Impact of the Sales Tax Rate on its Base: Evidence from a Small Town

Abstract

Local governments and businesses fear that increased local sales tax rates will induce losses to the local economy, even inducing losses so severe that no additional revenue will result from a higher tax rate. Earlier works by Fisher, Hamovitch, and Mikesell have examined sales loss in metropolitan areas, typically finding significant but not overwhelming effects. Those results do not address the question for small cities and typically are complicated by the expenditure effects resulting from the increased tax revenues. The present analysis uses unique data for a small town to examine the impact of a temporary sales tax rate increase with a retail sales share model. The evidence shows a significant but small sales impact that did not endure (a differential of 1% would lower city sales by 3.07%) and no impact on vendor location. The unfavorable rate differential produced a short-run effect, but not economic disaster.

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