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Removing the Sales Tax on Food

 The Tax Reform Task Force has been considering three different options regarding the removal of sales tax on food:

• Option 1: Eliminate sales tax on food and raise sales tax rates on non-food items to offset most of the revenue loss. This would also be a $60 million tax increase on business-to-business purchases.

• Option 2: Eliminate the sales tax on food without increasing sales tax rates or other taxes. This would reduce state and local government revenues by $226 million per year.

• Option 3: Provide a $75 per person refundable tax credit for low income families to offset the sales tax on food. This would impact state revenues by $50 million or less, depending on how many eligible families actually claimed the credit.

On Monday, November 28th, the Utah Taxpayers Association proposed a fourth option to the Tax Reform Task Force: removing the sales tax on food and using new revenues already projected to come from taxes on remote sales to make up the revenue difference. Currently, taxes are not being collected on Internet and mail order catalog sales unless the seller has nexus (typically physical presence) in Utah or unless the seller is voluntarily collecting and remitting sales taxes. Internet and mail order catalog sales by companies without nexus in Utah are referred to as “remote sales.” Within a couple of years, Utah along with most other states will begin collecting taxes on remote sales.

The Utah Taxpayers Association (January 2003 Newsletter) has advocated using tax revenues from remote sales taxes to cut taxes elsewhere rather than allowing these revenues to be used to grow government.

The advantages of the association’s proposal are as follows:

• Removing sales taxes will reduce the tax burden on low and middle income Utah families.

• Removing the sales tax on food will make Utah’s total state and local tax structure less regressive.

• Sales tax rates on non-food items will not have to be increased to make up for lost revenue.

• Utah will be collecting sales tax on remote Internet and mail order catalog purchases within the next couple of years. By coupling this revenue increase with a reduction in revenue due to the elimination of the sales tax on food, government spending growth will be slowed.

• State and local governments will not have to drastically reduce government spending on education and transportation since taxes from remote sales will offset $226 million reduction in state and local government revenue due to elimination of sales tax on food.

• The Governor and the Legislature will be able to implement additional tax cuts that will improve Utah’s economic climate.

Why remove the sales tax on food?

Sales taxes on food are highly regressive, meaning that sales taxes on food consume a higher percentage of a low income family’s income than a high income family’s income. The following tables show how the sales tax on food impact families of four of various income levels.

State and Local Sales Taxes on Food, Family of Four

Source: Utah Taxpayers Association based on 2004 Consumer Expenditure Survey, Bureau of Labor Statistics

In terms of absolute dollars, removing the sales tax on food is a bigger tax break for high income families than for low income families. Even though wealthier families spend much more on restaurant food, they also spend more on unprepared food. Nevertheless, with regards to percent of income, removing the sales tax on food is a bigger tax break for low income families.

Is removing the sales tax on food a good way to stimulate the economy?

Eliminating the sales tax on food is not the most effective tax cut in terms of promoting economic growth, even though reducing direct taxes on households increases consumer spending. While consumer expenditures are the single largest component of GDP, long term economic growth is best achieved by focusing on activities that improve productivity and increase exports of goods and services. Increasing business and worker productivity and increasing exports lead to higher wages which in turn lead to increased consumer expenditures. Tax cuts that are targeted towards increasing economic development in Utah include electable single sales factor for corporate income tax apportionment and removing sales taxes on telecommunications, manufacturing, and mining inputs. Click here for more information.

What are the options for addressing sales taxes on food?

To date, four options have been presented with regards to removing the sales tax on food.

Option 1: Remove sales tax on food and increase state rate from 4.75% to 5.25% while increasing the city rate from 1.0% to 1.1%.

This option increases the cost of purchasing cars, computers, and other non-food items.

Additionally, this proposal increases taxes on business inputs by at least $60 million per year. Excluding recent increases in unemployment taxes which are expected to decline in the next couple of years, this would be the single largest ongoing tax increase on businesses in Utah history and would negatively impact Utah’s business climate. According to the Utah State Tax Commission, Utah’s business tax burden is currently close to the business tax burdens in other western states.

Conventional wisdom says that businesses already receive preferential tax treatment so increasing business taxes is not a major concern, but the facts say otherwise.

• The single largest tax exemption in Utah is the 45% primary residence property tax exemption which annually shifts $218 million from primary residences to other classes of property, almost entirely businesses.

• Households are exempt from paying taxes on non-vehicular personal property like computers, appliances, and furnishings. In 2004, locally assessed businesses paid $106 million in personal property taxes.

• Businesses received less than half (47%) of all sales tax exemptions. With removal of sales tax on food, the business portion of sales tax exemptions would decrease to 33% of total sales tax exemptions.

Option 2: Remove sales tax on food without increasing the sales tax rate on non-food items.

This would reduce state revenues by $160 million and local government revenues by $66 million. Other tax cuts would not be possible, and there would be pressure over time to eventually increase other taxes, considering the magnitude of this reduction.

Option 3: Offer food sales tax credit to low income families.

Under this proposal, low income households would receive a refundable tax credit up to $75 per household member. The advantages of this approach are that the benefits are targeted towards low income families and the total impact to state and local budgets is less than $50 million. The disadvantage is that low income households living in vans down by the river probably won’t file for the credit.

Option 4: Eliminate the sales tax on food and offset the revenue loss with revenue gains from the tax on remote sales from Internet and mail order catalog.

This proposal is discussed at the beginning of this paper.

What needs to be done?

Option 4 is gaining support from various members of the Tax Reform Task Force and the Legislature. Fortunately, the Legislature has already passed legislation that requires sales taxes on remote sales (Internet and mail order catalog sales by companies without nexus in Utah) to be placed into a restricted general fund account which prevents the Legislature from using these revenues to increase government spending.

Before Utah fully implements taxes on remote sales, the Legislature needs to make some changes to Utah’s sales tax structure in order make compliance with the new law less cumbersome for small retailers that deliver goods and services to multiple sales tax jurisdictions. Under the new law, retailers will have to charge sales taxes based on the location of the customer instead of the location of the retailer (point-of-sale distribution of sales tax revenues to cities will not be changed.)

To facilitate this change, the Legislature will need to create a uniform statewide sales tax rate that will enable retailers to administer sales tax collections much more easily than if they were required to collect and remit sales taxes based on several different local sales tax rates.

Before taxes on remote sales can be implemented by states, Congress will also have to act. Congress will soon be addressing the issue of remote sales and will hopefully address the issue of nexus with regards to state corporate income taxes, making it more difficult for states to collect corporate income taxes from businesses that are not physically located in their states.

State and local sales tax revenues on remote sales are expected to exceed $200 million by 2012, but significant revenues will not be realized for at least another three or four years at the earliest. Therefore, under option 4, a complete elimination of sales taxes on food is still at least five or six years away. During this time, the Legislature should implement the tax credit for low income households. This would provide immediate relief for eligible households who apply for the credit. Moreover, by offering this credit starting next year, the Legislature will be building a $50 million ongoing appropriation into the budget that will make eventual elimination of the food sales tax easier once annual remote sales tax revenue approaches $200 million.