Across the country, states have become increasingly reliant on high sales taxes. In 2016, states collected $441 billion from sales taxes, according to the Tax Policy Center. In Connecticut, lawmakers introduced a bill that would increase the state sales tax rate from 6.35 percent to 6.85 percent, raising approximately $340 million during the next fiscal year according to tax projections.
What makes this proposed tax increase unique is how the funds would be used. Although most states use tax increases to fund new programs or reduce other taxes, Connecticut’s increased sales tax revenues would be used to “support” low-income communities. The majority of the funds, about $315 million, would be distributed using a wealth-based formula. Experts estimate 60 of Connecticut’s 169 cities and towns would receive a portion of the funds.
The finance committee is still considering how cities and towns would be allowed to use these funds. However, the sponsors indicate an emphasis would be placed on encouraging economic growth in the cities. The remaining $25 million would be made available to regional councils that provide services to multiple cities and towns.
One example posed by The Connecticut Mirror suggests a poor community could offset a high property tax rate by providing incentives to encourage a local company to expand and add jobs. Unfortunately, these kinds of incentives are problematic because they allow towns to choose winners and losers. Moreover, this typically entails further complicating tax codes and results in rampant crony capitalism. A better approach to economic development is to simply create a free-market economic environment to attract businesses.
The Connecticut proposal is a clear attempt to redistribute wealth from high-income areas to low- income areas. The problem with the effort is a misunderstanding of how sales taxes work. All sales taxes are regressive, placing an increased burden on low-income families. According to the Institute on Taxation and Economic Policy (ITEP), poor families pay almost eight times more as a share of their incomes in sales taxes than high-income families, while middle-income families pay more than five times the rate.
Increasing Connecticut’s sales tax will only magnify this disparity, as sales taxes always have a stronger effect on low-income consumers. Although low-income towns may receive more tax dollars from the hike, poorer families will be the ones bearing the burden of the increased tax. ITEP finds on average low-income families pay 7.1 percent of their incomes in sales taxes, middle-income families pay 4.8 percent, and the high-income families pay 0.9 percent.
The best way to minimize the regressive effect of the sales tax is by lowering the rate and widening the base, which reduces the burden on all consumers.
The following documents examine sales tax reform in greater detail.
Options for Broadening the U.S. Tax Base
In this Fiscal Fact piece, Scott Greenberg of the Tax Foundation discusses how moving to a system that relies on a broader tax base and lower tax rates would simplify the tax code, remove unfair preferences, and create economic growth.
Broadening the Sales Tax Base: Dos and Don’ts
In this presentation, Fred Nicely of the Council of State Taxation and Liz Malm of the Tax Foundation examine various approaches to sales tax reform and discuss which reforms are best suited to achieve positive results.
Research & Commentary: Targeted Tax Incentives Do Not Encourage Growth
In this Research & Commentary, Matthew Glans examines targeted tax incentives and how they fail to encourage economic growth at a high cost to taxpayers.
Nothing in this Research & Commentary is intended to influence the passage of legislation, and it does not necessarily represent the views of The Heartland Institute. For further information on this and other topics, visit the Budget & Tax News website, The Heartland Institute’s website, and PolicyBot, Heartland’s free online research database.
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