This article formulates and estimates a model of state government to assess the
effect of the elimination of state sales-tax deductibility on state fiscal decisions.
Government is modeled as maximizing a social welfare function defined over
public expenditures and taxes. The model yields a plausible characterization
of state government behavior. The simulations on the uncompensated and
compensated removal of sales-tax deductibility suggest that this change will
lead to cutbacks in key areas of state government spending and in state
government reliance on its major tax sources. The largest changes will be
sizable cutbacks in state government reliance on the sales tax and in spending
for income-transfer programs. Sales-tax revenues will fall by the largest
proportion in higher-income states and expenditures for income-transfer programs will fall by the largest proportion in lower-income states.
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