMIC STUDY by KENYON E. POOLE, Ph.D. A study prepared for The Ontario Committee on Taxation Printed and Published by FRANK FOGG Queen’s Printer Preface TH E present study was submitted at the beginning of 1964. Much has happened ■ since then with respect to all systems of taxation, including those of the Canadian provinces and the American states. Time limitations have prevented bringing these data up to 1968. The author would like, moreover, to take this opportunity to emphasize that his favourable view with respect to the sales tax is based on two considerations. First, the sales tax is only one tax in the revenue system as a whole. Second, exemptions can be provided for food, clothing, etc., which make the tax at least proportional in the first several thousand dollars of income and spending. In a recommendation in favour of a sales tax there is no implication that any desired use may not be made of a progressive income tax, a graduated inheritance tax, or even a graduated net worth tax. The several taxes can be combined in such a way as to satisfy the public’s view on the desired after-tax distribution of income and wealth. The author’s thanks are gladly given to those who contributed to the study at key points along the line of its development Robert Evans is due special thanks for preparing the first two chapters. The penultimate draft was read and criticized by Professors John Due of the University of Illinois and Donald MacGregor of the University of Toronto. They are not to be held responsible for the views expressed, which are the author’s alone. Others who read the manuscript and offered helpful suggestions are Robert Coen, Irving Goffman, Eric Ford, John Scadding, and Bredin Stapells. Dr. Robert Clark, Director of Economic Studies for the Ontario Committee on Taxation, also read the entire manuscript and made many helpful comments. The author is greatly indebted to Warren Hurst, Executive Director, for constant help throughout the writing of the study. Finally, thanks are due to Joseph Perry, for able research assistance, and to Mrs. Gerda O’Malley, for extremely competent typing services. Barbara Urquhart prepared the manu­ script for publication and Hugh Hanson provided indispensable help throughout, particularly in the final stages of publication. in Table of Contents Chapter 1 Introduction........................................................................................... 1 Chapter 2 The Sales Tax in the Provinces......................................................... 5 Chapter 3 The Sales Tax and the States of the United States.................. 8 Chapter 4 Shifting and Incidence of the Sales Tax....................................... 31 Chapter 5 Problems in Estimating the Distribution of the Burden of a Retail Sales Tax by Income Size................................................. 72 Chapter 6 Analysis of Tax Base and Exemptions under the Ontario Tax. 80 Chapter 7 Economic Consequences of the Ontario Sales Tax.................... 94 Chapter 8 Conclusions and Recommendations................................................. I ll List of Tables 3:1 Adoption of U.S. State General Sales Taxes (as of July 1963)................... 11 3:2 Revenue from General Sales Taxes, Selected fiscal years, 1932-1962.......... 14 3:3 General Sales Tax Yield Data for Individual States...................................... 15 3 :4 Growth of State Taxes in the United States.................................................... 16 3:5 State Tax Collections by Type of Tax, Selected States, 1963 (preliminary). 17 3:6 States’ Revenue from General Sales and Selective Sales Taxes, Fiscal Year, 1963........................................................................................................... 18 3:7 Per-Capita Sales Tax Payments, Selected States, 1956 and 1962................. 18 3:8 Provincial Sales Tax Revenues as Percentage of Provincial Total Tax Revenues, Fiscal Year Ending March, 1963................................................ 18 3:9 General Sales Tax Rates by Frequency of Use, Selected Years, 1938-63.. 21 3:10 Ontario and Selected U.S. State Sales Taxes, Per-Capita Yield at 1 % of Tax Rate............................................................................................................. 21 3:11 Ontario and States’ Sales Tax Yields at 1% Rate, Fiscal Year 1963......... 21 3:12 Sales Tax Collection Costs Expressed as a Percentage of Sales Tax Revenue 24 3:13 State General Sales Tax Rates as of September 1, 1962............................... 25 3:14 General Retail Sales Tax by States: Year Effective and Rate of Tax........ 27 3:15 Items Excluded or Exempted from Michigan Sales Tax (as of January 1, 1958).................................................................................................................... 28 3:16 Per-Capita Yields of State Sales Taxes in 1961............................................... 29 5:1 Hypothetical Expenditures for Two Families, Each with Four Members (Children Aged 5 and 7) and Each Family Earning $6,800, Spending $6,750, and Saving $500.................................................................................. 74 5:2 Sample Budgets for Two Families with Similar Incomes and Savings and the Resulting Taxes Paid................................................................................. 75 5:3 Estimated Distribution of the Burden of Sales Taxes Relative to Income which would have been Borne by California Families in 1950 if Goods Exempted from Taxation Were Subject to Tax, by Income Class.......... 78 6:1 A Decade of Change in Personal Expenditures for Services....................... 89 6:2 Sales Tax Treatment of Selected Services in Selected States, 1962............. 92 CHAPTER 1 Introduction A LL governments, however diverse their nature, have one primary feature in * * common. They need money. But the severity with which this need is felt will depend on the tax or other financial resources available to the government, and on the extent of its fiscal responsibilities. Thus the government of a wealthy com­ munity, where citizens demand only a limited range and depth of public services, may find that it can meet its fiscal needs by imposing relatively light burdens upon its citizens, and without paying undue attention to its revenue sources. Unfortu­ nately such governments are few and far between. More commonly, the demand for public services in a modem community is large and rapidly growing while tax revenues grow somewhat more slowly; and the government faced with such a budgetary squeeze is forced to devote considerable attention to expanding its revenue base. Over the past several decades, most Canadian provincial governments have faced this problem in a particularly acute form. Under the Canadian federal system, the division of fiscal responsibility is such that provincial governments must meet the demand for public services in just those areas— education, welfare, highways —where the demand is rising most rapidly. At the same time they are constitu­ tionally empowered to levy only direct taxes; and the major taxes in this field, the individual and corporate income taxes, are shared with the federal government. The remaining direct tax revenues, supplemented by federal grants, have not expanded rapidly enough to keep pace with provincial expenditures. The resulting budgetary squeeze can only be alleviated by an unacceptable reduction in the level of public services, or by the exploitation of some major source of new revenues. The retail sales tax has provided such a revenue source, and eight of the provinces have now yielded to the pressure of continuous and growing deficits and have enacted such a tax. The first provincial sales tax was enacted in Alberta in 1936 and removed in 1937, but the Saskatchewan tax enacted in 1937 became a per­ manent part of the provincial revenue system.1 Ontario, possessing by virtue of her wealth and economic diversity one of the strongest provincial revenue bases, nevertheless found herself in 1961 requiring funds on a large scale to meet the costs of a new hospitalization system, from a budget that had been running deficits of the order of $100 million for the previous five years. Thus she became the eighth province to bow to fiscal necessity and introduce a sales tax. The Ontario retail sales tax was announced by the Provincial Treasurer in his budget statement of March 9, 1961, and was enacted with some amendments to become effective on September 1 of that year. It placed on every purchaser of tangible property for consumption or use in Ontario a tax of 3 per cent of the fair 1 2 The R etail Sales Tax value of such property. Following the accepted pattern of provincial sales taxes, the tax was imposed on the purchaser, but the seller was designated as the agent of the Province for the purpose of collection of the tax. In this way the tax becomes a direct tax on the consumer or final purchaser of the property, cannot be shifted by him, and is hence intra vires the Province. If the same tax were placed on the seller of such property in the expectation that he would shift it forward to the consumer, it would become an indirect tax and as such could not constitutionally be levied by the Province. The Ontario sales tax rapidly established itself as a major source of provincial revenues, yielding $179 million in its first full fiscal year of operation.2 In that year,