Income tax vs. sales tax: What's better for Louisiana?

Last week Louisiana’s Republican Governor Bobby Jindal proposed replacing the state’s individual income and corporate taxes with a higher sales tax. While details are scarce, initial media reports suggest Jindal would both raise the sales tax rate and make more goods and services subject to the levy.

Louisiana’s current 8.86 percent average combined state and local sales tax rate (4 percent state rate and 4.86 percent average local rate) is already the third highest in the nation. Jindal’s plan would boost it to the highest level in the country by far. One published report suggests the state levy alone could be increased to as much as 7 percent.

Broadening the sales tax base is a mixed bag. On one hand, taxing more goods and services helps to limit the tax’s distortions across consumption and also allows for a lower tax rate, all else equal. But base broadening can also push more of the burden to low-income households. Louisiana currently excludes groceries and utilities from taxation; taxing them would be especially difficult for families with limited resources.

In fact, even without base broadening, the proposal would dramatically shift more of the burden of Louisiana’s taxes onto lower-income individuals. Since low-income households devote a higher share of their income to consumption, they end up paying higher effective tax rates than higher-income households which tend to spend less and save more. This concern is particularly stark in Louisiana, which was recently ranked as the sixth most unequal state in the country by one measure of inequality. 

The higher tax burden for low-income households is no small concern. Last year Louisiana collected $2.9 billion through the individual and corporate income taxes and another $2.6 billion through the general sales tax. Maintaining current revenues with Jindal’s plan would require that sales tax revenues more than double, which means that, absent a significant broadening of the tax base, the tax rate would also have to rise substantially.  For households that don’t pay income taxes and save little or no income, this amounts to close to a 4 percentage point drop in after-tax income—about the same magnitude of tax pain for these households as going off the fiscal cliff.

The swap would have theoretical advantages: Taxing consumption, rather than income, encourages saving. An expanded sales tax base, perhaps including some services, eliminates unequal treatment across types of spending. And getting rid of two major tax bases may lower administrative costs for state revenue collectors and virtually eliminate compliance costs for Louisiana’s taxpayers. Lastly, sales taxes can “export” the tax burden to non-residents, namely tourists, who spend in Louisiana but don’t live there.

Proponents of this major tax swap may also claim that eliminating the corporate tax will attract more businesses to Louisiana and dumping the personal income tax could make the state a magnet for high-income individuals.

Not all of these claims carry weight. There is little evidence that Americans will move to take advantage of lower state income tax rates. And since seven states already have no income tax, households that would move exclusively for lower tax rates would likely have already done so. It’s true that sales taxes help shift the tax burden to out-of-state tourists, but higher sales tax rates can also push consumption to other states, untaxed internet purchases, and off-the-book transactions.

Ultimately, the shift could lower compliance and administrative burdens, and help to boost long-run growth a little. But it’s not worth asking low-income households to shoulder such a large share of the burden to achieve such a small statewide gain.