Optimal Local Sales Tax

Abstract

The paper derives the consequences of a local sales tax within the framework of a spatial, general equilibrium model of an 'open' city. The model is initially set up for the residential economy only, with an exogenously given wage rate. Results of the simulations reveal that there exists a well-defined sales tax Laffer curve and an optimal revenue-maximising tax rate. Incorporation of the production side of the economy, with wage rate adjustment following the imposition of tax, strengthens the case for a higher sales taxation. The optimal sales tax rate appears to be sensitive to the exogenously given property tax rate, housing preferences, housing technologies and the elasticity of labour demand with respect to the wage rate.