The Effect of the Elimination of Sales Tax Deductibility on State Fiscal Decisions

Abstract

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.