Political Economy of Taxing Services in the United States 1

Abstract

The purpose of this study is to examine the possible determinants of broadening the sales tax base to include services using variables reflecting the political, economic, and demographic environment at the sub-national level in the United States. We start with providing a picture of taxation of services across different states over a 20-year time span. This descriptive part of our study illustrates the variability in taxation of services and leads to the question why some states tax many services while others exclude virtually all services from their sales tax base. The second part of our research addresses this question empirically using regression analysis. Specifically, we measure the impact of states’ political structure (party in power in the legislative and the executive branch), economy (personal income and unemployment), demography (elderly population and minorities), and fiscal policy (tax rates, revenues, etc.) on the number and type of services taxed. Our study contributes to prior literature by providing a detailed and comprehensive account of the taxes on services and some reasons for the cross-state differences. We use data on the number and types of services taxed in each state from the Federation of Tax Administrators (FTA) for the years 1990, 1996, 2004, and 2007. The political environment (legislative and/or executive branch) is measured with dummy variables for the party in power. Economic, fiscal, and demographic data come from the U.S. Census Bureau. Our findings show that the number of services taxed is higher when democrats dominate the political scene and the shares of elderly (65 and older) and young (under 25) population are higher. These results are sensitive, however, to some regression specifications.