Tuesday, June 9, 2015

Impact of Sales Versus Income Tax: Some Numbers

If you follow the Kansas legislature like I have recently, you've seen many debates on the correct way to increase taxes.  The debate has risen from a $400 million budget hole, leading to the longest legislative session in history seeking a solution.

The tax policy debate centers on which mechanism to use to raise taxes: Sales or Income taxes. Generally the sides are:
  • Liberals: Because sales taxes are regressive and harm those who can afford it least, we should raise the top income rate.
  • Conservatives: Because consumption based taxes are economically superior to income taxes, we should raise the sales tax.
So, how would these tax changes actually impact families at different income rates?


For this methodology I am making estimates of how a sales tax versus income tax impacts people in different income brackets in Kansas.  A few assumptions need to be made:
  • For sales tax, I'm using the assumption of a rate raise from 6.15% to 6.55%.
  • For income tax, I'm assuming a change in the top rate from the current 4.8% back to the 2012 level of 6.25%.
  • I used a four person family, married filing jointly, as our example for all cases.
  • There are additional downstream economic impacts of any tax policy, which are real, largely occur over-time, but do not significantly impact this analysis.  I've largely ignored these effects, including in reductions of consumption, business spending, and multiplier effects.
  • These tax changes don't produce the same income to the State, but they have been offered as competing ideas, so I consider the comparison largely valid
  • Sales tax is regressive largely because high income families spend less % of their income on sales-taxable items.  It's difficult to know what that actually looks like, but I used a couple of sources to estimate a curve (see plot below).  (source 1) (source 2) Also, if anyone has Kansas specific data, I'd be happy to re-run numbers


First a preface on terminology:

  • Total Tax Bill: State only, sales tax + income tax paid.
  • New Total Tax Bill: State only, sales tax + income tax paid, after proposed change.
  • Effective Tax Rate: effective rate of taxes, Total Tax Bill divided by Income.
  • Tax % Increase: Percent change in Total Tax Bill.
  • Tax Rate Increase: Percentage point change in Effective Tax Rate.

A look at the current tax model, we see a flat, but mildly progressive tax structure.  People generally pay between 3.5%:5.3% of total income in State sales and income taxes.

With the sales tax option, everyone's tax liability increases slightly. However if we calculate the % change the poorest Kansas will pay 6% ($40) more while richer Kansas will pay only 1.5% ($160) more than they currently do.  The effective rate spread moves to 3.7%:5.4%.   This would be considered a move towards a regressive tax, because the lowest earners see the highest % increase.

For the income tax option, we only changed the rate on the highest earners, back to 2012 values.  For this option, we see no change for household incomes less than $50,000.  We do however see a large % change in higher earning households, with $200K+ households seeing a 21% increase in Total Tax Bill YoY.  The new rate spread moves to 3.5%:6.4%, a very progressive move.

And for those of you who prefer to see all of the numbers in a convenient chart, with a bit more information.:


Overall, a change to sales tax will impact low-income Kansans much more than a change to income tax, especially if income only applies to top tier.  A change to the income tax system like this, however, has the potential to significantly and quickly increase the tax rate to higher income Kansans.

I am not taking a side in this (in my tax bracket, I know what solution benefits me), but I hope that this analysis at least contributes to the discussion/understanding in tax policies.  Feel free to direct message more or comment on this blog if you have any questions or methodological concerns.

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