Friday, October 07, 2011

Brief Primer on City Sales Tax Reduction Effects

There has been some debate lately about renewing sales taxes. In Fayetteville for example, a one cent sales tax is up for renewal. The Mayor is, like almost all politicians when faced with a potential revenue cut,  predicting dire cuts to emergency services like police and fire if the tax is not renewed. They almost always say the cuts will have to come out of fire and police, because if they told you they would have to lay off their idiot cousin who is on the payroll down at Parks and Recreation people might vote to give themselves a tax cut.

 So if city residents do vote to cut their taxes next week, the police and fire departments would be eliminated, armed gangs would roam the streets raping, looting, burning, pillaging, and raping. Also, an asteroid would literally wipe the city off the face of the earth but the remaining citizens would actually welcome that because life without the government getting that extra once percent sales tax would instantly degenerate into a barbaric cauldron of human disease and suffering that would make "Mad Max" look like Tea with The Queen. I exaggerate mildly for effect, but you have to admit their claims get pretty shrill sometimes.

 Such tactics are not a debate on public policy that respects citizens. Rather, it is an effort to frighten the easily spooked and shallow-thinking into continuing to turn their earnings over to their benevolent overlords in government. A calmer, rational look at what a sales tax cut would do presents a different picture.

 A city faced with a sales tax cut needs to consider two factors. The first and largest is "what percent of the time to shoppers in this city purchase in this city?" The second question is"how will this tax cut affect how competitive we are with area cities on big-ticket items?"

 Let's say my mom lives in Fayetteville, where she spends 90% of her money. Instead of paying $500 in Fayetteville city sales tax per quarter, she pays only $400 after the cut. The one cent sales tax reduction saves her $100 a quarter, and "costs" the city $100 a quarter. Or does it? The truth is, she is going to spend 90% of that $100 she saved in Fayetteville, because that's where she buys 90% of her stuff. So the city actually gets $100 x 0.9 X 0.08 = $7.20 additional cents from that hundred. If the person that she bought from also shops in Fayetteville 90% of the time then the city gets $82.80 x .9 x 0.08 = $5.96. If they also bought from a person who spends 90% of their money in the city then the city gets $5.53 cents of that money.

The amount declines very slowly from there so that once you consider the re-shopping effect the city barely loses over half ($58) of the revenue they thought they were going to lose. (Someone who is better at calculus than me says that continuing this series out would result in $42 of the initial $100 being returned to the city in taxes). This principle works well in cities like Fayetteville, who have the best shopping in the area. It does not work so well in cities like Farmington where people from the city spend a lot of their dollars shopping in other towns- like Fayetteville. Instead of spending 80% or 90% of their dollars in their own city, they may only spend 40% or so there. Those are the cities that need to be most concerned about a sales tax cut, not a town like Fayetteville. Too bad the Mayor is too busy cowering behind his nine foot executive desk to realize that. 

This brings us to the second point. For most big ticket items, a lower sales tax rate than other cities in the area would make Fayetteville a more attractive shopping option. Why pay 9% sales tax in Rogers when you can buy that $18,000 used car in Fayetteville and save $180 in taxes! In other words, some extra revenue would be generated just because the lower taxes would change behavior and cause other people to shop your city. While there, they may eat lunch and buy gas and do other things. It's hard to put real math to this, but let's say 5% of the tax cut to 7% could be returned this way. So instead of a $100 loss of revenue, the tax cut results in a $58 loss of revenue after factoring in re-shopping and perhaps somewhere around $74 in lost revenue when factoring in the lower tax rate's consequences in consumer purchasing. So instead of the city making $500 off of my mother last quarter, they only make $448.

 That's off the sales tax of course. Her $500 in property taxes would be unchanged. So instead of getting $1000 off of my mother in total revenue they make $948. Honestly folks, is the city going to have to close down your police protection over that? That loss of revenue probalby reflects what their budget was three to five years ago, and I distinctly remember the city having fire and police protection at that time. Question is, who will protect us from fear-mongering politicians?

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